Nedlloyd Lines B.V. v. Superior Court

We granted review to consider the effect of a choice-of-law clause in a contract between commercial entities to finance and operate an international shipping business. In our order granting review, we limited our consideration to the question whether and to what extent the law of Hong Kong, chosen in the parties’ agreement, should be applied in ruling on defendant’s demurrer to plaintiff’s complaint.

We conclude the choice-of-law clause, which requires that the contract be “governed by” the law of Hong Kong, a jurisdiction having a substantial connection with the parties, is fully enforceable and applicable to claims for breach of the implied covenant of good faith and fair dealing and for breach of fiduciary duties allegedly arising out of the contract. Our conclusion rests on the choice-of-law rules derived from California decisions and the Restatement Second of Conflict of Laws, which reflect strong policy considerations favoring the enforcement of freely negotiated choice-of-law clauses. Based on our conclusion, we will reverse the judgments of the Court of Appeal and remand for further proceedings.

Statement of Facts and Proceedings Below

Plaintiff and real party in interest Seawinds Limited (Seawinds) is a shipping company, currently undergoing reorganization under chapter 11 of the United States Bankruptcy Code, whose business consists of the operation of three container ships. Seawinds was incorporated in Hong Kong in late 1982 and has its principal place of business in Redwood City, California. Defendants and petitioners Nedlloyd Lines B.V., Royal Nedlloyd Group N.V., and KNSM Lines B.V. (collectively referred to as Nedlloyd) are interrelated shipping companies incorporated in the Netherlands with their principal place of business in Rotterdam.

In March 1983, Nedlloyd and other parties (including an Oregon corporation, a Hong Kong corporation, a British corporation, three individual residents of California, and a resident of Singapore) entered into a contract with Seawinds to purchase shares of Seawinds’s stock. The contract, which was entitled “Shareholders’ Agreement in Respect of Seawinds Limited,” stated that its purpose was “to establish [Seawinds] as a joint venture company to carry on a transportation operation.” The agreement also provided that Seawinds would carry on the business of the transportation company and that the parties to the agreement would use “means reasonably available” to ensure the business was a success.

The shareholders’ agreement between the parties contained the following choice-of-law and forum selection provision: “This agreement shall be governed by and construed in accordance with Hong Kong law and each party hereby irrevocably submits to the non-exclusive jurisdiction and service of process of the Hong Kong courts.”

In January 1989, Seawinds sued Nedlloyd, alleging in essence that Nedlloyd breached express and implied obligations under the shareholders’ agreement by: “(1) engaging in activities that led to the cancellation of charter hires that were essential to Seawinds’ business; (2) attempting to interfere with a proposed joint service agreement between Seawinds and the East Asiatic Company, and delaying its implementation; (3) making and then reneging on commitments to contribute additional capital, thereby dissuading others from dealing with Seawinds, and (4) making false and disparaging statements about Seawinds’ business operations and financial condition.” Seawinds’s original and first amended complaint included causes of action for breach of contract, breach of the implied covenant of good faith and fair dealing (in both contract and tort), and breach of fiduciary duty. This matter comes before us after trial court rulings on demurrers to Seawinds’s complaints.

Nedlloyd demurred to Seawinds’s original complaint on the grounds that it failed to state causes of action for breach of the implied covenant of good faith and fair dealing (either in contract or in tort) and breach of fiduciary duty. In support of its demurrer, Nedlloyd contended the shareholders’ agreement required the application of Hong Kong law to Seawinds’s claims. In opposition to the demurrer, Seawinds argued that California law should be applied to its causes of action.

In ruling on Nedlloyd’s demurrer, the trial court expressly determined that California law applied to all of Seawinds’s causes of action. It sustained the demurrers with leave to amend as to all causes of action, relying on grounds not pertinent to the issues before us. Nedlloyd sought a writ of mandate from the Court of Appeal directing the application of Hong Kong law. After the Court of Appeal summarily denied Nedlloyd’s initial writ petition, we granted Nedlloyd’s petition for review and transferred the case back to the Court of Appeal with instructions to issue an alternative writ.

