July 15, 2015 – In most American litigation, parties are responsible for paying their own litigation expenses, including attorneys’ fees, regardless of the outcome of a case.

This “pay-your-own-way” rule applies with equal force to claims arising on construction projects, subject to narrow exceptions. For example, a party who successfully prevails on a lien claim is entitled under the statutes to recovery of its attorneys’ fees.

By and large, however, the parties know going in that any litigation that ensues will be an expensive cost of doing business. This can be a severe penalty for a party who is plainly wronged by another. It can also be a powerful lever to a party making a non-meritorious claim to force meaningful settlement funds out of the other, who would otherwise necessarily have to spend the funds to defend itself.

Changing the Balance

The parties to construction contracts have the ability to change this balance by simply agreeing to the contrary if it makes sense in the context of a particular project.

In simple terms, parties can agree in their base contract that, for all claims arising on the project, the prevailing party is entitled to recover its litigation/arbitration expenses from the nonprevailing party. There are several important advantages to this approach.

First and foremost, “prevailing party” clauses serve as a powerful deterrent to litigation. For example, parties who prudently weigh the strengths and weaknesses of potential claims before commencing a legal proceeding might be less inclined to bring a lawsuit knowing that they are contemporaneously taking on the risk of paying the other party’s attorneys if they are wrong.

Second, such clauses often assist in the settlement process because they serve as a two-way lever that has the tendency to make both parties more reasonable. Third, at least an argument can be made that the objective of fundamental fairness can be best achieved by allocating the risk of the transactional costs of litigation to the party who is culpable in the first place. For these reasons, parties who traditionally were adverse to even considering such a change are frequently agreeing to exactly that.

Prevailing Party?

Unless properly drafted, however, such clauses can create problems in and of themselves. Let’s start with the simple definitional question of who is the prevailing party? This would be an easy question to answer in a case posing the single issue of which party is at fault for a nonconforming condition and, thus, is responsible for paying the costs to repair. But often, construction obligation is far more complicated.

For example, let’s say a contractor brings a “change order” claim against an owner to recover $5 million of additional costs brought about by an allegedly differing site condition. The owner acknowledges some funds are due, but substantially less.

After substantial litigation, the judge finds that the contractor is entitled to relief in the amount of $150,000. Is the contractor the prevailing party such that the owner must now pay not only the $150,000 for scope changes, but also the $750,000 spent by the contractor for attorneys’ and experts’ fees? Or has the owner prevailed because the contractor only succeeded in proving $150,000 of its $5 million claim?

And what if the owner has made counterclaims, winning a $100,000 judgment in its favor on those counterclaims? Who then is the prevailing party? The unfortunate reality is that these issues, by themselves, can often lead to further litigation, only further increasing the costs and the time to achieve closure for everyone.

A second potential risk relates to the specific items and amounts of costs that the prevailing party ultimately seeks to recover. Typically, after receiving an award, the prevailing party would then make a motion for an added award of its litigation expenses.

At that juncture, and without further guidance from the contract, the sky is the limit. It is not unusual for the prevailing party to claim, in addition to its attorneys’ and expert fees, all of its “internal costs,” sometimes defined as the salary value of every employee involved in the effort, together with technical support. This, too, often takes on an expensive litigation life of its own.

Careful Drafting

These problems can be avoided, at least in part, by careful drafting. A well-articulated definition of “prevailing party” is a must. For example, the parties could define the term to mean a party who achieves a fixed percentage (say, 75 percent) of the amount claimed. Or they could agree that the judge or arbitrator has the power to determine who is the prevailing party, subject to some definitive parameters set forth in the contract.

Second, some attempt to identify in the contract what is recoverable by the prevailing party goes a long way to fending off disputes later. For example, there might be a limit on attorneys’ fees (say, 10 to 33 percent of the recovery) or even simply through use of the word “reasonable.” Certain categories of expenses can be expressly excluded, like internal costs or mark-ups on subcontractor charges.

If the right drafting is done on the front end, the advantages discussed above can be preserved while minimizing the risk of the above problems.