Forum Selection Provisions in Credit Agreements

Be Careful What You Wish For:

Nicholas D. Krawec, Esq.

Bernstein-Burkley, P.C.

In the modern business world, where interstate and international transactions are commonplace, many commercial contracts include a clause commonly referred to as a “Forum Selection Clause”. This clause specifies the geographic location, and often the specific court or tribunal (such as the American Arbitration Association, or National Arbitration Forum), in which any lawsuit to adjudicate a dispute between the parties to the contract, regarding the contract’s terms, must be brought. This is done primarily by businesses to protect themselves from having to retain counsel and litigate cases far from their home office or nearest satellite office, but also may be included to take advantage of certain favorable laws, regulations or procedural rules within a particular jurisdiction.

In the context of commercial credit agreements and collection actions, the concerns of the creditor are slightly different, since it is the creditor who is usually the Plaintiff and thus has the initial choice of forum for adjudication of contract disputes. Moreover, rather than institute suit in the jurisdiction closest to the creditor’s home office, many creditors seek to locate and sue debtors wherever they can be found, since any attachable property belonging to the debtor is likely to be located there as well, and also because it avoids the delay and expense associated with transferring a judgment from the creditor’s jurisdiction to the debtor’s jurisdiction. However, if a creditor has inserted a forum selection clause in its credit agreements which vests exclusive jurisdiction in the court where the creditor’s home office is located, if the creditor and debtor are located within the same state, a judgment obtained in the creditor’s jurisdiction (county) can relatively easily be transferred to a local court in the debtor’s jurisdiction (county).  If the creditor and debtor are located in different states, the creditor can domesticate the judgment obtained in the creditor’s jurisdiction (state) in the court of the debtor’s jurisdiction (state) pursuant to the Uniform Enforcement of Foreign Judgments Act (UEFJA).  However, some states’ version of the UEFJA have a 30 day waiting period after domestication of the judgment, before a creditor can take action to execute upon (enforce) the domesticated, out of state judgment.  This allows time for the debtor to take action to attempt to challenge the out of state judgment on jurisdictional grounds.  If the courts of the debtor’s jurisdiction disfavor forum selection clauses, the debtor may succeed in getting the judgment which was domesticated in his state stricken, in which case the creditor must re-file the lawsuit in the debtor’s jurisdiction (and hope that the statute of limitations has not run on the cause of action).  The creditor must therefore take these factors into consideration when drafting a forum selection clause.

The most important consideration in drafting an effective forum selection clause which favors the interests of the creditor is examining the applicable law of the jurisdiction selected as the forum. This is particularly true in the case of consumer credit agreements, since many States have strong consumer protection laws which may hamper, delay, or increase the cost of collection. Additionally, under the terms of the Federal Fair Debt Collections Practices Act (FDCPA), which governs third party debt collectors collecting consumer debts, an action to recover a consumer debt must be brought either in the jurisdiction where the debtor resides, or in the jurisdiction in which the contract was signed (which can be the creditor’s place of business).  Moreover, most states consumer protection statutory framework includes a state version of the FDCPA, which may mirror the provisions of the FDCPA, and may apply to creditors collecting their own debts.  Thus, simply choosing the jurisdiction of the creditor’s home office or state of incorporation, as is common in many form contracts, may not be the best option, if for example, the creditor is located in California or Massachusetts. At the same time however, the creditor, in drafting a forum selection clause for its contracts, cannot simply choose, from among the fifty states, the one whose law is most favorable if neither creditor nor debtor conduct any business in that state, or if the transaction has no relation to that state, since most courts require that there be a reasonable relationship between the parties or transaction and the forum state before they will enforce the forum selection clause.

Creditors must also keep in mind that selecting a particular forum does not, in and of itself, guarantee that the laws of that jurisdiction will be the ones which are ultimately applied to the case. Each jurisdiction maintains its own “choice of law” rules which govern cases where parties from multiple jurisdictions with differing statutory and common law precepts are involved. In the case of credit agreements and contracts in general, many courts still apply the ancient rule “lex loci contractus,” which means that they will apply the substantive law of the jurisdiction where a contract was formed in rendering an interpretation of disputed provisions. Thus, it becomes vital that a creditor not only take into account the entire body of law of a particular jurisdiction when making a forum selection, including its choice of law rules, but also include in its credit agreements both substantive choice of law clauses and place of contracting clauses, the latter of which stipulates when and where a contract is formed.  For example, such a clause may read, “this contract shall be deemed to have been formed in the Commonwealth of Pennsylvania, and shall be governed by the laws of the Commonwealth of Pennsylvania.”

Finally, the creditor must also account for the attitude of particular jurisdictions towards forum selection clauses. Traditionally, forum shopping is discouraged, hence the requirement of a reasonable relationship between the selected forum on the one hand, and the parties and transaction on the other, noted above.  However, with the development of modern contract law, forum selection clauses are generally no longer disfavored, and will customarily be enforced subject to certain restrictions. A party challenging a forum selection clause has the burden of showing the clause is unreasonable. A party to the contract can show the clause’s unreasonableness by establishing that:

  1. it was induced by fraud or overreaching; or
  2. the forum is so unfair and inconvenient that it effectively deprives the party resisting the clause of a remedy or of its “day in court;” or
  3. enforcement would contravene a strong public policy of the State where the action is filed.

The Model Choice of Forum Act contains a balancing test, and states that an unselected court must give effect to the choice of the parties and refuse to entertain the action unless:

  1. the plaintiff cannot secure effective relief in the other state, for reasons other than delay in bringing the action; or
  2. the other state would be a substantially less convenient place for the trial of the action than this state; or
  3. the agreement as to the place of the action was obtained by misrepresentation, duress, abuse of economic power, or other unconscionable means; or
  4. it would for some other reason be unfair or unreasonable to enforce the agreement.

Due to all of the above considerations, it is very important that the inclusion of a forum selection clause in a credit agreement be done with extreme care, and preferably in consultation with a creditors’ rights attorney. While a carefully drafted forum selection clause and choice of law clause can facilitate the collection of the debt and ease the path toward judgment and execution, hastily prepared clauses, or ones prepared purely for convenience can just as easily delay the creditor’s obtaining of a judgment, increase costs, and adversely affect the overall viability of an otherwise sound cause of action.

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For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.

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