Fee Dispute Hotline
(312) 907-7275

Assisting with High-Stakes Attorney Fee Disputes

The NALFA

News Blog

Category: Fee Clause

NJ Case Has Lessons on Arbitration Clauses in Attorney Retainers

February 14, 2021

A recent Law 360 article by Hilary Gerzhoy, Deepika Ravi, and Amy Richardson, “NJ Case Has Lessons On Arbitration Clauses in Atty Retainers”, reports on arbitration clauses in attorney retainers in New Jersey.  This article was posted with permission.  The article reads:

On Dec. 21, 2020, the New Jersey Supreme Court issued Delaney v. Dickey, an opinion that severely limits the enforceability of arbitration provisions in law firm retainer agreements.  The court held that an arbitration provision in a retainer agreement is only enforceable if an attorney provides "an explanation of the advantages or disadvantages of arbitration" to a client before the client signs the retainer agreement.

The decision, which applies prospectively, tracks and builds on other jurisdictions' limitations on the enforceability of arbitration provisions in retainer agreements.  Attorneys wishing to resolve client disputes via arbitration should take close note of these heightened disclosure obligations.

Delaney v. Dickey

Delaney v. Dickey addressed whether an arbitration provision contained within Sills Cummis & Gross PC's four-page retainer agreement was enforceable.  A Sills attorney provided the retainer agreement to client Brian Delaney during an in-person meeting.  The retainer agreement contained a provision stating that any disputes about the law firm's fees or legal services would be resolved by arbitration.

The arbitration provision stated that the result of any arbitration would not be subject to appeal, and that Delaney's agreement to arbitration waived his right to a trial by jury:

The decision of the Arbitrator will be final and binding and neither the Firm nor you will have the right to appeal such decision, whether in a court or in another arbitration proceeding.  You understand that, by agreeing to arbitrate disputes as provided in this retainer letter, you are waiving any and all statutory and other rights that you may have to a trial by jury in connection with any such dispute, claim, or controversy.

The retainer agreement included a one-page attachment that contained a hyperlink to the JAMS rules.  However, the Sills attorney did not provide Delaney with a hard copy of the JAMS rules at the meeting.  The attachment also stated that the arbitration would be conducted by one impartial arbitrator; that the parties waived any claim for punitive damages; that the arbitration would be binding, nonappealable and confidential; and that the parties would share the arbitrator's fees and expenses, except that the arbitrator could award costs, expenses, and reasonable attorney fees and expert witness costs.

The New Jersey Supreme Court held that the arbitration provision was unenforceable "[b]ecause Delaney was not given an explanation of the advantages or disadvantages of arbitration."

The court recognized that the Sills attorney had disclosed, in the retainer agreement and attachment, several of the differences between an arbitral and judicial forum — but it found that disclosure insufficient.  Instead, the court required that the attorney provide an "explanation" of these differences — but it did not provide clear guidance on what is required for a sufficient explanation.  Importantly, the court held that an attorney must explain the differences between an arbitral and judicial forum, even when the client is "a sophisticated businessman."

The mere recitation of these differences in the retainer agreement, and the Sills attorney's "[offer] to answer any questions" Delaney had about the retainer agreement was insufficient to meet the attorney's fiduciary obligations.  Instead, the court imposed an obligation to explain the advantages and disadvantages of an arbitration provision either orally or in writing.

Although the court did not explicitly so state, its opinion suggests that an attorney cannot merely list the differences between an arbitral and judicial forum, but rather must explain how those differences might affect the client's interests in the event of a future dispute.

What Happens Outside of New Jersey?

The New Jersey Supreme Court pointed to a string of ethics opinions and case law from other states that support heightened disclosure obligations on an attorney where an arbitration provision is included in a retainer agreement.  The court also pointed to jurisdictions that require a lawyer to go even further and advise a client to seek independent counsel before agreeing to arbitrate future disputes.  Delaney closely tracks the American Bar Association's Formal Opinion 02-425, Retainer Agreement Requiring the Arbitration of Fee Disputes and Malpractice Claims, issued in 2002.