After complying with our direction, the Court of Appeal denied Nedlloyd’s first writ petition and discharged the alternative writ. In a published opinion, the Court of Appeal upheld the application of California law to Seawinds’s claims. We granted Nedlloyd’s petition for review.

In the meantime, the trial court overruled Nedlloyd’s demurrer to Sea-winds’s first amended complaint, again applying California law to Sea-winds’s causes of action. The Court of Appeal summarily denied Nedlloyd’s second writ petition challenging the order overruling the latter demurrer; we also granted review of that order and consolidated proceedings on the two writ matters so as to preserve the choice-of-law issue for review. As noted above, we have limited review in both proceedings to the choice-of-law issue.

Discussion

I. The proper test

We have not previously considered the enforceability of a contractual choice-of-law provision. We have, however, addressed the closely related issue of the enforceability of a contractual choice-of-forum provision, and we have made clear 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, Valentino & Smith, Inc. v. Superior Court (1976) 17 Cal.3d 491, 495-496 [131 Cal.Rptr. 374, 551 P.2d 1206] (Smith).) The forum selection provision in Smith was contained within a choice-of-law clause, and we observed that, “Such choice of law provisions are usually respected by California courts.” (Id., at p. 494.) We noted this result was consistent with the modern approach of section 187 of the Restatement Second of Conflict of Laws (Restatement). (17 Cal.3d at p. 494.) Prior Court of Appeal decisions, although not always explicitly referring to the Restatement, also overwhelmingly reflect the modern, mainstream approach adopted in the Restatement. (Mencor Enterprises, Inc. v. Hets Equities Corp. (1987) 190 Cal.App.3d 432, 435-436 [235 Cal.Rptr. 464] [explicit reference to Rest. § 187]; Hall v. Superior Court (1983) 150 Cal.App.3d 411, 417 [197 Cal.Rptr. 757] [no explicit reference]; Ashland Chemical Co. v. Provence (1982) 129 Cal.App.3d 790, 794-795 [181 Cal.Rptr. 340] [no explicit reference]; Gamer v. duPont Glore Forgan, Inc. (1976) 65 Cal.App.3d 280, 287 [135 Cal.Rptr. 230] [explicit reference to Rest. § 187].)

We reaffirm this approach. In determining the enforceability of arm’s-length contractual choice-of-law provisions, California courts shall apply the principles set forth in Restatement section 187, which reflects a strong policy favoring enforcement of such provisions.

More specifically, Restatement section 187, subdivision (2) sets forth the following standards: “The law of the state chosen by the parties to govern their contractual rights and duties will be applied, 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, unless either [f] (a) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties choice, or [f] (b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.”

Briefly restated, the proper approach under Restatement section 187, subdivision (2) is for the court first to determine either: (1) whether the chosen state has a substantial relationship to the parties or their transaction, or (2) whether there is any other reasonable basis for the parties’ choice of law. If neither of these tests is met, that is the end of the inquiry, and the court need not enforce the parties’ choice of law. If, however, either test is met, the court must next determine whether the chosen state’s law is contrary to a fundamental policy of California. If there is no such conflict, the court shall enforce the parties’ choice of law. If, however, there is a fundamental conflict with California law, the court must then determine whether California has a “materially greater interest than the chosen state in the determination of the particular issue . . . .” (Rest., § 187, subd. (2).) If California has a materially greater interest than the chosen state, the choice of law shall not be enforced, for the obvious reason that in such circumstance we will decline to enforce a law contrary to this state’s fundamental policy. We now apply the Restatement test to the facts of this case.

