Saturday, July 14, 2007

Business Law - Important Clauses for Small Business Contracts - Fee Shifting

I find myself explaining the “American Rule” on attorneys’ fees at least a couple of times per week, mostly to the owners of small businesses who need to bring collection claims against customers. Under the “American Rule,” each party to a dispute pays its own attorneys’ fees, whether that party wins or loses the case. This is in contrast to the “English Rule.” Under the English Rule, the loser in the dispute pays the winner’s legal fees.

In the United States the American Rule is the law, and you can only recover your legal fees in very limited situations: (1) where you have an agreement providing that the loser pay legal fees; (2) where a statute provides that the loser pays (for example: civil rights cases, consumer protection act cases); or (3) where a party acts in bad faith or without substantial justification.

Because we operate under the American Rule, one of the most important clauses that any business can have in its agreements is a clause mandating that the losing party in any dispute must also pay the winning party’s legal fees and costs. A sample “fee-shifting” clause is as follows: "The prevailing party in any dispute arising out of or related to this agreement shall be entitled to an award of its reasonable attorneys’ fees and costs."

This type of clause is so important because of the situation that occurs without it. If your business is owed $15,000.00 by one of its customers, and you bring your case to your lawyer to file suit, your lawyer is likely to tell you that the legal fees could be $5,000.00 to bring that matter through your local court system from filing through trial. As a result, immediately the value of your claim is arguably diminished by the cost of bringing the claim: reducing your best case scenario to $10,000.00.

By contrast, if you have a fee-shifting provision in your customer agreements, then the value of your claim is not automatically diminished by your expected legal fees. Instead, if you prevail in your case, then your best case scenario is a $15,000.00 award for your underlying collection claim, plus a possible $5,000.00 attorneys’ fee award.

It makes sense, particularly for the small business owner, to have a business lawyer review your standard contracts to make sure that those contracts include fee-shifting clauses. This is particularly so in those contracts that would form the basis for collecting your company’s revenues.

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