Heather Benzmiller Sultanian is a partner and Jarrett H. Gross is a managing associate at Sidley Austin. Views are the authors’ own.
Deal lawyers will be very familiar with indemnification clauses, which are a standard term in most M&A contracts.
Although the precise language may vary, the buyer or the seller (or both) typically agrees to indemnify the other for “losses” arising from a breach of the contract or specific terms of the contract.
A typical indemnification agreement defines the scope of those losses in expansive terms, and often includes “attorneys’ fees” or “legal fees” in the list of indemnifiable losses.
In the event the parties to a contract wind up in litigation over an alleged breach, a question often arises: Does the indemnification clause allow the indemnified party to recover its attorneys’ fees incurred in the litigation between the parties over the alleged breach (assuming the indemnified party prevails)? The answer to that question is more complicated than it might appear.
In a line of recent cases, Delaware courts have explained that, to accomplish “fee-shifting” in litigation between the parties to the contract (referred to as “first-party litigation”), it is not enough just to list attorneys’ fees as one of the types of indemnifiable losses.
So, if a deal lawyer wants to draft language entitling her client to recover attorneys’ fees incurred in litigation over a future breach of the contract, she should keep a few principles in mind.
1. Understand the default
Delaware courts follow the “American Rule,” under which each party to litigation bears its own attorneys’ fees and expenses.
Contracting parties can modify that rule by agreement, but they must be explicit if they wish to do so—and general references to attorneys’ fees will not suffice.
The requirement for clear and unequivocal language reflects a desire to preserve the American tradition of all parties paying their own legal expenses, unless the parties truly intend to deviate from that practice.
Courts reason that, if a generic reference to attorneys’ fees were sufficient to shift fees, a typical indemnification clause might swallow the American Rule.
2. Use explicit fee-shifting language
In the face of the American Rule, Delaware courts have determined that even quite broad language referencing attorneys’ fees may not be explicit enough to shift fees in first-party litigation.
For example, indemnification provisions stating that a party will be indemnified for “reasonable attorneys’ fees” have been deemed not sufficiently clear and unequivocal, as there are many types of attorneys’ fees that might be encompassed by that language apart from fees incurred in first-party litigation between the contracting parties.
Even an agreement that requires indemnification for attorneys’ fees “whether or not arising out of third party claims” has been found not to clearly convey the parties’ intent to shift fees in first-party litigation.
If parties to a contract governed by Delaware law intend to shift fees in litigation between the parties, they should explicitly address that scenario in the contract.
An effective fee-shifting provision should, first and foremost, explicitly reference litigation to enforce the agreement that is commenced by either party to the contract.
In addition, courts search in the provision for a reference to a “prevailing party,” which has long been a “hallmark term” of fee-shifting provisions.
Ultimately, although there is no specific language that must be used to accomplish fee-shifting, Delaware courts will look for terms and words that show the contracting parties had first-party litigation in mind.
3. Consider contract structure
When analyzing whether an indemnification agreement provides for fee-shifting, Delaware courts also frequently look to provisions elsewhere in the contract that explicitly permit fee-shifting under a more narrow set of circumstances—such as for breach of specific provisions of the contract or in first-party litigation regarding a specific subject matter.
There are a couple of reasons that these more specific provisions in the contract provide additional support for the conclusion that general indemnification provisions—even if they reference “attorneys’ fees”—do not shift fees in first-party litigation across the board.
First, courts reason that the existence of provisions that explicitly provide for fee-shifting under some circumstances shows that the parties knew how to draft a fee-shifting clause and could have done so in the general indemnification provision had they intended.
Second, if the general indemnification provision is read to provide for fee-shifting in all first-party litigation, there would have been no need to draft the separate term providing for fee-shifting under a more limited set of circumstances.
Courts are hesitant to read a general indemnification clause in a way that renders the more specific provision superfluous. So to reinforce the language of a provision intended to shift fees for first-party litigation, contracting parties should consider how other terms in the agreement shed light on the meaning and scope of the provision.
Counsel negotiating indemnification provisions for M&A contracts should carefully consider whether they intend for either party to cover the other’s attorneys’ fees in litigation arising from a breach of the contract. There are sound reasons why a party may or may not want such fees to be recoverable.
But if the parties intend to contract around the American Rule and provide for fee-shifting in first-party litigation, the language and structure of the contract must clearly and unequivocally reflect that intent.