Recent Developments on Prevailing Party Attorneys’ Fees In Construction Disputes: Erosion of the American Rule

It has long been the default rule in the United States that, absent a contract provision or statute expressly allowing for an award of attorneys’ fees, each party to a dispute – litigation or arbitration – pays its own attorneys’ fees. This is often referred to as the “American Rule”. While the American Rule remains the default and predominant rule for disputes in the United States, the construction industry seems to have experienced a noticeable shift in recent years. Construction legislation, arbitration rules, and contracting strategies have taken steps away from the American Rule and towards a “winner-take-all” approach when it comes to attorneys’ fees. This article highlights some of the trends that encourage prevailing party attorneys’ fees provisions in construction industry disputes.

Under the American Rule, from a trial victor’s perspective, even when justice is served and the plaintiff wins – plaintiffs are rarely made whole due to the expense of litigation. Often times, attorneys’ fees and costs significantly erode the victor’s judgment or award. Critics of the American Rule often point to the weaponization of attorneys’ fees by parties in a superior financial position. Those parties can increase litigation costs and make pursuit and recovery of a claim unfeasible or not worth the opportunity cost in time and money due to the expense of litigation. The threat of extensive litigation without a prevailing party attorneys’ fee provision can force a claim to be dropped or settled at a significant discount. Not lost on many plaintiffs in this situation is that the very claim they are bringing likely may have caused their financial predicament resulting in a dropped or significantly reduced claim. Further, the American Rule discourages litigation absent a sizeable claim because the attorneys’ fees incurred to recover on the claim can subsume smaller claims.

The American Rule is contrasted to the winner-take-all approach to litigation followed by most of the world outside the United States, where the prevailing party is awarded its attorneys’ fees. In theory, when fees are awarded to the winning party, plaintiffs are made whole with the recovery of their attorneys’ fees and prevailing defendants are made whole by recouping the attorneys’ fees they should never have been forced to incur. In practice, determining whom, if anyone, is the prevailing party can be difficult and parties can use the exposure and unpredictability of an attorneys’ fees award during settlement negotiations.

Legislation Favoring Prevailing Party Attorneys’ Fees Provisions

In 2016, in amending the Illinois Mechanics Lien Act to allow for lien substitution bonds on private projects, the Illinois legislature included a mandatory prevailing party attorneys’ fee provision for such disputes. Previously, Illinois was one of the few states that did not allow owners to “bond over” mechanics liens. Now, in Illinois and the vast majority of states that permit bonding-over of lien claims, a surety bond protects and prevents the owner’s property from being foreclosed upon. Instead of foreclosure proceedings, the lien claimant may recover the funds due and owing on a lien claim from a surety bond. While the amendment applies only to statutorily-compliant lien substitution bonds, its enactment greatly expands prevailing party attorneys’ fees liability on construction disputes as many construction payment disputes involve bonded-over lien claims.

Before the amendment, the Illinois Mechanics Lien Act allowed recovery of prevailing party attorneys’ fees only under circumstances of wrongful non-payment, “without just cause or right” – and even then, such recovery could only be made against the owner of the property. The Legislature’s recent amendment provides that when a lien substitution bond is obtained under the Illinois Mechanics Lien Act, the bond automatically triggers a prevailing party attorneys’ fee provision. Illinois Appellate Courts have not opined on whether parties can agree to waive this provision. As such, even parties that do not want a prevailing party attorneys’ fee provision or may not be aware of the automatic nature of the provision, are litigating under a prevailing party attorneys’ fee provision every time they bond over a mechanics lien.

As the vast majority of construction disputes involve lien claims and because owners (or their lenders) nearly uniformly require the bonding-over of mechanics lien claims when liens are recorded on the property, the effect of the amendment is to insert a prevailing party attorney’s fees provision into many construction disputes where there otherwise is no such prevailing party provision.

To avoid abuse of a prevailing party attorneys’ fee provision and ensure fees are reasonably related to the amount in dispute, the Illinois legislature tied the amount of recovery of attorneys’ fees to the value of the lien claim. The prevailing party clause in the Illinois Mechanics Lien Act provides that if the claimant is awarded at least 75% of the amount claimed, it is entitled to recover reasonable attorneys’ fees up to the penal sum of the bond remaining after payment of the award plus interest. The bond principal, on the other hand, becomes the prevailing party only if the claimant is awarded less than 25% of its claim, in which case the principal may recover attorneys’ fees up to 50% of the claim.

Legislators outside of Illinois also have passed statutes to include prevailing party provisions involving construction disputes. Most notably, the Texas legislature passed a statute allowing prevailing party attorneys’ fees on all breach of contract cases. As nearly all construction disputes include breach of contract claims, in Texas the losing party to a construction contract dispute must pay the other side’s attorneys’ fees regardless of whether the parties agreed to a prevailing party attorneys’ fee provision in their contract. Legislatures across other jurisdictions have enacted statutes that provide for prevailing party attorneys’ fees specific to construction claims as well, such as certain public works statutes and fraud claims.

Arbitration Rules Providing For Prevailing Party Awards

Due to the complex and fact-intensive nature of most construction disputes, many construction contracts contain arbitration provisions. In electing arbitration over litigation, the parties often do not intend to open the door to a prevailing party attorneys’ fees award. An agreement to arbitrate is not an agreement to a prevailing party attorneys’ fee provision. Under the Federal Arbitration Act and other state equivalents, there is no right to prevailing party attorneys’ fees in arbitration. However, some of the most frequently used arbitration organizations, most notably the American Arbitration Association (“AAA”), have arbitration rules that allow for and seemingly encourage prevailing party attorneys’ fee awards.