II. Application of the test in this case

A. Breach of contract

Nedlloyd did not assert in its second demurrer that the amended complaint failed to state a cause of action under Hong Kong law for breach of contract. Rather, Nedlloyd challenged the amended complaint’s breach of contract allegations only on the ground of uncertainty. (Code Civ. Proc., § 430.10, subd. (f).) In light of our order limiting review to the issue of whether Hong Kong law “should be applied in ruling on the demurrers,” we need not and do not consider the correctness of the trial court’s ruling on the demurrer to this cause of action. As we shall explain, however, Hong Kong law, although not asserted as a bar to Seawinds’s contract cause of action at the pleading stage, does govern all causes of action pleaded in the amended complaint, including the contract cause of action.

B. Implied covenant of good faith and fair dealing

1. Substantial relationship or reasonable basis

As to the first required determination, Hong Kong—“the chosen state”—clearly has a “substantial relationship to the parties.” (Rest., § 187, sübd. (2)(a).) The shareholders’ agreement, which is incorporated by reference in Seawinds’ first amended complaint, shows that Seawinds is incorporated under the laws of Hong Kong and has a registered office there. The same is true of one of the shareholder parties to the agreement—Red Coconut Trading Co. The incorporation of these parties in Hong Kong provides the required “substantial relationship.” (Id., com. f [substantial relationship present when “one of the parties is domiciled” in the chosen state]; Carlock v. Pillsbury Co. (D.Minn. 1988) 719 F.Supp. 791, 807 [“A party’s incorporation in a state is a contact sufficient to allow the parties to choose that state’s law to govern their contract.”]; Hale v. Co-Mar Offshore Corp. (W.D.La. 1984) 588 F.Supp. 1212, 1215 [same effect].)

Moreover, the presence of two Hong Kong corporations as parties also provides a “reasonable basis” for a contractual provision requiring application of Hong Kong law. “If one of the parties resides in the chosen state, the parties have a reasonable basis for their choice.” (Consul Ltd. v. Solide Enterprises, Inc., supra, 802 F.2d 1143, 1147.) The reasonableness of choosing Hong Kong becomes manifest when the nature of the agreement before us is considered. A state of incorporation is certainly at least one government entity with a keen and intimate interest in internal corporate affairs, including the purchase and sale of its shares, as well as corporate management and operations. (See Corp. Code, § 102 [applying California’s general corporation law to domestic corporations].)

2. Existence of fundamental public policy

We next consider whether application of the law chosen by the parties would be contrary to “a fundamental policy” of California. We perceive no fundamental policy of California requiring the application of California law to Seawinds’s claims based on the implied covenant of good faith and fair dealing. The covenant is not a government regulatory policy designed to restrict freedom of contract, but an implied promise inserted in an agreement to carry out the presumed intentions of contracting parties. (Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 689-690 [254 Cal.Rptr.211, 765 P.2d 373] (Foley) [“When a court enforces the implied covenant it is in essence acting to protect ‘the interest in having promises performed’ [citation]—the traditional realm of a contract action—rather than to protect some general duty to society which the law places on an employer without regard to the substance of its contractual obligations to its employee.”].)

Seawinds directs us to no authority exalting the implied covenant of good faith and fair dealing over the express covenant of these parties that Hong Kong law shall govern their agreement. We have located none. Because Seawinds has identified no fundamental policy of our state at issue in its essentially contractual dispute with Nedlloyd, the second exception to the rule of section 187 of the Restatement does not apply.

C. Fiduciary duty cause of action

1. Scope of the choice-of-law clause

Seawinds contends that, whether or not the choice-of-law clause governs Seawinds’s implied covenant claim, Seawinds’s fiduciary duty claim is somehow independent of the shareholders’ agreement and therefore outside the intended scope of the clause. Seawinds thus concludes California law must be applied to this claim. We disagree.

When two sophisticated, commercial entities agree to a choice-of-law clause like the one in this case, the most reasonable interpretation of their actions is that they intended for the clause to apply to all causes of action arising from or related to their contract. Initially, such an interpretation is supported by the plain meaning of the language used by the parties. The choice-of-law clause in the shareholders’ agreement provides: “This agreement shall be governed by and construed in accordance with Hong Kong law and each party hereby irrevocably submits to the non-exclusive jurisdiction and service of process of the Hong Kong courts.” (Italics added.)

