Prevailing Party: The Contractual Booby Trap
A contractual booby trap often overlooked is the “prevailing party” clause. This contractual term shifts the risk and expense of disputes and legal proceedings in ways that not only harm the bottom line, but also limit leverage and options when faced with adversarial claims.
The United States largely follows the “American Rule” when it comes to legal fees. This rule requires each party to a dispute pay their own lawyers, consultants and representatives. Despite that, virtually every state also allows contracting parties to define how fees and costs will be borne if there is a dispute on the contract. These terms are usually called prevailing party clauses.
On their face, prevailing party clauses seem reasonable. The concept is that by increasing cost risk frivolous claims are discouraged and parties are less likely to default to legal proceedings. In the real world, these clauses are often abused and can present “bet-the-company” risks to small trades like glaziers. These risks come from the fact that the prevailing party terms are often vague, failing to define who prevailed and what fees are awarded, and are even hidden throughout contracts.
The most common problem with these provisions rests in the failure to sufficiently define which party “prevailed” in a dispute. Where a claim is decided fully in favor of one party, the situation may be clear. In others, a party might feel it “prevailed” when it defended a claim but the award was only a fractional share of the original demand. In that situation, the defending party may still be required to pay the other side’s legal fees simply because it had to pay out on the claim, regardless of common sense.
Which fees are covered?
Another risk is the failure to specify what fees are subject to award. Expenses in lawsuits or arbitrations are large and come from sources beyond lawyers. Court costs, experts, arbitrator fees and exhibits are just a few of the varied cost items that come with bringing or defending legal proceedings. There are few limitations on the scope of what can be recovered where a prevailing party clause does not define what costs are included or excluded.
Are the clauses hidden?
Prevailing party clauses are also risky because they are often hidden in other clauses or do not have an easily identifiable heading. Language addressing fee recovery can be built into numerous sections of contracts and repeated multiple times throughout an agreement. For example, indemnity and “ADR” clauses often each have their own prevailing party language. So too can pricing disputes and change order provisions.
Beyond these drafting concepts, the simple presence of prevailing party fee exposure can impact options. Even where the clause is well-drafted, the additional cost exposure can impact claim strategies by limiting activities to manage potential cost exposure. These clauses can also influence overall value, with parties paying too much or getting too little simply to avoid fee exposure. Add to that the complexities surrounding whether prevailing party fees are covered by insurance, and the bottom-line risk is clear.
Take care with the contract
While seemingly reasonable, the realities accompanying prevailing party clauses are complex. Moreover, the only real way to address those complexities lies in the contract itself. Careful attention to these clauses and their active negotiation should be as sensitive as other, more familiar risk terms like insurance and indemnity.
The best scenario is where prevailing party fee terms are removed from an agreement. This is the most equitable position and places the parties on equal footing. While one side may suggest that prevailing party exposure is needed to dissuade frivolous litigation, a reasoned response is simply why they think litigation must result. Parties are often sufficiently motivated to simply do good work to avoid litigation.
If the clause remains in place, the risks noted earlier must be addressed. Care must be taken to specify who is the “prevailing” party in any dispute. Contractual disputes rarely result in a clear success for one side, so the contract must address that potential. Better prevailing party clauses also anticipate things like cross-claims, dollar-value thresholds and dismissal values within their definition of who is entitled to an award of fees.
Likewise, and while not all costs can be identified, managing prevailing party exposure is helped by specifically defining included and excluded costs. Given the variety of costs that can accompany a dispute, negotiations on this point are often easier when there is an agreement to specifically identify recoverable costs, and everything else is disclaimed.
And where faced with huge contracts, careful review is required to ensure all prevailing party clauses have been identified. Admittedly, this can be a lengthy review. Even so, the effort to identify these clauses early can realize a reasonable return on investment by limiting prevailing party exposure at a later date.