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The Approach of California in Applying Its Law to Foreign Corporations, and Whether a Contractual "Choice-of-Law"
Provision Can Overcome This

 CALIFORNIA’S APPROACH

Introduction

The concept of "piercing the corporate veil" is a judicial creation. "Resolution of a piercing question is almost always left to a judge's determination of corporate illegitimacy," since "almost all state corporations statutes simply ignore the whole idea of piercing the corporate veil." Robert B. Thompson, "Piercing The Corporate Veil: An Empirical Study," 76 Cornell L. Rev. 1036, 1041 (1991). In all 50 states "piercing" is a common law doctrine. Id. at 1053.

California has, under certain conditions, applied its statutory law to corporations incorporated in other states. Although its statutes do not mention "piercing," it is possible that a state which aggressively applies its statutory law to foreign corporations would apply its common law in the same manner. Id. However, to date, neither the courts in California nor any other state have confronted the issue of which law applies in the context of shareholder liability for debts incurred in the normal course of corporate business by a foreign corporation acting in another state. See Mark R Patterson, "Is Unlimited Liability Really Unattainable, Of Long Arms and Short Sales?," 56 Ohio St. L.J. 815, 862 (1995) ("The central question in choosing the appropriate law to govern a corporation asks whether the particular issue involved is an internal one or one that involves third parties. This question is one that has not yet been answered in the context of shareholder liability.") Thus, there is no clear answer to the question of whether a state such as California would "pierce the corporate veil" of a foreign corporation doing business there. However, a review of federal constitutional principles on similar issues, and a review of California's application of its corporation laws to foreign corporations in various contexts will shed some light on the issue.

FEDERAL CONSTITUTIONAL ISSUES

Several provisions of the United States Constitution are implicated by the issue of a state applying its own laws to a foreign corporation doing business in the state. Among these are the full faith and credit clause, the commerce clause, the contract clause, the due process clause, and the equal protection clause. Before discussing these, two United States Supreme Court cases from the early part of this century must be reviewed, as they dealt specifically with California applying its law to shareholders of foreign corporations.

"Until 1931, California imposed unlimited, pro rata liability on shareholders of both its own and other states’ corporations." Patterson, supra, 56 Ohio St. L.J. at 820. This rule of pro rata unlimited liability applied to both corporate torts and a corporation's contractual debts, and specifically applied to foreign corporations doing business in California. See Henry Hansmann and Reinier Kraakman, "A Procedural Focus On Unlimited Shareholder Liability," 106 Harv. L. Rev. 446, 452 (1992). This provision of state law was challenged as unconstitutional, but the United States Supreme Court upheld the law on two occasions.

The first case was Pinney v. Nelson, 183 U.S. 144 (1901). Here, the Court upheld the law since the corporation at issue had a charter which explicitly provided for doing business in California. The Court viewed this as an express contractual undertaking to apply California law. See Patterson, supra, 56 Ohio St. L.J. at 822 n. 33; Janet Cooper Alexander, "Unlimited Shareholder Liability Through A Procedural Lens," 106 Harv. L. Rev. 387, 412 n. 121 (1992).

The second case was Thomas v. Matthiessen, 232 U.S. 221 (1914). Here, "the Court faced an attempt by a citizen of California to recover from a citizen of New York on debts owed by an Arizona corporation in which the New Yorker was a shareholder. Despite the defendant shareholder's explicit agreement with the corporation that he would not be liable for corporate debts, and a corporate charter provision to that effect, the Court concluded that California law could be applied. " Patterson, supra, 56 Ohio St. L.J. at 821. See also Hansmann and Kraakman, supra, 106 Harv L. Rev at 452. ("The Supreme Court held ... that California could apply its statute even to out-of-state shareholders of a firm incorporated in another state whose law specifically provided for limited shareholder liability.")

The key to the decision was that the defendant explicitly assented to the corporation doing business in California. The Court stated:

When the defendant authorized [business in California] he could not avoid the consequences by saying that he did not foresee or intend, or that he forbade them. He knew that California had laws and he took his risk of what they might be, when, as we must hold, he gave his assent to doing business there.

Thomas, supra, 232 U.S. at 234-35 (opinion by Holmes, J.).

