17 Jun Don’t Forget That Litigation Clause in Your Commercial Contracts

In our last two blogs, Edwards Law has discussed ways of drafting your contracts to effectively exit a commercial real estate joint venture and how to dispose of commercial real estate interests via a Section 1031 Exchange.  However, if you are interested in growing your existing business and preventing financial ruin, you and your business can also use creative and important contract-drafting solutions to minimize litigation about your company’s business contracts and ensure financial success.

A standard provision that you and your business must include in all commercial contracts is a “litigation” clause, which allocates litigation costs and expenses to the losing party in a dispute about your contract by requiring the losing party to reimburse the prevailing party for the prevailing party’s litigation costs and expenses.  Litigation costs and expenses typically consist of attorneys’ fees, court costs, and other expenses.  Including such a litigation clause in your business contract can motivate the parties to settle disputes whenever possible because it provides an economic disincentive to the parties against bringing frivolous lawsuits and unnecessarily protracting lawsuits that the parties should be able to easily settle out of court.

While some businesses, depending on the nature of the parties to a contract and the transaction (typically, the party that is more likely to be defending a lawsuit) sometimes choose to exclude a litigation clause to deter the other party from bringing meritorious claims, it is not recommended that you avoid this provision because disputes inevitably happen, and your company must try to minimize any damages resulting from such disputes.

Bases for Recovery of Attorneys’ Fees and Scope of Standard Litigation Clause

‌Attorneys’ fees are typically the largest component of the cost of pursuing or defending litigation. Colorado courts generally follow the “American Rule,” where each side is responsible for its own attorneys’ fees.  However, a party to litigation may be able to recover its attorneys’ fees if a statute allows for attorneys’ fees; the claims or defenses are frivolous; or if a contract provides for recovery of attorneys’ fees.

‌Colorado courts generally enforce litigation clauses in business contracts that clearly specify the allocation of litigation expenses between parties.  In a typical clause, the losing party in litigation agrees to reimburse the prevailing party for all of the prevailing party’s litigation costs and expenses, including attorneys’ fees, court costs, and other expenses.

Also, the standard litigation clause typically applies only to litigation costs and expenses and does not apply to transaction costs such as the costs to investigate the merits of entering into the transaction (also referred to as due diligence), or negotiating, drafting and closing the transaction.

Sample Litigation Clause

A good sample litigation clause looks like this:

Litigation Costs and Expenses. If any party institutes any legal suit, action, or proceeding against the other party [to enforce this Agreement (or obtain any other remedy regarding any breach of this Agreement)/arising out of[ or relating to] this Agreement, including, but not limited to, contract, equity, tort, fraud, and statutory claims], the prevailing party in[ a final, non-appealable judgment regarding] the suit, action, or proceeding is entitled to receive, and the non-prevailing party shall pay, in addition to all other remedies to which the prevailing party may be entitled, the costs and expenses incurred by the prevailing party in conducting the suit, action, or proceeding, including [reasonable/actual] attorneys’ fees and expenses[,/ and] court costs[, and [OTHER EXPENSES]], even if not recoverable by law[ (including, without limitation, all fees, taxes, costs, and expenses incident to appellate, bankruptcy, and post-judgment proceedings)].

Other Matters to Address in the Litigation Clause

You and your business should also consider whether and to what degree the litigation clause should address the scope of claims, and whether you and your business want to recover actual versus reasonable attorneys’ fees, court costs, and other expenses. Keep in mind however that despite your litigation clause language, the amounts of these awards may be limited by statute or within the judge’s discretion.

For example, while courts may base actual fees on the actual hours expended by your attorney and your attorney’s customary hourly billing rate, in determining reasonable fees, courts use their discretion by implementing a “reasonable-hours-times-reasonable-rates” formula and may also consider:

• the time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly;
• the likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;
• the fee customarily charged in the locality for similar legal services;
• the amount involved and the results obtained;
• the time limitations imposed by the client or by the circumstances;
• the nature and length of the professional relationship with the client; and
• the experience, reputation, and ability of the lawyer or lawyers performing the services.

You can also draft a litigation clause to request the recovery of fees, costs, and expenses associated with judgment enforcement, including, “without limitation, all fees, taxes, costs, and expenses incident to appellate, bankruptcy, and post-judgment proceedings.”  Recovery of costs and expenses are not normally recoverable, but Colorado allows parties to contractually provide for cost allocation.

Lastly, your litigation clause can also detail the degree to which a party must prevail.  When a claim exists for a violation of a contractual obligation, the prevailing party, for purposes of awarding attorneys’ fees, is normally the party in whose favor the court renders a decision or verdict on liability.  However in cases involving multiple claims, some of which are successful and some of which are not, trial courts have broad discretion to determine which party, if any, is the prevailing party; and whether costs should be awarded.  A party may be a prevailing party even when the damages actually awarded to that party are nominal or significantly less than those requested.  You and your attorney should be careful to draft the clause to specify the degree to which the party seeking to recover litigation costs and expenses must prevail.  For example, your attorney can draft the litigation clause to define “prevailing party” as the party that (1) prevails on all of its claims or (2) prevails on just some claims or (3) wins the trial on the merits (rather than settlement its claims, even if the settlement award is substantial).

If you and your business are in the process of drafting business contracts or you are interested in revising your business’s current business contracts, call Edwards Law today to get a head start on the process.  The first call is free, so you have nothing to lose—but potentially your business to expensive and protracted litigation.