The opinion concluded that a binding arbitration provision requiring all "disputes concerning fees and malpractice claims" to be resolved via arbitration does not violate ABA Model Rule of Professional Conduct 1.4(b), "provided that the client has been fully apprised of the advantages and disadvantages of arbitration and has given her informed consent to the inclusion of the arbitration provision in the retainer agreement" and the arbitration provision does not "insulate ... or limit the liability to which she would otherwise be exposed under common and/or statutory law."

Because a lawyer has a fiduciary "duty to explain matters to a client," she must "advise clients of the possible adverse consequences as well as the benefits that may arise from the execution of an agreement" that includes an arbitration provision.  Accordingly, compliance with Rule 1.4(b) requires that the lawyer "'explain' the implications of the proposed binding arbitration provision 'to the extent reasonably necessary to permit the client to make [an] informed decision' about whether to agree to the [provision's] inclusion" in the retainer agreement.

Unlike the New Jersey opinion, the ABA concluded that just how extensie that disclosure must be will depend on "the sophistication of the client."  However, consistent with Delaney, the lawyer "should make clear that arbitration typically results in the client's waiver of significant rights, such as the waiver of the right to a jury trial, the possible waiver of broad discovery, and the loss of the right to appeal."

For these reasons, the Sills attorney's failure to explain these differences to Delaney would similarly fail under the ABA standard.  While ABA opinions are persuasive, not binding, authority on the states, they are an important road map for attorneys seeking to understand their ethical and practical obligations.

The District of Columbia takes a similar approach.  D.C. Ethics Opinion 376, published in November 2018, concludes that an agreement to arbitrate fee disputes and legal malpractice claims is otherwise permitted by the rules, provided that the lawyer has adequately informed the client about "material risks of and reasonably available alternatives to" the proposed arbitration clause such that the client is "fully informed."

That requires, at minimum, that the attorney inform the client about differences between a judicial and arbitral forum as to (1) the fees to be charged; (2) the scope of discovery; (3) a right to a jury; and (4) a right to an appeal.  Like ABA Formal Opinion 02-425, the D.C. opinion also advises that the scope of the discussion depends on the level of sophistication of the client.

What Should an Attorney Explain to a Client, and How?

While the Delaney case is only controlling in New Jersey, it provides useful guidance for attorneys hoping to create binding arbitration provisions in retainer agreements.  As the Delaney court noted, the differences between resolving an attorney-client dispute in arbitration or before a judicial forum can be communicated orally, in writing, or both.

The New Jersey Superior Court's Appellate Division stated in Delaney that it did not hold that the "reasonable explanation" required of an attorney cannot be contained in the written retainer agreement.  However, the New Jersey Supreme Court's opinion did not directly address that question, suggesting that an attorney can sufficiently explain the advantages and disadvantages of the arbitral forum within the retainer agreement.

Rather, the court held that the disclosure in the case before it — which merely recited several of the differences between a judicial and arbitral forum, with no additional explanation provided orally or in writing about these or other differences — was insufficient.  Recognizing that not all arbitration provisions are alike, the court enumerated several differences between an arbitral and judicial forum about which a client might need to be advised including the following:

1.  An arbitration resolves a dispute before a single arbitrator and not a jury of one's peers.

2.  The arbitrator's decision is final and binding with no right of appeal.

3.  Unlike court proceedings, arbitration proceedings are conducted privately and the outcome will remain confidential.

4.  Unlike court proceedings, the arbitration process offers a more limited right to discovery.

5.  The client may be responsible, in part, for the costs of the arbitration proceedings, including payments to the arbitrator.

6.  A plaintiff prevailing in a judicial forum may be entitled to punitive damages, but that right may be waived in an arbitral forum.

7.  A judicial forum generally does not permit reasonable attorney fees to be imposed against a nonprevailing client in a nonfrivolous malpractice action, whereas an arbitral forum may permit an award that imposes costs, expenses and reasonable attorney fees against the nonprevailing party.

However, the court was silent as to how an attorney is to translate that list into a compliant explanation to a client.  Practically then, attorneys should, at a minimum, explain — not merely recite — these differences to a client prior to the client agreeing to a mandatory arbitration provision.