As summed up by Professor Patterson, "Thomas appears quite clearly to say that a state can impose its own shareholder liability policy on even foreign corporations doing business in the state. The only condition on which the Court appeared to rely was the shareholder's knowledge of the California unlimited liability statute. Patterson, supra, 56 Ohio St. L.J at 822; contra Alexander, supra, 106 Harv. L. Rev at 412 n. 121. Thus, if one does business in a state and has knowledge of that state's laws, Thomas may cause a higher level of liability than would be the case in the state of incorporation. Despite this, other cases show the viability of other federal constitutional prohibitions to one state applying its own laws to a foreign corporation.

 Full Faith And Credit Clause

Article IV, section 1 of the U.S. Constitution states that "Full Faith and Credit shall be given in each State to the public Acts . . . of every other State." In Nevada v. Hall, 440 U.S. 410 (1979), an employee of the University of Nevada caused a car accident in California while on official business. Patricia Hall and her son, John, were seriously injured, while the employee was killed. The Halls sued in a California state court against the deceased's estate, the University of Nevada, and the state of Nevada. Under Nevada law, the state and the university's liability was limited to $25,000 per claimant. The trial court applied California law, and the jury awarded the Halls $1,150,000 in damages. The United States Supreme Court affirmed.

Among other issues, the Court turned away a challenge under the full faith and credit clause. While conceding that "in certain limited situations, the courts of one State must apply the statutory law of another State," id. at 421, "the Full Faith and Credit Clause does not require a State to apply another State's law in violation of its own legitimate public policy." Id. at 422. "With regard to persons injured on California roads, California had, the Court maintained, a substantial 'interest' in applying the policy, expressed in its laws, of full recovery for victims of other's negligence; and to require California to sacrifice this interest in any way would be ‘obnoxious’ to California public policy." Gary J Simson, "The Role of History In Constitutional Interpretation: A Case Study," 70 Cornell L. Rev. 253, 256 (1985).

Thus if a state has a substantial interest in applying its own public policy, the full faith and credit clause will not bar the use of forum law instead of the law of another state. Protection of the creditors of foreign corporations is a legitimate public policy of the state of California. See Stephen R. Ginger, "Regulation Of Quasi-Foreign Corporations In California: Reflections On Section 2115 After Wilson V. Louisiana-Pacific Resources, Inc.," 14 Sw. U. L. Rev. 665, 679 (1984); cf. Comment, "California's Statutory Attempt To Regulate Foreign Corporations: Will It Survive The Commerce Clause?", 16 San Diego L. Rev. 943, 955 (1979):

It is difficult to understand why California so diligently strives to protect creditor interests. Creditors are not coerced to transact business or to develop contacts with any corporate entity. Debtor- creditor transactions are usually business dealings at arm's length. Creditor protection should arise from self-initiated industry regulation, legal counsel and contractual provisions.

Despite the merit of this position, the California courts protect creditors. Thus, the full faith and credit clause does not offer much protection for one hoping to be bound by the laws of the state of incorporation, and not the laws of the state in which business is conducted.

Commerce Clause

Article I, section 8, cl. 3 of the U.S. Constitution gives Congress the power "to regulate commerce . . . among the several states." Where Congress has not chosen to regulate a subject, such as corporation law which, to date, has been left to the states, the so-called "dormant" commerce power comes into play. In Pike v. Bruce Church, Inc., 397 U.S. 137 (1970), the United States Supreme Court laid out the test for the constitutionality of a state statute which effects commerce:

Where the statute regulates evenhandedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits. If a legitimate local purpose is found, then the question becomes one of degree. And the extent of the burden that will be tolerated will of course depend on the nature of the local interest involved, and on whether it could be promoted as well with a lesser impact on interstate activities.

Id. at 142 (citation omitted).

If a state attempts to apply its corporation laws to a foreign corporation for the purpose, for example, of protecting local creditors, this will be upheld unless the burden imposed on interstate commerce is excessive in relation to the putative local benefit. This is a rather amorphous test. Fortunately, there are other tests used to determine a commerce clause violation.

In general, "[a] state law may neither discriminate against out-of-state entities nor subject such entities to a burden of inconsistent regulations." Patterson, supra, 56 Ohio St. L.J. at 858. The first part of this test is demonstrated by CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69 (1987). Here, the Supreme Court upheld an Indiana antitakeover provision:

Although the Indiana law imposed burdens on the acquisition of Indiana corporations that did not apply to corporations in other states, the Court did not believe that that was the relevant inquiry. Instead, the key point was that the Indiana law applied equally to in-state and out-of-state investors: 'Because nothing in the Indiana act imposes a greater burden on out-of-state offerors than it does on similarly situated Indiana offerors, we reject the contention that the act discriminates against interstate commerce.'