The phrase “governed by” is a broad one signifying a relationship of absolute direction, control, and restraint. Thus, the clause reflects the parties’ clear contemplation that “the agreement” is to be completely and absolutely controlled by Hong Kong law. No exceptions are provided. In the context of this case, the agreement to be controlled by Hong Kong law is a shareholders’ agreement that expressly provides for the purchase of shares in Seawinds by Nedlloyd and creates the relationship between shareholder and corporation that gives rise to Seawinds’s cause of action. Nedlloyd’s fiduciary duties, if any, arise from—and can exist only because of—the shareholders’ agreement pursuant to which Seawinds’s stock was purchased by Nedlloyd.

In order to control completely the agreement of the parties, Hong Kong law must also govern the stock purchase portion of that agreement and the legal duties created by or emanating from the stock purchase, including any fiduciary duties. If Hong Kong law were not applied to these duties, it would effectively control only part of the agreement, not all of it. Such an interpretation would be inconsistent with the unrestricted character of the choice-of-law clause.

Our conclusion in this regard comports with common sense and commercial reality. When a rational businessperson enters into an agreement establishing a transaction or relationship and provides that disputes arising from the agreement shall be governed by the law of an identified jurisdiction, the logical conclusion is that he or she intended that law to apply to all disputes arising out of the transaction or relationship. We seriously doubt that any rational businessperson, attempting to provide by contract for an efficient and business-like resolution of possible future disputes, would intend that the laws of multiple jurisdictions would apply to a single controversy having its origin in a single, contract-based relationship. Nor do we believe such a person would reasonably desire a protracted litigation battle concerning only the threshold question of what law was to be applied to which asserted claims or issues. Indeed, the manifest purpose of a choice-of-law clause is precisely to avoid such a battle.

Seawinds’s view of the problem—which would require extensive litigation of the parties’ supposed intentions regarding the choice-of-law clause to the end that the laws of multiple states might be applied to their dispute—is more likely the product of postdispute litigation strategy, not predispute contractual intent. If commercially sophisticated parties (such as those now before us) truly intend the result advocated by Seawinds, they should, in fairness to one another and in the interest of economy in dispute resolution, negotiate and obtain the assent of their fellow parties to explicit contract language specifying what jurisdiction’s law applies to what issues.

Justice Mosk long ago cogently observed that, “Given two experienced businessmen dealing at arm’s length, both represented by competent counsel, it has become virtually impossible under recently evolving rules of evidence to draft a written contract that will produce predictable results in court. The written word, heretofore deemed immutable, is now at all times subject to alteration by self-serving recitals based upon fading memories of antecedent events. This, I submit, is a serious impediment to the certainty required in commercial transactions.” (Delta Dynamics, Inc. v. Arioto (1968) 69 Cal.2d 525, 532 [72 Cal.Rptr. 785, 446 P.2d 785] (dis. opn. of Mosk, J.).)

With due acknowledgment of Justice Mosk’s prescience, other courts have more recently reiterated that, “While [the] rule [of easily pleaded ambiguity] creates much business for lawyers and an occasional windfall to some clients, it leads only to frustration and delay for most litigants and clogs already overburdened courts.” (Trident Center v. Connecticut General Life Ins, (9th Cir. 1988) 847 F.2d 564, 569; Wilson Arlington Co. v. Prudential Ins. Co. (9th Cir. 1990) 912 F.2d 366, 370.) We need not envelop choice-of-law clauses in this fog of uncertainty and ambiguity.

For the reasons stated above, we hold a valid choice-of-law clause, which provides that a specified body of law “governs” the “agreement” between the parties, encompasses all causes of action arising from or related to that agreement, regardless of how they are characterized, including tortious breaches of duties emanating from the agreement or the legal relationships it creates.