The attorney's explanation should include, for example, that applicable arbitration procedures offer limited discovery — for instance, the JAMS procedures "limit each party to 'one deposition of an opposing [p]arty or of one individual under the control of the opposing [p]arty'" whereas judicial rules do not have a set limitation on the number of depositions available.

The attorney should also explain that, unlike a court proceeding where neither party pays for a judge's time, parties in arbitration often split the cost of the arbitrator's hourly rate, which can be costly.  And, at least in New Jersey, an attorney must provide a hard copy of the rules governing the arbitration — but note that neither D.C. Ethics Opinion 376 nor ABA Formal Opinion 02-425 imposes that requirement.  And, perhaps most importantly, an attorney must understand the relative benefits and disadvantages of arbitration so as to answer any client questions.

Conclusion

While agreements to arbitrate attorney-client disputes are routinely permitted, attorneys' ability to enforce such agreements will turn on the client's ultimate understanding of the implications of agreeing to arbitration.  Attorneys should, as always, consult the ABA Model Rules of Professional Conduct and related guidance in their jurisdiction — and when in doubt, should err on the side of explaining, both orally and in writing, the benefits and disadvantages of an arbitral forum.

Hilary Gerzhoy is an associate, and Deepika Ravi and Amy Richardson are partners, at Harris Wiltshire & Grannis LLP.

Illinois Court Weighs if Wage Law Provides for Attorney Fees

February 10, 2021

A recent Law 360 story by Celeste Bott, “Court Must Weigh if Ill. Wage Law Provides For Atty Fees”, reports that an Illinois appellate court held that a former police officer isn't entitled to attorney fees under the settlement reached in his wage suit with a Chicago-area village, instructing the circuit court to consider on remand whether he can recover the fees under the Illinois Wage Payment and Collection Act.

Former officer David Graham contends he's entitled to attorney fees under the Illinois wage law, which provides workers can recoup fees in a successful civil action brought by "any employee not timely paid wages, final compensation, or wage supplements by his or her employer." Graham, who reached a settlement with the village of Dolton after a benefits dispute, argues that Employee Disability Act benefits constitute "wages," according to the appellate court.

The village had countered that Employee Disability Act benefits are not considered "wages" because they do not compensate employees for work "actually performed," according to the opinion.  The panel said the circuit court never addressed Graham's arguments that he is entitled to attorney fees under the Wage Payment and Collection Act, remanding with directions to consider whether he could recover attorney fees and costs pursuant to the statute.

In Illinois, each party is responsible for his own attorney fees, and the settlement agreement didn't contain a contractual fee-shifting provision that puts the village on the hook for more than $100,000 in fees and costs, the panel said.  Graham had argued that the entire agreement constituted a "contractual undertaking," and that the lower court had relied on a section of that agreement that states that the parties acknowledged he was "the prevailing party for purposes of his petition for [attorney] fees and costs," according to the opinion.

"Although this provision provides that plaintiff is the prevailing party for purposes of his fee petition, it does not expressly provide that the parties agreed that plaintiff, as the prevailing party, is entitled to recover attorney fees from defendant in the underlying action," the panel said.  But in the very next section of the agreement, the parties did expressly set forth which party was responsible for attorney fees if either side has to file suit for a breach of the settlement deal, the court said.

"If a party is forced to file a breach of contract action, the agreement provides that the prevailing party in that action would be entitled to reasonable attorney fees," the court said.  "Because this case is not an enforcement action, section six of the agreement does not apply."

Article: The Right Retainer: Classic, Security or Advance-Payment?

February 7, 2021

A recent New York Law Journal article by Milton Williams and Christopher Dioguardi, “Retaining the ‘Right’ Retainer: Classic, Security or Advance-Payment?,” reports on different retainer types in New York.  This article was posted with permission.  The article reads:

This article evaluates which type of retainer agreement gives attorneys the best chance to preemptively shield their retainer fees before a client ends up in bankruptcy or the Department of Justice seizes and forfeits the client’s assets.

The scenario is this: A struggling business on the precipice of bankruptcy, or a criminal defendant whose property is subject to forfeiture, would like to hire you.  The prospective client has funds available to pay its legal fees, but what if you and/or the client expect that bankruptcy trustees or the Department of Justice will soon claim those funds for themselves?