Patterson, supra, 56 Ohio St. L.J. at 858-59 (quoting CTS Corp., 481 U.S. at 88). But in C. F. Edgar v. MITE Corp., 457 U.S. 624 (1982), the Court struck down an Illinois statute regulating tender offers as violative of the commerce clause, since the statute failed the test laid out in Pike, supra.

The second leg, regarding subjecting entities to the burden of inconsistent regulations, is fertile ground for finding commerce clause violations. Two landmark cases illustrate this principle. The first case is Southern Pacific Co. v. Arizona, 325 U.S. 761 (1945). Here, the Court struck down an Arizona statute which limited the length of railroad trains:

The practical effect of the statute was to disrupt interstate commerce, at considerable expense, by requiring railroad operators to break down and reassemble long trains at the Arizona state border. The Court noted that 'if one state may regulate train lengths, so may all the others, and they need not prescribe the same maximum limitation,' suggesting that the cumulative effect of potentially conflicting statutes poses a serious threat to the free flow of commerce.

Ginger, supra, 14 Sw. U. L. Rev. at 677 (quoting Southern Pacific, 325 U.S. at 775).

The second case is Bibb v. Navajo Freight Lines, Inc., 359 U.S. 520 (1959). Here, Illinois had a statute which required that trucks operating on its highways be equipped with contour mudguards. This statute conflicted with the statutes of 45 other states, which permitted other types of mudguards. Further, one state prohibited contour mudguards as unsafe. Although the Court recognized the authority of the state to regulate safety matters, it "held that the statute's marginal efficacy as a safety measure could not justify its interference with interstate commerce." Ginger, supra, 14 Sw. U. L, Rev. at 677.

Arguably, a state which attempted to apply its law to foreign corporations could be subjecting them to inconsistent regulations, which would burden interstate commerce. See Alexander, supra, 106 Harv. L. Rev. at 409-10; but see Patterson, supra, 56 Ohio St. L.J. at 860-62 . If so, the attempt would violate the commerce clause and be unconstitutional.

Contract Clause

Article I, section 10, cl.1 of the U.S. Constitution prohibits the states from passing any "law impairing the obligation of contracts." The test for determining a violation of the contract clause was stated in Allied Structural Steel Co. v. Spannaus, 438 U.S. 234 (1978):

The first inquiry must be whether the state law has, in fact, operated as a substantial impairment of a contractual relationship. The severity of the impairment measures the height of the hurdle the state legislation must clear. Minimal alteration of contractual obligations may end the inquiry at its first stage. Severe impairment, on the other hand, will push the inquiry to a careful examination of the nature and purpose of the state legislation.

Id. at 244-45.

In this case, the Supreme Court struck down a Minnesota law which subjected certain companies which had pension plans to a "pension funding charge" if the company terminated its pension fund or closed its Minnesota office. The company at issue was assessed a charge of $185,000 when it closed its Minnesota office. The law thus had a severe impact on the company's legitimate contractual obligations in calculating its annual pension contributions, and violated the contract clause.

If a state's attempt to apply its law to a foreign corporation had a severe impact on the corporate charter, it could be violative of the contract clause. This obviously would be determined on a case-by-case basis.

Due Process Clause

The 14th Amendment to the U.S. Constitution prohibits the states from depriving "any person of life liberty, or property, without due process-of law." When dealing with economic legislation, the test comes from Duke Power Co. v. Carolina Env. Studv Group, 438 U.S. 59 (1978). Under this case, the legislation is clothed with a presumption of constitutionality, and "the burden is on one complaining of a due process violation to establish that the legislature has acted in an arbitrary and irrational way." Id. at 83. Arguably, a state is not acting irrationally by applying its law to a foreign corporation if that corporation has significant ties to that state. When there are such significant contacts, application of state law to foreign corporations does not offend due process. See Allstate Ins. Co. v. Hague, 449 U.S. 302, 308-09 (1981).