2. Enforceability of chosen law as to fiduciary duty claim

Applying the test we have adopted (see pt. I, ante, at pp. 464-466.), we find no reason not to apply the parties’ choice of law to Seawinds’s cause of action for breach of fiduciary duty. As we have explained, Hong Kong, the chosen state, has a “substantial relationship to the parties” because two of those parties are incorporated there. Moreover, their incorporation in that state affords a “reasonable basis” for choosing Hong Kong law. (See pt. II.B.1., ante, at pp. 467-468].)

Seawinds identifies no fundamental public policy of this state that would be offended by application of Hong Kong law to a claim by a Hong Kong corporation against its allegedly controlling shareholder. We are directed to no California statute or constitutional provision designed to preclude freedom of contract in this context. Indeed, even in the absence of a choice-of-law clause, Hong Kong’s overriding interest in the internal affairs of corporations domiciled there would in most cases require application of its law. (See Rest., § 306 [obligations owed by majority shareholder to corporation determined by the law of the state of incorporation except in unusual circumstances not present here]; McDermott Inc. v. Lewis (Del.Super.Ct. 1987) 531 A.2d 206, 214-216 [corporate voting rights dispute governed by law of state of incorporation]; Matter of Reading Co. (3d Cir. 1983) 711 F.2d 509,517 [minority shareholder fiduciary duty claim governed by law of state of incorporation].)

For strategic reasons related to its current dispute with Nedlloyd, Sea-winds seeks to create a fiduciary relationship by disregarding the law Seawinds voluntarily agreed to accept as binding—the law of a state that also happens to be Seawinds’s own corporate domicile. To allow Seawinds to use California law in this fashion would further no ascertainable fundamental policy of California; indeed, it would undermine California’s policy of respecting the choices made by parties to voluntarily negotiated agreements.

Disposition

By a choice-of-law clause in a fully negotiated commercial contract, the parties have chosen Hong Kong law to apply to their dispute in this case, including each of the causes of action asserted by Seawinds.

Seawinds’s action is now proceeding based on its first amended complaint, which will be the focus of further proceedings applying Hong Kong law to resolve the parties’ differences. Therefore, the judgments of the Court of Appeal in the consolidated proceedings (Court of Appeal Nos. A049718 and A050535) are reversed, and the matters are remanded to the Court of Appeal with instructions to issue a peremptory writ of mandate directing the trial court to reconsider its ruling on Nedlloyd’s demurrer to Seawinds’s first amended complaint in light of applicable Hong Kong law.

Lucas, C. J., Arabian, J., and George, J., concurred.

Federal courts applying California’s conflicts law have also adhered to this approach. (Consul Ltd. v. Solide Enterprises, Inc. (9th Cir. 1986) 802 F.2d 1143, 1146-1147; S. A. Empresa, etc. v. Boeing Co. (9th Cir. 1981) 641 F.2d 746, 749; Sarlot-Kantarjian v. First Pa. Mortg. Trust (9th Cir. 1979) 599 F.2d 915, 917.) The mainstream nature of this approach is further reflected by a recent study indicating that 15 states other than California follow the general approach of the Restatement Second. (Chow, Limiting Erie in a New Age of International Law: Toward a Federal Common Law of international Choice of Law (1988) 74 Iowa L.Rev. 165, 190-191.)

There may be an exception to application of the Restatement approach. Choice-of-law issues arising from contracts subject to the Uniform Commercial Code are governed by California Commercial Code section 1105, subdivision (1), which provides that, subject to specified exceptions, the parties may choose the law of a state having a “reasonable relation” to the transaction. This “reasonable relation” test appears to be similar to the “substantial relationship” test we adopt from the Restatement. (See official code com. to U. Com. Code § 1-105 [Deering’s Ann. Cal. U. Com. Code, § 1105 (1986 ed.) p. 10; 23A West’s Ann. Cal. U. Com. Code, § 1105 (1964 ed.) p. 37].) Neither party to this action, however, contends that California Uniform Commercial Code section 1105 applies to their contract. We therefore need not and do not determine whether and to what extent, if any, the Commercial Code and Restatement approaches are different.