For example, the AAA’s case initiation forms encourage parties to agree to a prevailing party attorneys’ fee provision at the time the dispute is initiated. For every AAA case, the party initiating the arbitration prepares a 1-page AAA form arbitration demand. The form has a box for the party to check if it is requesting an award of attorneys’ fees. Several jurisdictions have confirmed that when both parties “check the box” under the AAA Construction Industry Arbitration Rules, the parties have empowered the arbitrator(s) with the discretion to award attorneys’ fees to the prevailing party.

The effect of the AAA rule and the convenience of the box on the initiation form is to encourage prevailing party fee awards. While many parties intentionally check the attorneys’ fees box seeking mutual agreement for an award of prevailing party attorneys’ fees, some parties check the box without even realizing they may be triggering a prevailing party attorneys’ fee provision. This can result in one or more parties unintentionally agreeing to a prevailing party fee award. The unintentional checking of the box occurs because it is common and even customary in litigation pleadings to request attorneys’ fees even if there is no obvious entitlement for such fees. Attorneys often include a boilerplate attorneys’ fee requests in court-filed complaints because there is no consequence in court for requesting such fees and the request often serves as a reservation of rights if a path for a fee award is discovered after filing the complaint.

Attorneys and clients should carefully weigh the pros and cons of checking the box each time they initiate or respond to a AAA arbitration demand. In short, the AAA’s decision to include the attorneys’ fee box on its 1-page demand and its rule seemingly empowering arbitrators to award attorneys’ fees if such fees are mutually requested, may result in parties arbitrating cases under the winner-take-all approach even when there is no path to such fees in the applicable statutes or contract.

Prevailing Party Attorneys’ Fees Provisions In Contracts

When owners, architects, and contractors enter into their contracts, they often – and should – address whether they want to allow for prevailing party attorneys’ fees in the event of a dispute. In accordance with the American Rule, prevailing party attorneys’ fees provisions exist only if both parties agree to the provision. The construction contract forms most frequently used as the starting point for negotiations are the AIA Contract Documents, EJCDC Contract Documents, and ConsensusDocs. As parties often do not negotiate each and every provision, the contract form’s default provisions are often the final terms of the parties’ agreement or lead to the negotiated compromise. Historically, none of the form construction contracts included a prevailing party attorneys’ fees provision. This has recently changed.

Recently, ConsensusDocs revised its construction contract forms to default to the winner-take-all approach and include prevailing party attorneys’ fee provisions. ConsensusDocs expressly stated that its reason for the change was because it believed prevailing party fees encouraged settlement. See ConsensusDocs Guidebook, page 18 of 163 (2019). Whether prevailing party fee provisions encourage settlement of a dispute is a hotly debated topic and one for which the answer often depends on a number of case specific factors.

Notably, unlike in the AAA setting where the decision to include a prevailing party fee provision is made at the time of initiating the formal dispute process so that the parties likely have significant information as to what issues will be prosecuted – the decision as to whether to include a prevailing party attorneys’ fee provision in a contract is based on far less information. At the time of contracting, claims arising out of the terms of the contract are unknown and entirely hypothetical. Whether to include a prevailing party provision in your contract is a strategic decision that should take into account a number of variables including the size and complexity of the project, financial wherewithal of the contracting parties, complexity of the services provided, history of dealings with the contracting party, litigious history of the contracting party, and other project-specific and party-specific considerations.

Importantly, for parties that decide to include the prevailing party fees provision in their contracts, they should also include a definition of prevailing party. Absent a definition, courts have struggled with determining which party is the prevailing party and the trial court or arbitrator has great discretion to determine whom, if anyone, is the prevailing party. The definition should include a percentage of recovery and language defining what it means to prevail on the claim. For example, a common definition for prevailing party requires the plaintiff to be awarded “all or substantially all of the disputed amount.” That language discourages plaintiffs from inflating their claims and/or benefiting from a potential prevailing party attorneys’ fee award when they prevail on a small portion of their claim. A definition should also be included for when the defendant should be deemed the prevailing party and whether, given multiple claims, the claims should be addressed separately or cumulatively.

The AIA and EJCDC forms have not defaulted to include a prevailing party attorneys’ fee provision. However, parties can elect to modify the form contracts and include a prevailing party attorneys’ fee provision and prevailing party definitions.

The Future of Prevailing Attorneys’ Fees Provisions

Attorneys’ fees are often significant and can exceed the amount in dispute. Prevailing party attorneys’ fee provisions have the potential to dramatically alter the calculus of whether to settle a dispute or even pursue a claim. This is especially true of construction cases, which are often fact, document, and witness intensive. While some believe that prevailing party provisions increase the likelihood of settlement due to the increased risk exposure on the parties, others maintain that such provisions merely embolden plaintiffs or defendants whom are adamant that they will prevail. The debate will continue and the answer often lies in each construction industry participant’s unique and specific circumstances. However, all construction industry decision-makers should be keenly aware of the above-highlighted trends towards prevailing party fee provisions and should take the time to consider the pros and cons of prevailing party attorneys’ fees provisions in every contract negotiation, arbitration, or potential dispute. Attorneys’ fee provisions should not be ignored because the consequences of prevailing party attorneys’ fees awards can be severe or highly beneficial, depending on whether you prevail on a claim.

Recent Developments on Prevailing Party Attorneys’ Fees In Construction Disputes: Erosion of the American Rule

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