New North Carolina Law Significantly Expands Ability to Recover Attorneys’ Fees in Business Litigation

Until recently, litigants involved in contractual disputes in North Carolina were often surprised to learn that their ability to recover attorneys’ fees was very limited, even if the contract at issue provided for such recovery. However, a new North Carolina law has greatly expanded the enforceability of such provisions. The new law validates “reciprocal attorneys’ fees provisions” (with some limitations) and grants courts and arbitrators the power to enforce them. This new law will significantly impact the drafting of business contracts in North Carolina and litigation involving those contracts.

Historically, contractual provisions providing for the reimbursement of attorneys’ fees were not enforced by North Carolina courts, except in very limited circumstances where recovery was permitted by statute. While this judicial rule was rooted in a policy objective of protecting parties with less bargaining power or a lower level of sophistication, its practical effect was often doubt, confusion and inconsistency in awarding attorneys’ fees. It also placed North Carolina outside the mainstream, since most states enforce contractual provisions regarding recovery of attorneys’ fees.

While the new law provides that contractual attorneys’ fees provisions are generally enforceable, it contains important limitations.

The new law only applies to attorneys’ fees provisions in written business contracts

The law applies to contracts entered into on or after October 1, 2011, and is limited to written “business contracts,” a term defined to mean those entered into “primarily for business and commercial purposes.” Specifically excluded are employment contracts, consumer contracts and contracts to which a governmental entity is a party.

The ability to recover attorneys’ fees must be “reciprocal”

A reciprocal attorneys’ fees provision is defined in the statute as a provision by which each party agrees, upon the terms and subject to the conditions set forth in the contract that are made applicable to all parties, to pay or reimburse the other parties for attorneys’ fees and expenses incurred by reason of any suit, action, proceeding or arbitration involving the contract. Put simply, the provision will be enforced only if it applies to all parties to the contract.

The law places limits on the amount of attorneys’ fees that may be recovered

First, it is important to note that the law gives the court or arbitrator discretion to enforce contractual attorneys’ fees provisions—it does not require enforcement.

The law also limits recovery to “reasonable attorneys’ fees,” and reserves the task of determining what is “reasonable” to the court or arbitrator. Any contractual provisions that attempt to fix the amount of attorneys’ fees to be recovered (for example, a provision stating that attorneys’ fees shall be a certain percentage of the amount recovered in the litigation) will not be binding. Instead, the law provides that the court or arbitrator “may consider all relevant facts and circumstances” in determining what is reasonable and sets forth a non-exclusive list of thirteen factors that may be considered. The factors include the amount in controversy and the results obtained in the litigation, the timing and amount of any settlement offers, the skill required to perform the legal services rendered, the extent to which the party seeking to recover attorneys’ fees prevailed, and any disparity in economic circumstances or bargaining power between the parties. In short, the amount of recovery, if any, will be subject to a number of variables.

The statute also contains two (perhaps conflicting) caps on the amount of attorneys’ fees that may be recovered in any action “primarily for the recovery of monetary damages” (as opposed to actions seeking primarily injunctive or other equitable relief). One provision of the statute states that attorneys’ fees may not exceed the monetary damages awarded, while another states that the amount of attorneys’ fees may not exceed the amount in controversy. In the absence of any clarifying legislation, it appears that the maximum recovery would be the lower of the two caps, though this is not entirely certain.

The contract must be in writing and must be signed "by hand"

For a reciprocal attorneys’ fees provision to be enforced, the contract must be in writing and all parties to the contract must “sign by hand.” Based on legislative history, it appears that the requirement that the contract be “signed by hand” may have been intended to exclude only those limited situations where assent to a written contract is not also evidenced by a “writing,” such as online interactions involving “click-through agreements” and shrink-wrap licenses that are automatically triggered when software is used, though that interpretation is not entirely clear. The “signed by hand” requirement is unusual and, unless clarified by the legislature, likely to result in additional issues in litigation involving contracts that were not manually signed.

The contracting parties are free to define the circumstances under which the provision will apply, so long as they are reciprocal

The new law does not specify the circumstances under which the obligation to pay another party’s legal fees is triggered, and the contracting parties are thus free to specify the requirements for the provision to go into effect (so long as the obligations applies to all parties).

When drafting or evaluating a contract that contains a reciprocal attorneys’ fees provision, businesses should consider this issue carefully. One option that many contracting parties may find appealing is to specify that attorneys’ fees will be awarded to the “prevailing party” in a dispute. In such cases, two points are worth considering. First, a careful and precise definition of “prevailing party” should be included in the contract. Second, regardless of how “prevailing party” is defined, the court or arbitrator will ultimately determine the amount of attorneys’ fees awarded. One of the factors mentioned in the statute for consideration when making that decision is whether the party seeking to recover attorneys’ fees “prevailed in the action.” The extent to which courts and arbitrators will defer to the contracting parties’ definition of “prevailing party” remains to be seen, but contractual language on this point may influence a decision and therefore remains critically important.

Another alternative that contracting parties may consider is a provision that permits recovery of attorneys’ fees by the party seeking to enforce the contract under certain circumstances (but would not permit the defendant to recover its fees). Such a provision would presumably be valid under the statute because it applies to both parties to the contract and is therefore reciprocal. Contracting parties considering such a provision should tread carefully. Depending on the circumstances, it may be the case that one party to the contract is relatively unlikely to bring suit to enforce it (the licensee of software, for example). In such cases, that party may be disadvantaged by a provision that does not permit a defendant to recover attorneys’ fees.

The new law only applies when the contract is subject to North Carolina law

By its terms, the new law only applies to contracts “governed by the laws” of North Carolina. Contractual choice of law provisions have therefore taken on increased importance. Contracting parties wishing to take full advantage of the expanded enforceability of attorneys’ fees provisions should be careful not to invoke another state’s substantive law (particularly one that does not favor enforcement of such provisions).

The new law does not affect the ability to recover attorneys fees under previously-existing statutes

The new law does not repeal or modify existing North Carolina law regarding the recovery of attorneys’ fees in cases involving a note, conditional sale contract or other evidence of indebtedness falling within the scope of Section 6-21.2 of the North Carolina General Statutes. In such cases, the party enforcing the contract may elect to recover attorneys’ fees under either statute (though not both).

Summary

The ability to enforce reciprocal attorneys’ fees provision is a powerful tool and an important change in North Carolina law. It allows contracting parties involved in litigation to hold the breaching party responsible for the legal fees incurred in compelling the breaching party to do what it agreed to do. Going forward, businesses considering whether to include such a provision in a contract must be aware of the potential costs and benefits of doing so, and must carefully consider the specific contractual language at issue.