At the outset of an engagement, an attorney can structure his or her retainer agreement to protect the retainer to the greatest extent possible in the event the client’s creditor comes knocking.  New York law recognizes three types of retainers: “classic,” “security,” and “advance payment.”  And under New York law, a retainer fee is shielded from attachment so long as the client does not retain an interest in the funds. See Gala Enterprises v. Hewlett Packard Co., 970 F. Supp. 212, 219 (S.D.N.Y. 1997).  For this reason, described in more detail below, it is the “advance payment” retainer agreement that will likely provide the most protection.

The ‘Classic’ Retainer

This type of retainer is typically a single, up-front payment to the lawyer simply for being available to the client—the attorney commits to future legal work for a specific period of time, regardless of inconvenience or workload constraints.  The classic retainer is not for legal services, and is therefore earned upon receipt, whether or not the attorney performs any services for the client (i.e., it is nonrefundable). See Agusta & Ross v. Trancamp Contr., 193 Misc.2d 781, 785-86 (N.Y. Civ. Ct. 2002) (general retainer compensates a lawyer for “agree[ing] implicitly to turn down other work opportunities that might interfere with his ability to perform the retainer-client’s needs” and “giv[ing] up the right to be retained by a host of clients whose interests might conflict with those of the retainer-client”).

Because the classic retainer is earned upon receipt and is nonrefundable, it without a doubt provides the most protection against would-be creditors.  However, the classic retainer is really only “classic” in the sense that it relates to antiquity.  Indeed, it is difficult to imagine a situation in the modern practice of law where a client would want to pay a classic retainer.  And attorneys would be remiss to draw up a nonrefundable classic retainer agreement unless certain specific conditions are met.

In general, under New York Rule of Professional Conduct 1.5(d)(4), “[a] lawyer shall not enter into an arrangement for, charge or collect … a nonrefundable retainer fee.” Further, under Rule 1.16(e), fees paid to a lawyer in advance for legal services are nonrefundable only to the extent they have been earned by the lawyer: “upon termination of representation, a lawyer shall promptly refund any part of a fee paid in advance that has not been earned.” See also Matter of Cooperman, 83 N.Y.2d 465, 471 (1994) (holding that nonrefundable retainer fee agreements clash with public policy and transgress the rules of professional conduct; affirming lower court decision that the use of nonrefundable fee arrangements warranted two-year suspension.); Gala Enterprises, 970 F. Supp. at 219 (narrowly construing the holding in Cooperman, and holding that only retainers with express non-refundability language are invalid per se).

The Security Retainer

While the classic retainer might offer the attorney the most security, the security retainer offers little defense against a client’s future creditors.  Typically, payments pursuant to a security retainer are placed in an escrow or trust account to be drawn upon only as the fee is earned.  In other words, the security retainer remains the property of the client until the attorney applies it to charges for services rendered.

So long as the client retains an interest in escrowed funds, the escrow account is attachable.  Under New York law, a security retainer may be attached so long as it is subject to the client’s “present or future control,” or is required to be returned to the client if not used to pay for services rendered. See, e.g., Lang v. State of New York, 258 A.D.2d 165, 171 (1st Dept. 1999); Potter v. MacLean, 75 A.D.3d 686, 687 (3d Dept. 2010) (defendant owed more than $20,000 in arrears on child support obligations and subsequently paid law firm a $15,000 retainer fee; the court found that the retainer fee, which was held in escrow, was subject to restraining order); M.M. v. T.M., 17 N.Y.S.3d 588, 599 (N.Y. Sup. Ct. 2015) (wife’s restraining notice against husband’s attorney’s security retainer was valid and enforceable); see also Pahlavi v. Laidlaw Holdings, 180 A.D.2d 595, 595-96 (1st Dept. 1992) (judgment debtor deposited $50,000 with his attorney after receipt of a restraining order and the court ordered his law firm to return them).