There exists a separate due process concern. The reach of a state's courts is limited by the due process clause. To obtain in personam jurisdiction over a defendant not present in the forum, the defendant must have certain "minimum contacts" with the forum. See International Shoe Co. v. Washington, 326 U.S. 310 (1945). If the defendant "purposely availed" itself of the privilege of conducting activities in the forum state, either directly or indirectly, World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286, 297 (1980), or it "purposely directed" its activities at residents of the forum, Burger King Corp. v. Rudzewicz, 471 U.S. 462, 472 (1985), then due process is met. At bottom, such a state court judgment must not "offend 'traditional notions of fair play and substantial justice."' International Shoe, 326 U.S. at 316 (quoting Milliken v. Meyer, 311 U.S. 457, 463 (1944).

Thus, if a foreign corporation has significant contacts in a state, it probably does not offend due process for the state at issue to apply its law and render judgments against the foreign corporation.

Equal Protection Clause

The 14th Amendment to the U.S. Constitution prohibits the states from "deny[ing] to any person within its jurisdiction the equal protection of the laws." Classifications made in economic regulatory laws are upheld if a rational basis supports them. See Railway Express v. New York, 336 U.S. 106 (1949). In New Orleans v. Dukes, 427 U.S. 297 (1976) the Supreme Court stated that:

States are accorded wide latitude in the regulation of their local economies under their police powers, and rational distinctions may be made with substantially less than mathematical exactitude.

Id. at 303. Thus, a state, in attempting to apply its law to foreign corporations, does not have to treat all foreign corporations exactly alike. Rather, it can treat them differently so long as a rational basis exists for doing so.

Summary

As can be seen from the above discussion, the various federal constitutional concerns pertaining to a state applying its law to foreign corporations are substantial. The strongest weapon appears to be the commerce clause, and it is on this ground that most commentators have found fault with California's application of its law to foreign corporations. (Discussed infra.)

CALIFORNIA CORPORATIONS CODE SECTION 2115

As summarized by Stephen R. Ginger:

Section 2115 applies numerous portions of the California Corporations Code governing internal affairs to foreign corporations which do a substantial amount of business in California and which are predominantly owned by Californians. A foreign corporation becomes subject to California law when it satisfies a two-pronged test. First, the average of its property, payroll, and sales factors as defined in the California Revenue and Taxation Code must exceed fifty percent during its latest full income year. Second, more than fifty percent of its outstanding voting securities must be held of record by persons having addresses in California.

Ginger, supra, 14 Sw. U. L. Rev. at 668-69 (footnotes omitted). See also Alexander, supra, 106 Harv L. Rev, at 433-34.

As can be seen, Section 2115 applies to foreign corporations which do more than half of their business in California and are more than half owned by persons having addresses in California. Furthermore, it does not apply to foreign corporations which trade their shares on a national stock exchange or on NASDAQ. Id. at 434 n. 225.

In Wilson v. Louisiana-Pacific Resources, Inc., 187 Cal. Rptr. 852, 138 Cal. App.3d 216 (1983), a California appellate court upheld Section 2115 against a constitutional challenge. The issue was whether California could impose its law requiring cumulative voting upon a Utah corporation. The corporation's principal place of business was California, it did more than half of its business there, and more than half of its shares were owned by California residents.

The court addressed each of the five federal constitutional issues discussed above, and turned them all away. It denied the full faith and credit clause was violated since California has a strong public policy of

protecting cumulative voting, and Utah has no interests which are offended by cumulative voting. The court also stated that California has never blindly followed the internal affairs doctrine. Id. at 858, 138 Cal. App. 3d at 224.

As to the commerce clause, the court stated that Section 2115 applied evenhandedly, effectuated a legitimate public purpose, and had only an incidental effect on interstate commerce. Furthermore, there is little likelihood of foreign corporations being subjected to inconsistent regulations, as a corporation can only do a majority of its business in one state at a time, and can have a majority of its shareholders in only one state at a time. While this is true, the court's logic is faulty on this issue, as will be discussed infra.

As to the contract clause issue, the court found that the forced alteration of the corporation's charter to provide for cumulative voting was a minimum alteration which caused no hardship.

As to due process, no violation occurred since it is not irrational for California to regulate a corporation which does a majority of its business in California and which is owned by a majority of Californians. Further, the significance of the corporation's contacts with California allowed California law to be applied and its courts to render in personam judgments.

