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Court of Chancery Enforces Contractual Fee-Shifting Provision

August 8, 2012
Lewis H. Lazarus
Delaware Business Court Insider

A contract provision in a limited liability company agreement that entitles the prevailing party to reimbursement for all reasonable fees and costs in connection with enforcement of the agreement, including reasonable attorney fees, is not unusual. In defending against such a claim, a nonprevailing party may challenge whether the claims arose under the agreement, whether expenses incurred in related litigation in other courts merit reimbursement and whether the fees are reasonable in light of the comparable fees and rates of the nonprevailing party. Sometimes a question arises, where similar issues exist involving substantially similar contracts but different parties, of whether the court must allocate the fees among the separate parties. What is unusual is for all of these issues to be addressed in one opinion. The Court of Chancery's recent decision in ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, 2012 WL 3027351 (Del. Ch. July 9, 2012), does just that and provides important guidance to practitioners regarding the nature of a claim for breach of the implied covenant of good faith and fair dealing and enforcement of contractual fee-shifting provisions.

BREACH OF THE IMPLIED COVENANT

"A claim for breach of the implied covenant is a contract claim, requires proof of breach-of-contract elements and yields contract remedies," the court held. In so holding, the ASB court rejected the defendants' argument that the implied covenant was outside the fee-shifting provision, which related solely to enforcement of the contract (and hence not to claims for breach of fiduciary duty or sounding in tort). A defendant had asserted a counterclaim and contended that a plaintiff was contractually liable for all reasonable fees and costs for violating the implied covenant of good faith and fair dealing by failing to maximize revenue in a real estate venture governed by a limited liability company agreement that included the fee-shifting provision. A defendant having asserted its own right to contractual fee-shifting, the court gave short shrift to its arguments that the plaintiff who prevailed in defending against its counterclaim was not similarly entitled. The court's discussion of why the counterclaim sounded in contract is what gives the case significance beyond the parties' immediate dispute.

The court emphasized that a contract claim for breach of the implied covenant differs from a tort or breach of fiduciary duty claim. The latter focus on the parties' relationship when the alleged breach occurs; the former asks "what the parties would have agreed to themselves had they considered the issue in their original bargaining positions at the time of contracting." In addition to this temporal difference, the court explained that the "good faith and fair dealing" components differ from those terms as used in the fiduciary context:

"'Fair dealing' is not akin to the fair process component of entire fairness, i.e., whether the fiduciary acted fairly when engaging in the challenged transaction as measured by duties of loyalty and care whose contours are mapped out by Delaware precedents. It is rather a commitment to deal 'fairly' in the sense of consistently with the terms of the parties' agreement and its purpose. Likewise 'good faith' does not envision loyalty to the contractual counterparty, but rather faithfulness to the scope, purpose and terms of the parties' contract. Both necessarily turn on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally."

IMPLIED COVENANT AFFECTS EXERCISE OF DISCRETIONARY RIGHTS

In assessing a claim for breach of the implied covenant, the ASB court directs once again that a court look back to the parties' expectations at the time of contracting. The duty is not "free-floating"; compliance with the requirement to reasonably exercise discretion is measured by the expectations of the parties at the time of contracting. The court recognized that express contractual provisions control, but that "even the most carefully drafted agreement will harbor residual nooks and crannies for the implied covenant to fill." While proof of a culpable mental state may suffice to prove breach of the implied covenant, scienter is not required. In the absence of an anti-reliance clause applicable to the challenged conduct, "proof of fraud violates the implied covenant, not because breach of the implied covenant requires fraud, but because 'no fraud' is an implied contractual term." Based on these principles, the court concluded that the defendant had stated a claim for breach of the implied covenant that sounded in contract, that plaintiff was required to defend against it to prevail and had in fact prevailed, and hence the fee-shifting provision applied.

FEE-SHIFTING REQUIRED DEFENDANTS TO REIMBURSE PLAINTIFFS

Each of the three defendants in the Delaware action had filed separate federal actions to enforce substantially identical limited liability agreements involving three different properties. Plaintiffs in the later-filed Delaware action sought reformation of the LLC agreements in Delaware. The defendants refused to stay the federal actions pending resolution of the Delaware reformation claim. Having found for the plaintiffs in the Delaware action, the court held that the four actions "formed one single controversy." The court explained that if any Delaware defendant had prevailed in any of the federal actions, the resulting judgment would have had a preclusive effect on the Delaware action. Applying Delaware law, the court thus held that the plaintiffs had incurred fees and costs in the federal cases "in connection with" the Delaware action to enforce the LLC agreements and hence the fee-shifting provisions of the LLC agreements applied.

PLAINTIFFS FEES WERE REASONABLE

In exercising its discretion to determine the reasonableness of the plaintiffs' requested fees and costs of approximately $3.268 million, the court noted that the Supreme Court directs a judge to consider the factors set forth in Rule 1.5(a) of the Delaware Lawyers' Rules of Professional Conduct. The court rejected the defendants' claim that the rates of plaintiffs counsel DLA Piper were too high, measured against the defendants' counsel's rates. The court found that DLA Piper's rates were reasonable "in light of DLA Piper's prominence, the qualifications of its practitioners and the legal market in which the firm provides services." The court also rejected the defendants' contention that DLA Piper had spent too much time measured against the time spent by the defendants' counsel. The court noted that while DLA Piper had spent twice as much time preparing for expert depositions, it had invalidated the defendants' expert at deposition while the plaintiffs' expert's credibility was unshaken. As the court held, "preparation matters." The court also noted that the defendants substantially relied upon inside counsel to perform a variety of discovery and trial tasks that otherwise would have been done by outside counsel.

Having rejected the defendants' challenge to the amount of fees and costs, the court then determined that, apart from fees and costs related to one discrete dispute, the parties should be jointly and severally liable for the full amount of the fee award. The court reasoned that the LLC agreements "presented different facets of the same case." Thus, the same legal work would have been necessary whether the parties litigated over three agreements in one forum, as in the Delaware action, or over one agreement with the other two agreements as context, as in the federal actions. Additional "frictional" work resulted from having three entities instead of one. The court concluded that "because no one entity was to blame, it makes little sense to allocate the core substantive work artificially by assigning a portion to a particular contract or entity."

LESSONS LEARNED

Among the lessons learned from ASB is that parties to a contract governed by Delaware law with a clear fee-shifting provision can expect a Delaware court to enforce the provision. A party who elects to pursue litigation in multiple fora, the resolution of which would be dispositive of related Delaware litigation, can expect to have the fees and costs of the non-Delaware actions included in the fee award if the opposing party prevails. If a party is diligent and effective, the mere fact that its counsel's time is more than that of the opposing counsel is not a ground to reduce its fee; the court appreciates that "preparation matters." Finally, the case may well be more remembered for its explanation of how the implied covenant of good faith and fair dealing differs from fiduciary duty or tort claims. Practitioners with an implied covenant claim, as well as those seeking to enforce a contractual fee-shifting provision, thus would be well served by a careful review of ASB.