The Advance-Payment Retainer

Similar to the security retainer, the advance-payment retainer is a fee paid in advance for all or some of the services to be performed on a specific matter.  However, unlike a security retainer, ownership of the advance-payment retainer passes to the attorney immediately upon payment in exchange for the attorney’s promise to provide the legal services.  This type of retainer is likely the best way to ensure that the client has sufficient funds to pay for expected legal services.

Under an advance-payment retainer agreement, the law firm places the money into its operating account and may use the money as it chooses, subject only to the requirement that any unearned fee paid in advance be promptly refunded to the client upon termination of the relationship (recall Rule 1.16(e)).

A client’s contingent future interest in an advance-payment retainer, if any, that would be refunded if the firm’s services were prematurely terminated is not a sufficient basis for attachment. See Gala Enterprises, 970 F. Supp. at 219.  Therefore, the most secure option will likely be to require an advance payment for all services to be rendered, commonly referred to as a flat or fixed fee.  In other words, a creditor would not be able to seize such a retainer, even if part of the retainer may yet be refundable.  In Gala Enterprises, the court held that because a $150,000 flat fee as well as a $500,000 flat fee were subject to refund only if the legal services were prematurely terminated, the fees were therefore not attachable.

However, just because a client has paid an advance-payment retainer, does not mean that the retainer is untouchable.  Two specific possibilities come to mind.  First, Gala Enterprises illustrates that law firms might need to defend against fraudulent conveyance claims.  That being said, if the retainer is not excessive or unreasonable, the attorney is in a good position to defend against any such claims.  It goes without saying, when establishing a flat fee—or any fee for that matter—the fee must not be excessive. See Rule 1.5(a) (“[a] lawyer shall not make an agreement for, charge, or collect an excessive [] fee …”).

Second, attorneys of course must not accept funds that may have been obtained by fraud. See, e.g., S.E.C. v. Princeton Economic Intern. Ltd., 84 F. Supp. 2d 443 (S.D.N.Y. 2000) (lawyer who blindly accepts fees from client under circumstances that would cause reasonable lawyer to question client’s intent in paying fees accepts fees at his peril.).

Conclusion

In sum, we offer this advice:

  1. Review the Rules of Professional Conduct and case law cited herein, as well as the relevant New York State Bar Association ethics opinions, specifically: Ethics Opinion 570, June 7, 1985; Ethics Opinion 816, Oct. 25, 2007; Ethics Opinion 983, Oct. 8, 2013; and Ethics Opinion 1202, Dec. 2, 2020.
  1. Be transparent and direct with prospective clients regarding retainer agreements.
  2. A reasonable advance-payment retainer for all services to be rendered will give attorneys the most protection against future unknown creditors.
  3. Make clear in the retainer agreement that the client acknowledges and agrees that the advance-payment will become the law firm’s property upon receipt and will be deposited into the law firm’s operating account, not into an escrow account or a segregated bank account.
  4. Acknowledge in the retainer agreement that the client may be entitled to a refund of all or part of advance payment based on the value of the legal services performed prior to termination.

Milton Williams is a partner and Christopher Dioguardi is an associate at Walden Macht & Haran LLP in New York.

Article: A Double Attorney Fee Clause Is Held Not a Penalty in NY

February 6, 2021

A recent New York Law Journal article by Michael P. Regan, “A Double Attorney Fees Clause Is Held Not a Penalty, But What’s Next,” reports on a recent case in New York where the court held that a provision of a commercial contract requiring the payment of double the amount of attorney fees expended by the ‘substantially prevailing party” in a litigation between the contacting parties is not unenforceable penalty.  This article was posted with permission.  The article reads:

The Appellate Division, Second Department held in Loughlin v. Meghji, 186 A.D.3d 1633, on Sept. 30, 2020, that a provision of a commercial contract requiring the payment of double the amount of attorney fees expended by the “substantially prevailing party” in a litigation between the contracting parties is not an unenforceable penalty.  While some may believe that this particular provision is, in fact, a penalty, the court’s mode of analysis in reaching that result is the more important takeaway for commercial lawyers.

Instead of focusing on the more traditional factual inquiries in determining the enforceability of such provisions, the court in Loughlin invoked the simpler rule that sophisticated commercial parties should be held to the terms of the contract that they signed onto.  It remains to be seen whether Loughlin signals a growing shift in how New York courts treat such provisions in commercial contracts, and whether this new approach knows any boundaries.

