Clients of architecture firms are increasingly mandating “prevailing party” contractual provisions that allow the successful party in a dispute between the client and the firm to recover legal costs as well as any damages. Often, architecture firms find such provisions acceptable because they assume that if they have to sue a client for a fee, they can recover their legal expenses. However, clients usually are in a much stronger financial position and use such contractual provisions to their benefit by transferring their often exorbitant legal costs to the architecture firm in any dispute between the parties (or threatening to do so), thus forcing the architecture firm into surrendering its fee or otherwise compromising its rights.
Contractually Assumed Obligations Are Not Covered as Damages
Firms should be aware that any agreement on the recovery of legal fees by the prevailing party is a contractual obligation a firm is free to assume. Professional liability insurance, however, will not cover the risk of the firm paying prevailing party costs to its client. As with all carriers, the professional liability policy issued by CNA excludes coverage for costs “arising out of the liability of others you assume under any oral or written contract or agreement, except that coverage otherwise available to you shall apply to your liability that exists in the absence of such contract or agreement.” Under U.S. common law there is no right to recover legal fees in contractual or tort litigation. This means that in any dispute between the parties to the contract, if the client attempts to recover its legal fees based on a contractual provision, the policy would neither defend the firm against such action nor pay on the firm’s behalf.
U.S. Law Does Not Recognize Legal Fees as Damages
With very few exceptions, attorneys’ fees are not generally awarded or recoverable as damages. There are a few statutory causes of action that may permit a prevailing party to recover attorneys’ fees as an element of damages. Except in these certain statutory situations, U.S. law is that each party in a contract dispute pays its own legal expenses.
U.S. contract law, however, allows the parties to a contract to create their own “private law” that could result in a party exceeding its normal legal liability. So a firm could gamble its assets on litigating a dispute with its client, but that does not change the firm’s insurance coverage or broaden the definition of damages covered by the policy. The issue as to whether the CNA policy would cover attorneys’ fees focuses almost exclusively on the basis for the award. That is, CNA will only cover liability (including liability for attorneys’ fees awarded as damages under statutory law) that would exist in the absence of a contract. There is no coverage for awards that are based on some contractual fee-shifting provision.
Prevailing Party Provisions Can Distort the Settlement Process
In addition to putting a firm’s assets at risk, a prevailing party provision creates another risk. The threat to the architecture firm of an uninsured obligation to pay the legal costs of the other party usually has a chilling effect on such actions as attempts to collect fees for professional services. Prevailing party provisions also often result in the coercion of the weaker party—the architect—by the financially stronger client. Even in a professional liability claim situation, there may be pressure to settle where there may be minimal liability simply to prevent the policyholder from being exposed to paying from its own assets the often inflated legal fees of the client. And if litigation is pursued to its conclusion, a client can find one cause of action, such as the missing of a milestone date or one forgotten design detail, on which it could prevail. Even any minor recovery by the client could be interpreted as the client prevailing. Then the client can exaggerate legal fees, and the jeopardy may be too much for the design firm.
Arbitration and Mediation Can Present Additional Risk
Mediation is an attempt to reach a negotiated settlement of a dispute. Therefore, there is no “prevailing party,” and any attempt by a client to have it designated as a prevailing party for the purpose of reimbursement of its legal fees disrupts the process and could cause the architecture firm to increase its contribution to any settlement. Although arbitration rules allow an arbitrator to grant any remedy or relief that is just and equitable and within the terms of the agreement of the parties, state arbitration laws modeled on the Uniform Arbitration Act follow the U.S. law’s prohibition of the award of attorneys’ fees in the absence of express contractual authorization.
However, there is always a problem when such a provision is tied to a mandatory and binding arbitration provision, since in determining an award, the arbitrator is usually not authorized to, and rarely attempts to, name a prevailing party. If in making an award to a party an arbitrator considers the dispute costs as part of the recovery to the party so awarded, there is no determination that legal fees were separately assigned. While most arbitration awards do favor one party over the other, the concept is different than in litigation. The arbitration provision should specifically state that the arbitrator must follow the contractual provisions and must determine, for the purpose of awarding costs, a prevailing party. If that is acceptable to both parties arranging the arbitration, the architecture firm must also recognize that such a component of an award would not be paid by professional liability insurance.
There Is No Prevailing Party in a Third-Party Claim
At times, a client might be sued by a third party seeking damages and alleging that the damages were caused by the negligence of the client’s architect. If the damages were the result of the firm’s negligence, U.S. law requires the negligent firm to rectify the damages. In some states, that measure of damages might include the legal costs of the client defending itself against a claim for which it has no legal responsibility. If the harm to a third party alleging negligence by the architect is determined during litigation in which the architect is found to have been solely negligent, the expenses of the “innocent” client might constitute damages under state law. If the client’s legal costs and other expenses of a third-party claim are recoverable under applicable law as damages to the client, they could be indemnified by the professional liability insurance coverage.
As with all contractual provisions, there may be statutory or case law issues affecting prevailing party provisions that should be addressed by local counsel.
Victor O. Schinnerer & Company, Inc. and CNA work with the AIA Trust to offer AIA members quality risk management coverage through the AIA Trust Professional Liability Insurance Program and Business Owners Program to address the challenges that architects face today and in the future. Detailed information about both these programs may be found on the AIA Trust website, www.TheAIATrust.com.