Contract Reimbursement Clauses

April 13, 2006

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Generally, the U.S. courts lack a loser pays system, which is a serious risk factor inherent in litigation. One way to control these risk factors is to find exceptions that make the loser pay in a lawsuit.

Simply put, the parties to a contract may agree in writing that the loser in a legal dispute must reimburse the other party for his attorney's fees and related costs.

In practice, this is a standard clause used by large commercial parties in many types of contracts. However, here the clause is almost always one-sided. Specifically, the clause usually will provide that, if the large commercial party brings an action to enforce the contract, the other party (i.e., a small business party or a consumer) will reimburse the large commercial party for its attorney's fees and related costs.

For example, a franchise agreement almost certainly will provide for this result, if the franchisor has to enforce the agreement against the franchisee. However, the law clearly allows the parties to contract for a more equitable arrangement. Thus, a more complete clause might provide simply that the loser in a legal dispute must reimburse the other party for his attorney's fees and related courts. This would mean that either party, as either a plaintiff or as a defendant, would be awarded reimbursement, if he or she prevailed in the action. For example, this type of clause would mean a franchisee would be awarded reimbursement if he brought a successful claim against the franchisor, or if the franchisee successfully defended a claim brought by the franchisor.

The clause also could be expanded beyond a standard one-sided clause, but still made more limited than a complete clause. For example, the clause might authorize reimbursement to either party who successfully brought a claim, but not authorize reimbursement to either party who successfully defended against a claim.

The real point is that the law allows the parties to control the reimbursement clause. In practice, the nature of the clause will be limited by two factors--the relative bargaining power of the parties and legal limitations that may apply to contracts between a business entity and consumers.

For instance, a franchisee may not have sufficient bargaining power to force a franchisor to include a complete or an expanded clause in a franchise agreement. With respect to consumer contracts, courts normally uphold a one-sided clause that authorizes reimbursement only to the business party who successfully brings a claim. However, a broader one-sided clause that also authorizes reimbursement to the business party who successfully defends against a claim, but further provides for no reimbursement to the consumer in any situation, may be deemed unfair and, therefore, invalid, as a violation of public policy.

In general, the small business owner should consider whether he or she is likely to be a plaintiff or a defendant, with respect to the agreement, and draft the reimbursement clause accordingly. The small business owner should always seek professional guidance when drafting or reviewing contracts in general, and in drafting the reimbursement clause in particular.

The small business owner should also be aware of some limited statutory exceptions to the lack of a loser pays system.