The decision in Loughlin does not discuss Court of Appeals’ opinion in Equitable Lumber v. IPA Land Dev., 38 N.Y.2d 516 (1976), which is often cited in this context.  In Equitable Lumber, the Court of Appeals scrutinized the enforceability of a contractual provision establishing 30% as a reasonable attorneys’ fee to be paid in connection with any enforcement and collection efforts by the seller under the parties’ contract, and noted that courts routinely address the enforceability of similar clauses providing for attorney fees in a liquidated amount. See Equitable Lumber, at 522-24.

The court remitted for the resolution of traditional fact inquiries concerning the enforceability of a liquidated damages provision, to wit: (a) was a 30% fee reasonable in the light of the damages to be anticipated by a party in the seller’s position, or, alternatively, (b) was the fee commensurate with the actual arrangement agreed upon by this plaintiff and its attorney? See id. at 524.  Further, the court directed the lower court to determine “whether the amount stipulated was unreasonably large or grossly disproportionate to the damages which the [seller] was likely to suffer” in the event it did not rely on the liquidated damages clause and, if so, indicated that the provision should be voided as a penalty. Id.

Recent decisions from the Commercial Division, New York County, have followed the analysis set forth in Equitable Lumber.  For example, in Julius Silvert v. Open Kitchen 17, 2019 NY Slip Op 30394(U) (Sup. Ct. N.Y. Co.), Justice Cohen, citing Equitable Lumber, declined to enforce, on summary judgment, a contractual provision setting the amount of attorney fees at 33.33% of the balance due under the parties’ credit agreement. See Julius Silvert, at pp. 3-6.

The court held, inter alia, that “[f]ixing attorney’s fees at an arbitrary percentage of an unknown amount … acts as a kind of liquidated damages provision, one which may constitute an unenforceable penalty.” Id. at p. 4. In contrast to Loughlin, Justice Cohen declined to award attorney fees based solely “on the face of the [parties’ agreement],” and held that more information is required to determine whether such a payment for legal fees is fair and reasonable. Id. at pp. 5-6.

Likewise, in Maina v. Rapid Funding NYC, 2014 NY Slip Op 30952(U) (Sup. Ct. N.Y. Co.), Justice Sherwood held that a provision contained in a promissory note, entitling the lender to a payment of attorney fees in the amount of 20% of the principal and interest then due on the note, is an unenforceable penalty. See Maina, at *5, citing Equitable Lumber.  The court reasoned that a party is only entitled to such an attorney fees award “if it demonstrates that the quality and quantity of the legal services rendered were such to warrant, on a quantum meruit basis, that full percentage [provided for in the contract].” Id.

In contrast to Equitable Lumber and its progeny, the decision in Loughlin eschews the traditional method of analyzing the enforceability of a contractual provision requiring a payment of attorney fees based on a fixed, pre-determined percentage of fees incurred—in this case, a whopping 200% of such fees.  Instead, the court principally relies on the Court of Appeals’ holding in Vermont Teddy Bear Co. v. 538 Madison Realty Co., 1 N.Y.3d 470 (2004), which emphasizes the importance of enforcing commercial contracts according to their terms, especially in the context of real-estate transactions. See Vermont Teddy Bear Co., at 475.  But Vermont Teddy Bear dealt with the notice requirements of a commercial lease, not the enforceability of a liquidated damages provision—let alone in the context of awarding attorney fees.  Further, a provision which requires a payment based on a multiple of future, undetermined attorney fees, does not create the kind of “commercial certainty” that the court was seeking to achieve in Vermont Teddy Bear.

Further, the decision in Loughlin cites to the court’s prior decision in White Plains Plaza Realty v. Town Sports Int’l, 79 A.D.3d 1025 (2d Dept. 2010), another commercial-lease dispute, in which the contract provided for holdover rent at 200% of ordinary, monthly rent.  But whereas a multiple of holdover rent can be easily identified and calculated, a multiple of future attorney fees, yet to be incurred, is a more nebulous construct that has been recognized to be “particularly susceptible to abuse[.]” Julius Silvert, at p. 5.

