Freedom of Contract: Choice of Law

Case:

The Joint Venture Company consists of four parties: two Japanese parties, one Singaporean party and one Indonesian party (the “Parties”). Under the Joint Venture Agreement, the parties agree on English Law as their choice of law and the Arbitration in Singapore as their choice of forum to settle any dispute.

Relevant Issues:

1. If the parties are Indonesian citizens, are they obliged to make an agreement under Indonesian Law?

2. How will the parties avoid “penyelundupan hukum” while making their choice of law? And how far can the conception of choice of law be applied in this case

Analysis

Freedom of Contract and Obligation to Make an Agreement Under Indonesian Law

In general, Indonesian law adopts the principle of freedom of contract. This means that as long as the contract has fulfilled the four basic statutory requirements set out in Article 1320 of the Indonesia Civil Code (“ICC”) (i.e., consent, capacity, certainty and permissible cause, e.g., does not contravene the prevailing regulations and principles of public order and morality), it will be regarded as law for the signatories, and they should comply.

Moreover, the third book of the ICC also adopts the doctrine that allows the waiver of the provision which is regulated in the third book of the Indonesian Civil Code). In other words, the provision that is regulated in the third book of the Indonesian Civil Code is only a complementary law (hukum pelengkap).

Under Indonesian Law, there is no mandatory rule or provision stating that every agreement entered into by an Indonesian citizen must be arranged under Indonesian Law. Therefore, referring to the doctrine of freedom of contract and the conditions required for the legality of an agreement, the parties may make an agreement under foreign law as long as the agreement fulfills the provision of Article 1320 of the Indonesian Civil Code and does not contravene other Indonesia Laws, ethics and the public order (pursuant to Article 1337, Indonesian Civil Code).

Evasion of Law (“Penyelundupan hukum”) and Choice of Law

Each party is free to enter into a contract with their own choice of law. Such terms are pursuant to the principle of freedom of contract that is universally accepted. However, the parties only have the freedom to make their choice of law but not to make their own law. As mentioned in point 1 above, the parties have the right to make an agreement under foreign law, as well as the right to their own choice of law. Choice of law, or the proper law of the contract in other terminology, means the parties have the freedom to choose the law which will apply to their agreement.

There are, however, limitations for parties in conducting their choice of law that are generally accepted under several law systems, including the Civil Law system (Indonesia is one of many countries that have adopted the Civil Law system), among others:

(i) The contract has an international aspect and is applicable only in the commercial sector.

(ii) The chosen law has a real connection with the contract. If the law chosen by the parties has no connection with the substance of the contract and the parties have no reasonable reason to determine their choice of law, the judge will determine which law will be applied.

(iii) The choice of law clause does not have the effect of evading mandatory rules or important public policies of domestic law (lex fori).

(iv) The choice of law does not constitute an evasion of law/fraus legis (penyelundupan hukum) The choice of law principle may not be intended as a way of subjecting, in whole or in part, the contract under foreign law by means of avoiding the mandatory law from the law system that should be applied, if it’s not implemented.

(v) The choice of law clause does not contravene domestic law or the public order.

(vi) The choice of law is not conducted by one of the parties with a more powerful bargaining position.

Basically, the concept of choice of law has two means, choice of jurisdiction (choice of Court) and choice of law by the parties. Although the parties have agreed on their choice of law as mentioned in the contract, this does not mean the parties have agreed to settle their dispute in such jurisdiction.

There are two approaches in determining the choice of law to govern a dispute that is submitted to the Court where the parties have already agreed on the choice of law provision in their contract.

(i) The Court will decide based on traditional vested right approaches, in which case the law applied is based on the jurisdiction in which the contract is made (lex loci contractus) or on the domestic court forum which is more familiar to the judges (lex fori). The arguments adopted by the judges for applying the lex fori include public policy, renvoi and procedure as law (hukum acara).

(ii) The Court will decide based on governmental interest analysis approaches, in which case the applied law is the governing law of one of the parties that has the most connection, characteristic and interest in the dispute resolution.

For cases relating to the implementation of foreign law, the judge will decide whether the court has jurisdiction to examine the case. If the case has the intention of evading the operation of some mandatory provisions of a domestic law, or there was an element of fraud or duress or undue influence involved in the signing of the contract, or there was some other evidence of bad faith, or the parties have already agreed on the choice of law, the judge will decide that the court has jurisdiction to examine the case, in which case the judge has three options:

(i) To implement the law chosen by the parties
(ii) To implement the law where the contract is made
(iii) To implement the domestic law which is more familiar

references:

Abdul Gani Abdullah, “Pandangan Yuridis Conflict of Law dan Choice of Law dalam Kontrak Bisnis Internasional,” Buletin Hukum Perbankan dan Kebanksetralan (Vol. 3, No. 3, December 2005)

R. Subekti, Pokok-pokok Hukum Perdata (Jakarta: Intermasa, 2001)

Yansen Darmanto Latip, Pilihan Hukum dan Pilihan Forum dalam Kontrak Internasional (Jakarta: Program Pascasarjana Fakultas Hukum Universitas Indonesia, 2002)