Lastly, the court found no equal protection violation on the issue of the exemption of foreign corporations that are publicly traded. Since publicly traded companies are already highly regulated, it is rational to exempt them from this particular law.

As stated the court's commerce clause analysis was flawed. It is true that if all states had similar laws requiring "majority" business and ownership before their law could be applied to foreign corporations, there would be no inconsistent state regulations. But what happens if states have different threshold requirements? As Stephen R. Ginger points out, if a second state had a threshold of 40%, while a third had a statute that subjected any corporation which does business "locally" to local law, under the theory of Section 2115 all three states could potentially apply their laws to the same foreign corporation simultaneously. Ginger, supra, 14 Sw. U. L. Rev. at 678. In such a situation, the corporation would be subjected to inconsistent regulations in violation of the commerce clause. It is on this ground that many commentators have questioned the validity of Section 2115. See id. at 668, 671-83; Bernard S. Black, "Is Corporate Law Trivial? A Political And Economic Analysis," 84 Nw. U. L. Rev. 542, 580 (1990); Deborah A. Demott, "Perspectives On Choice Of Law For Corporate Internal Affairs;" 48 Law & Contemp. Probs. 161, 187-88 (1985); Comment, supra, 16 San Diego L. Rev at 955; contra, Patterson, supra, 56 Ohio St L.J. at 858-62.

Perhaps more significantly, a California Superior Court has held that Section 2115 violates the commerce clause. Louart Corp. v. Arden-Mayfair, Inc., Civ. No. C-192-091 (Super. Ct. of Los Angeles County, May 1, 1978)(unpublished opinion). See Ginger, supra, 14 Sw. U. L. Rev. at 667, 667 n. 19, 681-82. Given all of this, it is likely that if the Supreme Court of the United States ever addressed the issue, Section 2115 would be declared unconstitutional.

Other California Corporations Code Sections Applied To Foreign Corporations

Three other California decisions require discussion. The first is Valtz v. Penta Invest. Corp., 188 Cal. Rptr. 922, 139 Cal. App.3d 803 (1983). Here, a California appellate court applied California Corporations Code Section 1600 to a Delaware corporation. Section 1600 grants to shareholders owning at least 5% of a corporation's stock "an absolute right" to inspect copy the shareholder list. This contradicts Delaware law.

The court, in an analysis similar to Wilson, supra, denied that extending Section 1600 to a foreign corporation violated the full faith and credit due process, commerce, and equal protection clauses of the federal constitution, Importantly, the court stated that Wilson stands for the proposition that "there is no constitutional impediment to state regulation of a foreign corporation with significant contacts with the state if the regulation does not unduly burden interstate commerce." Valtz, 188 Cal. Rptr. at 926, 139 Cal. App.3d at 810 . Also, a state has the "unquestioned" right "to regulate a corporation which chooses to reap the benefits of doing business within the state." Id. If the court is correct, the limitations found in Section 2115, pertaining to amount of business and ownership interests, would not be a hindrance to a California court applying California law to a foreign corporation.

The second case is North American Asbestos Corp. v. Superior Court, 225 Cal Rptr. 877, 180 Cal. App.3d 902 (1986). Here, the court applied California Corporations Code Section 2010 to an Illinois corporation. Section 2010 provides that a dissolved corporation continues to exist, forever, for purposes of defending actions against it for injuries arising out of its pre-dissolution activities. Illinois law allows suits of this type only if they are filed within two years of the date of the corporate dissolution.

In a balance of interests, the court held that Illinois interests would not be greatly impaired by applying California law, but that California's interests would be greatly impaired by applying Illinois law. "California has a strong interest in permitting its residents to seek compensation for injuries caused by hazardous substances and in insuring that damages are appropriately shared by codefendants." Id. at 880, 180 Cal App.3d at 907.

A dissenting judge argued that since Section 2010 was not specifically incorporated by Section 2115, it can only apply to domestic corporations. Id. at 883-84, 180 Cal. App.3d at 911-13 (Scott, J.dissenting). Since the majority ignored this point, it is evident that on certain issues, the courts of California will ignore Section 2115's limitations and apply California law to foreign corporations.