The decision in Loughlin may be indicative of an increasing judicial reluctance to interfere with the bargain struck by commercial parties.  But under the mode of analysis utilized in Loughlin, it is unclear what restrictions the court would impose on even more extreme variations of such a clause, if any.  For instance, would a clause entitling the “substantially prevailing party” to a payment of 500% of incurred litigation fees be enforceable as between commercial parties?  Under the principle that commercial parties must adhere to the agreement they struck, at all costs, the bounds of such a provision seem endless.  And as set forth in Equitable Lumber and its progeny, good reasons exist to impose limits on the use of such provisions.  Indeed, provisions like the one in Loughlin dramatically alter the “American Rule,” employ the courts in creating financial windfalls to commercial parties, and act as a deterrent against the filing and prosecution of important claims.

Michael P. Regan is a litigation partner in the firm of Tannenbaum Helpern Syracuse & Hirschtritt LLP in New York.

Article: Granting Arbitrators the Power to Award Attorney Fees

January 4, 2021

A recent Legal Intelligencer article by Abraham J. Gafni, “Unintentionally Granting Arbitrators the Power to Award Attorney Fees” reports on granting the power to award attorney fees in arbitration.  This article was posted with permission.  The article reads:

In this pandemic period, as courts are limited in their ability to conduct civil trials, parties increasingly consider whether and how to settle their disputes through arbitration.  In his article last month in the Legal Intelligencer, “How Pre-Lawsuit Demand Letters Can Undermine Arbitration” (Nov. 16, 2020), Charles Forer, through his erstwhile attorney foil Bob, explained how a party who had entered into an agreement providing for mandatory arbitration almost suffered the unintended consequence of forfeiting that right by threatening litigation in court.

Yet another area in which this “law of unintended consequences” appears to be regularly occurring these days is when a party unintentionally extends authority to the arbitrator to award attorney fees.  The general “American Rule,” of course, is that, in the absence of a contractual agreement or statutory provision, each party is responsible for its own attorney fees.  Similarly, arbitrators generally lack the authority to award attorney fees.  Nonetheless, parties often determine that it is within their interests to include a provision in the arbitration agreement allowing the arbitrators to award them.

Even when the parties have not included such authority in the arbitration agreement, however, they may unexpectedly find that through their arbitration pleadings or other actions during the arbitration proceeding, they have granted such authority and become responsible for the payment of their successful adversaries’ attorney fees.

A recent opinion of the Massachusetts Superior Court, business litigation session, reflected how a party’s own actions authorized an arbitration panel to award attorney’s fees even though the contract did not provide that authority. See Credit Suisse Securities (USA), (Credit Suisse) v. Galli, No. 2020-0709-BLS 2 (Aug. 31, 2020).  The case involved employees who were formerly employed by Credit Suisse.  They filed an arbitration demand against Credit Suisse alleging a violation of the Massachusetts Wage Act (Wage Act) and related contract claims, asserting that Credit Suisse had failed to pay them earned deferred compensation.

Credit Suisse denied these allegations and filed a counterclaim claiming that the employees had breached their contracts with Credit Suisse.  Consequently, in addition to asserting a claim of millions of dollars in compensatory damages it sought “transaction costs, interest and fees.”  In closing arguments, the employees’ counsel specifically sought attorney fees, asserting that the arbitrators could award them pursuant to the Wage Act, and “because we believe that Credit Suisse, in filing their counterclaims … are requesting” not only millions of dollars in compensatory damages but also “related transaction costs and fees.”  Employees’ position was that since both parties were requesting attorney fees and costs, the arbitrators had the authority to award such fees to the successful party.

In response, in its closing arguments, Credit Suisse’s counsel stated that “we do not think there is any legal basis for an award of fees and expense in this case,” but added that if the arbitration panel were to award fees to the employees, the fee application was insufficiently itemized.  However, they did not directly contest the assertion that Credit Suisse had itself requested attorneys’ fees or that by so doing it had given the arbitrators the authority to award such fees even without a finding of a Wage Act violation.  Moreover, at no time in the proceedings, did they make clear to the arbitrators that they were withdrawing any claim for attorneys’ fees should they prevail.

