Can the Threat of Fees Discourage Unnecessary Fiduciary Disputes? Maybe...

The early stages of partner and shareholder relationships are about hope and promise, not discord and dispute. Yet, the earliest stage—and during the drafting of the partner or shareholder agreement—offer real opportunities to address and potentially discourage disputes.

One often-utilized approach comes in the form of fee- and cost-shifting provisions. At the highest level, such provisions are designed to force a potential litigant to thoroughly assess the likelihood of success prior to starting a legal dispute. But, as the case with most legal tools, the level of efficacy is somewhat nuanced.

A Typical Fee-Shifting Provision

Fee-shifting provisions will generally incorporate a range of potential legal proceedings and allow the prevailing party to recover reasonable fees and costs if such a proceeding is initiated. A common and not necessarily recommended example follows:

Fee Shifting: Should any legal action, arbitration, or proceeding be brought to enforce or interpret any provision of this Agreement, the prevailing party shall be entitled to recover reasonable attorney fees, court costs, and other expenses incurred in connection with such action, in addition to any other relief to which the prevailing party may be entitled.

Typically provisions like this are boilerplate and passed along, cut-and-pasted, without much thought or reflection. Yet, even in those cases, the provisions can provide some benefit, although tailoring them to individual circumstances can improve their relative value.

The Potential Benefit of Fee-Shifting Provisions

Attorney fee-shifting provisions telegraph the risks and costs associated with a legal dispute. Consequently, such provisions can discourage the most frivolous litigation because the parties to the agreement become motivated to engage in a meaningful risk assessment that includes the financial implications of the dispute if the matter is litigated to a final resolution. Such assessments provide a level of rationality in situations that are often highly emotional and driven by personal animosity.

Drafting Tip: Include some language that calls out the risks to the parties. For example, fee-shifting provisions should reference legal costs incurred from mediation, arbitration, litigation, and appeals until a final, non-appealable judgment is reached. The costs identified in this provision should also include, without limitation, attorney fees, expert fees, and court costs. These lists of examples declare what is at stake when a party wants to go to court.

Even when litigation is initiated, these provisions can have a “reasonableness influence” in that they can encourage parties to act more reasonable within the litigation to increase the likelihood that parties can recover their fees should they prevail and protect against losses should they not. When such provisions are most effective, they can lead to more efficient legal strategy and disincentivize petty legal tactics.

Drafting Tip: Most jurisdictions imply a covenant of good faith and fair dealing in every contract, which requires all contracting parties to act reasonable with one another. As a reminder of this obligation, fee shifting provisions should include clauses that require parties to act reasonably when prosecuting claims against one another and incur only those legal fees and expenses that are proportional to the needs of the case. A reasonableness standard also increases the odds of courts enforcing fee shifting provisions.

Fee-shifting provisions can also encourage settlement at many stages of litigation. Early phases of the proceedings present the parties with the opportunity to preserve unspent resources and control the outcome. In later phases, each party needs to assess the reality that the fees and costs incurred over the entire litigation could become their responsibility. Such uncertainty can encourage a pragmatic rationality that leads to the parties taking the outcome into their own hands and working together to minimize the looming risk that could become any respective party’s ultimate responsibility.

The Maybe

Some aspects of fee-shifting provisions are more nuanced. Most notably, many laud fee-shifting provisions for accomplishing a sort of “leveling the playing field” and potentially balancing financial burdens where a party with a viable claim is under-resourced. That said, a party can only realize this benefit by seeing a matter through to the end, prevailing, and then convincing a court that their fees and costs were reasonable. In addition, in some cases, the party with more financial resources might use fee shifting as a strategic advantage, pressuring the other party to settle despite the merits of the case.

Common aspects of fee-shifting provisions can also implicate their efficacy. For example, the deceptively simple question of what it means to be a prevailing party can present myriad complications. If you prevailed on three of your five claims, are you wholly a prevailing party? If you prevailed on all your claims, but your damages were de minimis, are you wholly a prevailing party? If you were found to have breached a duty, but there is no damage, who is the prevailing party?

And then there is the related question of what constitutes reasonable fees and costs and whether they were incurred in connection with the action on which one has prevailed. Practically speaking, for the small percentage of cases tried to a verdict, determination of fees and costs presents an additional and potentially onerous stage of the litigation with a range of attendant risks. Such risks include limited fee recovery and a round of expensive appellate proceedings associated with the fee award, among other things.

Conclusion

Ultimately, fee-shifting agreements can discourage frivolous litigation, promote a degree of fairness, incentivize settlement, and encourage reasonable behavior during disputes. That said, they are not a panacea, and parties and potential parties should not be overly taken in by their ultimate impact. In addition, depending on the specific circumstances, careful attention to aspects of such provisions can increase the likelihood that they are a net positive for all parties to the agreement should things not turn out the way they had hoped.