The last case is Havlicek v. Coast-To-Coast Analytical Services, Inc., 46 Cal. Rptr.2d 696, 39 Cal. App.4th 1844 (1995). Here, the court applied California Corporations Code Section 1602 to a Delaware corporation. Section 1602 grants the "absolute right" to every director of a corporation to inspect and copy all books, records, and documents of the corporation. The section also specifically applies to foreign corporations which have their principal executive office in California. This contradicts Delaware law.

The court applied the balance of interests test used in North American Asbestos, supra. . The court decided that California's public policy of broad inspection rights outweighed Delaware's interest in the matter, since Delaware's only connection to the corporation was that it issued the certificate of incorporation.

The court further rejected the corporation's argument that Section 1602 should not apply since the corporation did not meet the threshold ownership requirement of Section 2115. It did so on the ground that Section 1602 contained its own "long-arm" provision. (On this analysis, the limitations of Section 2115 can be overridden merely by having each corporation law contain its own "long-arm" provision.) By this "logic", there is an increased likelihood that a foreign corporation will be subjected to inconsistent regulations since the "majority" commerce clause justification of Wilson, supra, is obviated. Clearly, the court did not see this flaw in its analysis. The court also rejected challenges based upon the commerce clause and the full faith and credit clause.

As these cases indicate, the California appellate courts are quite aggressive in applying their corporation law to foreign corporations. As stated at the outset, a state which acts this way may well apply the common law doctrine of "piercing the corporate veil" in the same manner. Does this mean that a foreign corporation has no protection against this eventuality? Not at all. A contractual choice-of-law provision could save the day. Fortunately, the courts in California analyze this issue in a far more logical manner than they do their corporate law,

CONTRACTUAL CHOICE -OF -LAW PROVISIONS

General Rule

The policy behind recognizing the choice by the parties to a contract, of the law which pertains to the contract, was well stated half a century ago:

[I]f we regard it as one of the principal purposes of the conflict of laws to protect the justified expectations of the parties, then the intention of the parties rule is the one which fulfills that purpose better than any rival rule, and quite particularly better than the place of contracting rule. If the parties have agreed upon the application of some particular law, then they have thought and acted in accordance with it.

Max Rheinstein, Book Review, 15 U. Chi. L. Rev. 478, 486 (1948).

Through the years, many courts have followed this principle. For example, in A.S. Rampell, Inc. v. Hyster Co., 3 N.Y.2d 369, 144 N.E.2d 371, 165 N.Y.S.2d 475 (1957), the issue was whether an oral modification of the written contract at issue was valid. Under New York law, it would not be. However, under Oregon law, the oral modification would be valid. Hyster Co. was an Oregon corporation doing business in New York. Its written contract with Rampell declared that Oregon law would control. Since Oregon had a reasonable relationship to the choice-of-law of the parties, the New York court applied Oregon law and upheld the oral modification.

This rule applies even if the choice-of-law provision invalidates all or part of the contract. This is shown by Foreman v. George Foreman Assocs., Ltd. 517 F.2d 354 (9th Cir. 1975). Here, boxer George Foreman, a California resident, entered into a boxing management contract with a Pennsylvania limited partnership. The contract stipulated that California law would apply. Foreman brought suit to avoid enforcement of the contract. The trial court found that since Foreman was a resident of California and the contract was signed there, the parties' choice-of-law was entitled to respect. Furthermore, since the contract violated several regulations promulgated by the California State Athletic Commission, the contract was invalid.

The 9th Circuit Court of Appeals affirmed this ruling, on the ground that California has a strong public policy in protecting boxers from mortgaging their futures. I f the choice-of-law provision was not enforced, the public policy would be violated. Id. at 356-57.

The rules revealed by these and other cases have found their way into the Restatement (Second) of Conflict of Laws. The pertinent section is 187(l):

(1)The law of the state chosen by the parties to govern their contractual rights and duties will be applied if the particular issue is one which the parties could have resolved by an explicit provision in their agreement directed to that issue.

The "Restatement recognizes [that] there should be no limitation on the power of the parties to incorporate foreign law into their contract." Robert Allen Sedler, "The Contracts Provisions Of The Restatement (Second): An Analysis And A Critique," 72 Colum. L. Rev. 279, 287 (1972).

Under Section 187(2) the express choice-of-law is still recognized "even if the particular issue is one, which the parties could not have resolved, by an explicit provision in their agreement directed to that issue." There are, however, three exceptions to Section 187(2). First, the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties' choice. Second, misrepresentation, duress, undue influence, or mistake secured the consent of one of the parties to the inclusion of the provision. Third, application of the state's law chosen would be contrary to a fundamental policy of the state that would be able to apply its own law but for the choice-of-law provision. See Sedler, supra, 72 Colum. L. Rev. at 290.