Subdivision (1) of section 187 of the Restatement states: “(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.” As comment c to section 187, subdivision (1) explains: “The rule of this Subsection is a rule providing for incorporation by reference and is not a rule of choice of law. The parties, generally speaking, have power to determine the terms of their contractual engagements. They may spell out these terms in the contract. In the alternative, they may incorporate into the contract by reference extrinsic material which may, among other things, be the provisions of some foreign law. . . . [M]ost rules of contract law are designed to fill gaps in a contract which the parties could themselves have filled with express provisions.” (Rest., § 187, subd. (1), com. c, p. 563.) The record in this case does not indicate that the parties incorporated by reference extrinsic material in the form of Hong Kong law in order to fill a gap in their contract. Subdivision (1) therefore is not at issue, and we need not and do not further consider its potential application or scope.

As noted above, a different result might obtain under Restatement section 187, subdivision (1), which appears to allow the parties in some circumstances to specify the law of a state that has no relation to the parties or their transaction. The Restatement gives these two illustrations: “4. In State X, A establishes a trust and provides that B, the trustee, shall be paid commissions at the highest rate permissible under the local law of state Y. A and B are both domiciled in X, and the trust has no relation to any state but X. In X, the highest permissible rate of commissions for trustees is 5 per cent. In Y, the highest permissible rate is 4 per cent. The choice-of-law provision will be given effect, and B will be held entitled to commissions at the rate of 4 per cent. [5] 5. Same facts as in Illustration 4 except that the highest permissible rate of commissions in X is 4 per cent and in Y is 5 per cent. Effect will not be given to the choice-of-law provision since under X local law the parties lacked power to provide for a rate of commissions in excess of 4 per cent and Y, the state of the chosen law, has no relation to the parties or the trust.” (Rest., § 187, subd. (1), com. c., illus. 4 & 5, p. 564; italics added.)

To be more precise, we note that Restatement section 187, subdivision (2) refers not merely to the forum state—for example, California in the present case—but rather to the state “. . . which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.” For example, there may be an occasional case in which California is the forum, and the parties have chosen the law of another state, but the law of yet a third state, rather than California’s, would apply absent the parties’ choice. In that situation, a California court will look to the fundamental policy of the third state in determining whether to enforce the parties’ choice of law. The present case is not such a situation.

There may also be instances when the chosen state has a materially greater interest in the matter than does California, but enforcement of the law of the chosen state would lead to a result contrary to a fundamental policy of California. In some such cases, enforcement of the law of the chosen state may be appropriate despite California’s policy to the contrary. (S. A. Empresa, etc. v. Boeing Co., supra, 641 F.2d 746, 749.) Careful consideration, however, of California’s policy and the other state’s interest would be required. No such question is present in this case, and we thus need not and do not decide how Restatement section 187 would apply in such circumstances.

As we have noted, the choice-of-law clause states: “This agreement shall be governed by and construed in accordance with Hong Kong law . . . .” (Italics added.) The agreement, of course, includes the choice-of-law clause itself. Thus the question of whether that clause is ambiguous as to its scope (i.e., whether it includes the fiduciary duty claim) is a question of contract interpretation that in the normal course should be determined pursuant to Hong Kong law. (S. A. Empresa, etc. v. Boeing Co., supra, 641 F.2d 746, 751 [interpreting choice-of-law clause pursuant to law chosen by the parties]; McGill v. Hill (1982) 31 Wn.App. 542 [644 P.2d 680, 683].) The parties in this case, however, did not request judicial notice of Hong Kong law on this question of interpretation (Bvid. Code, §452, subd. (f)) or supply us with evidence of the relevant aspects of that law (Bvid. Code, § 453, subd. (b)). The question therefore becomes one of California law. (Com 7 Ins. Co. of Newark v. Pacific-Peru Const. (9th Cir. 1977) 558 F.2d 948, 952; Rest., § 136, subd. (2), com. h, p. 378.)