The "American Rule" for Attorney Fees and what to do about it.

Spring 2015 Article

THE "AMERICAN RULE" FOR ATTORNEY  FEES AND WHAT TO DO ABOUT IT.

I. Introduction

Consider the following situation. A European company sells $30,000 worth of goods or services to a company in California pursuant to a purchase order prepared by the European company. After making a few payments, the Californian company stops making payments leaving the European company with an unpaid $20,000 balance.

What can the European company do to enforce its claim? Of course, it may hire an attorney and file a lawsuit, but before the suit is resolved, any recovery will likely be exhausted in attorney fees and litigation costs. And, much to the surprise of the European company who are likely accustomed to having these fees recoverable as part of a judgment against the debtor, under the "American rule", the attorney fees incurred to enforce this claim are not recoverable unless the European company made that an express condition of its agreement to provide services.

II. American Rule v. European Rule

The "American rule" for attorney fees incurred in litigation is straightforward: unless the contract between the parties or a statute states otherwise, each party in the lawsuit must pay for its own attorney fees. To put this in another way, regardless of who wins the lawsuit, there is no basis for "fee-shifting" from the prevailing party to the losing party.

In contrast, the "European rule" is the reverse; it is the so-called "loser pays" rule for litigation. Consequently, the losing party in litigation must not only pay whatever judgment is awarded against it, but it is also responsible for the attorney fees of the other party.

III. Rationale

The rationale of the European rule is obvious. If a party must potentially bear the burden for the other party's attorney fees, then it will consider much more carefully whether the risk of the lawsuit is worth the potential recovery. As such, this basic "fee-shifting" rule discourages frivolous lawsuits and, for more meritorious claims, encourages both parties to explore fully the potential for settlement before employing aggressive and expensive litigation tactics.

In contrast, the intent of the "American rule" is the opposite. In true democratic fashion, the American rule favors access to courts for all potential litigants instead of discouraging lawsuits. Similarly, the American legal system also permits the related concept of contingency fees, where the plaintiff in a case such as a personal injury claim or employment claim can have an attorney finance his/her litigation costs and then pay the attorney fees by assigning to the attorney a percentage of the recovery, which can often be multiples larger than the fees would be if paid hourly (however, the attorney assumes the risk of success at trial). By doing this, the system favors access to the courts by allowing a party without resources to file a lawsuit without a threat that they will be held responsible for a large award of attorney fees, which a litigant with more resources could bear much more easily.

IV. Concerns for foreign businesses operating in U.S.

The American Rule can cause difficulties for businesses operating in the United States in two significant ways. First, as suggested in the introduction of this article, a party may find itself with a valid claim for breach of contract or for collection of debt, but they are unable to enforce it without spending more than the claim itself is worth. This problem can be compounded by the fact that an "experienced" and unethical debtor can exploit this situation by refusing to pay the debt because he knows that the cost of enforcement is prohibitive.

Even more concerning, a business could find itself in the position of defending a claim where the opposing party faces minimal cost to pursue the claim, but can burden the business disproportionately through the litigation process. This situation can be of particular concern in situations such as a claim by an employee or former employee, where the plaintiff's counsel can conduct "scorched earth" tactics such as taking depositions of officers and personnel, serving extensive written, etc., but the employer has no equivalent measures because the employee can only be deposed once and does not have the record-keeping requirements of a business.

V. Ways to Mitigate

Fortunately, with a minimum of planning, a business can position itself better to both prosecute and defend potential claims. First, the business should insure for all reasonable insurable losses. These insurable losses include not merely commonly insured losses like general liability or workers' compensation losses, but also more specific claims like employment liability. By doing this, a business cannot prevent the litigation, but it can make another party - the insurer - pay for the litigation costs and potential awards.

However, a business can also protect itself, particularly in the commercial context, by including in all of its contracts a "prevailing party" attorney fee clause. Then, if litigation is necessary, the party may not only recover its claim for damages, but the costs of pursuing that claim as well.

If we consider the same situation that with which we began this article, but instead assume that the European company includes a "prevailing party" attorney fee clause in its contract, the outcome is likely quite different. In that instance, not only would the company have an opportunity to recover its fees if litigation is needed, the debtor company is also much more likely to pay its debt and avoid litigation. With the addition of just a few lines of text to its agreement, the company has increased its likelihood of being paid in full - and avoiding litigation - considerably.

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Requests for information or insights on this issue may be addressed to michael.purcell@vallalaw.com.

This article is for information purposes only and does not constitute legal advice. The information contained herein may be outdated or incomplete, and shall in no way be taken as an indication of future results. The transmission of this article is not intended to create, nor its receipt constitutes, an attorney-client relationship between sender and receiver. You should not act on the information contained in this article without first seeking the advice of an attorney.



[1] Michael Purcell, Esq. (michael.purcell@vallalaw.com) Associate Counsel at Valla & Associates Inc., P.C. (www.vallalaw.com).