The arbitration panel awarded the employees compensatory damages as well as over $100,000 in attorney fees.  Credit Suisse appealed, arguing that the panel had exceeded its powers in awarding such fees.  In considering this contention, the court noted that judicial review of an arbitral decision “is extremely narrow and exceedingly deferential.”  Among the limited bases for vacating an award under both the Federal Arbitration Act, 9 U.S.C. Section 10(a)(4) and the Wage Act, however, is where the arbitrators have exceeded the scope of their arbitral authority.

Had the arbitration panel found violations of the Wage Act, the employees would have been entitled to attorney fees pursuant to that statute. The court noted, however, that it was unclear whether the findings of the panel had been based upon violations of the Wage Act.

Critically, however, the arbitration panel did not cite the Wage Act as the basis for its award of attorney fees.  Rather, according to the Massachusetts Superior Court, “the panel stated that it had the authority to award fees because each side had requested its fees.  Where the parties mutually request attorney’s fees in an arbitration, courts have concluded that this mutual request can provide the requisite legal basis for an award of fees, even though the general rule is that each party pays its own attorney fees.  This is precisely what happened here.”

In citing other cases containing a similar holding, the court noted that Rule 43(d) of the Commercial Arbitration Rules of the American Arbitration Association at Rule 43(d) also authorizes the award of attorney fees where all parties have requested it.  In short, “by expressly demanding attorney’s fees and then submitting that demand (through its counterclaim) to arbitration, Credit Suisse effectively gave the arbitrators the authority they would not have otherwise had to award such fees to the prevailing party.”

The court distinguished this situation from Matter of Stewart Abori & Chang, 282 A.D. 2d 385, 723 N.Y.S. 2d 492 (App. Div. 2001), in which the court vacated the arbitrator’s award of attorney fees to the prevailing party because prior to the rendering of the award, the opposing party withdrew its claim to recover its own attorney fees and objected to the opponent’s claim for such relief. It was not deemed, therefore, to have acquiesced in the arbitrator’s consideration of that claim.

Finally, Credit Suisse sought to escape this conclusion by arguing that its counterclaim only asked for “fees,” not “attorney fees.”  This contention was also rejected by the court.  It noted that it was clear from the employees’ closing argument that the employees understood the Credit Suisse counterclaim to be seeking attorney fees and the employees’ own counsel were also seeking attorney fees, regardless of whether an award in its favor was based on a Wage Act violation.  In the face of these contentions by the employees, however, Credit Suisse was silent, neither correcting the supposed mischaracterization of its counterclaim nor making clear that Credit Suisse was not seeking attorney fees.  In addition, its only expressed opposition to the award of attorney fees was based solely on the sufficiency of the fee application submitted by the employees.

Otherwise stated, while Credit Suisse did not actively litigate the issue of its own fees, it never expressly withdrew that claim.  In addition, Credit Suisse did not dispute the employees’ assertion in closing arguments that the parties had agreed to submit the question of attorney fees for resolution by the panel.

In summary, whether arbitrators should be granted the authority to award attorney fees is an issue that must always be considered when drafting an arbitration agreement; and, of course, as the nature of any future dispute is not yet known and the incorporation of such a provision will be adopted without any knowledge of the potential financial burden that may result , counsel must always evaluate the likelihood of success in the arbitration, the relative financial situations of the parties, and the ability to bear such further expense in the event of an adverse result.

What has been further demonstrated here is that parties must remain wary of the possibility of becoming responsible for attorney fees, even when the arbitration agreement does not provide for such by making or joining in such a demand or, perhaps, by simply remaining silent and not objecting in the face of the other side’s request for attorney fees.  Unfortunately, this often occurs merely because parties wish to demonstrate that their aggressiveness and confidence match that of their adversaries.  Ignoring the potential risk of this unintended consequence, however, may result in a significant award well beyond what was contemplated by the parties when they agreed to arbitration.

Abraham J. Gafni is a retired judge and mediator/arbitrator with ADR Options.  He is also a professor of law emeritus at the Villanova University Charles Widger School of Law.