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UPDATE: Federal Appeals Court Ignores Parties' Choice of Another State's Law Regarding Fee and Cost Recovery

 

Many contracts contain attorneys’ fees and costs recovery provisions. These provisions generally entitle the prevailing party in a lawsuit or arbitration arising out of the contract to an award against the other party of the fees and costs it incurs in the litigation.  Practitioners often include recovery provisions in contracts because they tend to dissuade the parties from breaching the contract, disincentivize the parties from bringing meritless suits over the contract, and reward the parties for prevailing in any suits that might be brought.

Some provisions are written in a way that entitles only one of the contracting parties to recover fees and costs if it prevails in litigation. However, California Civil Code Section 1717 empowers the courts to ignore the unilateral nature of those provisions and to provide for a reciprocal entitlement by both parties to fee and cost recovery. 

Not all states follow California’s rule.  In Georgia, for example, the parties may agree in their contract that only one of them is entitled to recover fees and costs if it prevails in litigation.  A new case, however, suggests that such provisions might not be enforceable in California litigation.  In First Intercontinental Bank vs. Ahn, 2015 Westlaw 4899711 (9th Cir.), the Ninth Circuit Court of Appeal held that a unilateral recovery clause contained in a promissory note governed by Georgia law must be read as a reciprocal clause in California litigation because of the strong public policy favoring reciprocality expressed in Civil Code Section 1717.

In First Intercontinental, a bank lent a group of borrowers about $2,000,000 to buy a hotel in Louisiana.  The promissory note memorializing the loan contained a Georgia choice of law clause and a unilateral recovery provision that entitled only the bank to a fees and costs award if it prevailed in litigation relating to the loan. 

The bank subsequently released one of the borrowers from all liability relating to the loan. Years later, the remaining borrowers defaulted, and the bank filed a lawsuit in federal court in California against all of the borrowers, including the one who had been released.  The released borrower successfully obtained the dismissal of the claims against her on summary judgment, and asked the court for an award of fees and costs under Civil Code Section 1717.  The trial court granted the award, and the bank appealed. 

The Ninth Circuit upheld the award.  It ruled that, although the promissory note was governed by Georgia law pursuant to its choice of law clause, California law (specifically, Section 1717), applied because California has a fundamental interest in protecting its citizens from unilateral fee and cost recovery provisions. While the court recognized that California cases were split over whether Section 1717 “embodies a fundamental policy of the state” such that it should trump competing state laws, it speculated that the California Supreme Court would probably reach that conclusion in future litigation.  The court also noted the bank’s curious decision to file the action in California “even though we have no reason to believe it could not have filed the same action in a federal district court in Georgia.”

The First Intercontinental decision is important even though, as a federal decision, it is not binding on state courts.  Parties might go into contractual relationships believing that a particular non-California state law will apply, ultimately to have their choice of law ignored in California litigation if the court finds that a fundamental California policy interest is at stake.  Practitioners and clients alike will have to pay more attention to so-called “boilerplate” provisions, like choice of law and conflict of law clauses, both of which are frequently not given their due consideration.  And litigators will have to think twice about selecting the forum for their lawsuits.  If the bank in First Intercontinental had filed its action in Georgia or insisted on the inclusion of a Georgia conflict of law clause in the promissory note, things might have turned out differently for it than they did.  Until the California Supreme Court rules that Section 1717 “embodies a fundamental policy of the state,” however, the law in California will remain murky and inconsistent.

For more information about First Intercontinental or this legal update, please contact Michael F. Donner.

This posting is intended to summarize recent developments in the law for informational purposes only. It is not intended, and does not constitute, legal advice. We make no warranties of its completeness or accuracy. Because questions regarding the application and interpretation of these and other laws require qualified legal analysis, we ask that you direct any such questions to us following an appropriate, formal retention.

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