Besides the Restatement, the Uniform Commercial Code (UCCA) also allows the patties to a commercial contract to choose the applicable state law, so long as the transaction "bears a reasonable relation" to the state chosen. See UCC Section 1-105. The UCC is the law of all 50 states.

Thus, the general law of this country is that parties to a contract may choose the law of a state to govern the contract, and that courts will uphold the choice in order to further the expectations of the parties. This rule is valid in California.

California Law Regarding Contractual Choice-Of-Law Provisions

In Bernkrant v. Fowler, 12 Cal. Rptr. 266, 360 P.2d 906, 55 Cal.2d 588 (1961), the California Supreme Court upheld an oral contract involving the refinancing of obligations arising from a sale of Nevada land to Nevada residents, although the seller was domiciled in California. It applied Nevada law to uphold the contract, as California law would have voided it. The court reasoned that the reasonable expectation of the parties mandated this result.

In Smith, Valentino & Smith, Inc. v. Superior Court, 131 Cal. Rptr. 374 551 P.2d 1206, 17 Cal.3d 491 (1976), the California Supreme Court upheld the use of a forum selection clause and a choice-of-law clause. The court stated that "choice-of-law provisions are usually respected by California courts." Id. at 376, 7 Cal.3d at 495. The court also stated that, although there is a public policy favoring access to California courts by resident plaintiffs:

We likewise conclude that the policy is satisfied in those cases where, as here, a plaintiff has freely and voluntarily negotiated away his right to a California forum. In so holding we are in accord with the modern trend which favors enforceability of such forum selection clauses.

Id. at 377, 17 Cal.3d at 495 (citing The Bremen v. Zapata Off-Shore Co., 407 U.S. 1 (1972). The court added that:

No satisfying reason of public policy has been suggested why enforcement should be denied a forum selection clause appearing in a contract entered into freely and voluntarily by parties who have negotiated at arm's length.

Smith, 131 Cal. Rptr. at 377, 7 Cal.3d at 495-96.

The most recent case is very important. In.Hambrecht & Quist Venture Partners v. American Medical International, Inc., 46 Cal. Rptr.2d 33, 38 Cal. App.4th 1532 (1995), the court upheld a choice-of-law provision in a stock purchase agreement which stated that the agreement "shall be governed by and construed in accordance with the laws of the State of Delaware." Id. at 36, 38 Cal. App.4th at 538. Initially, the court held that the word "laws" in the provision includes case law. Therefore it is arguable that a state's appellate court opinions on "piercing the corporate veil" be incorporated into a choice-of-law provision.

Second, the court explicitly stated that California courts "shall" apply the principles found in Restatement Section 187. Id. at 40, 38 Ca' App.4th at 1544. The court held that a "substantial relationship" exists with the chosen state if one party is merely incorporated there. It is irrelevent if the corporation's principal place of business is in the forum state. Id. at 41, 38 Cal. App.4th at 1545-46. Further, the court found no fundamental state policy against applying Delaware’s statute of limitations to a claim brought in a California court. Thus, the contractual provision was upheld.

This case makes clear that parties who freely bargain for a choice-of-law provision can choose the "law" of the state wherein either party is incorporated. If the particular law to be applied does not offend the public policy of the state which would apply its own law but for the choice-of-law provision, the choice will be respected.

CONCLUSION

Although California is quite aggressive in applying its corporation law to foreign corporations, its analysis is arguably vulnerable under the commerce clause, since corporations may be subjected to inconsistent regulations. However, the problem may be avoided with an openly bargained choice-of-law provision incorporating the law of a state which has a reasonable relationship to the transaction.


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California's Approach to Choice of Law in the Absence of an Effective Choice by the Parties - Learn what jurisdiction is all about.

The Approach of New York, Wisconsin, and Texas in Applying Their Law to Foreign Corporations (as Compared to California) Three states with a different approach.

Do you Need an Office and Bank Account in Nevada?
- Unless your employees and business are located in Nevada, most likely, the answer is NO!

Snake Oil Strategies Proposed by Others That just Simply Don't Work - The most important article on this site!



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