Justices appear divided on fee clause interpretation

On May 3 the California Supreme Court heard arguments in the fee-award case, Mountain Air Enterprises, LLC v. Sundowner Towers, LLC, S223536. The hearing took place fewer than 30 days after the court's decision in another such case, DisputeSuite.com, LLC. v. Scoreinc.com, S226652 (April 6, 2017), which defined, in some contexts, what it means to "prevail" in a civil suit for purposes of contractually based legal fee awards.

Review was granted in Mountain Air to resolve a simply stated issue: "Can a party's assertion of an affirmative-defense trigger a clause that awards attorney's fees to the party who prevails in an 'action' or 'proceeding' to enforce the contract?"

The Courts of Appeal have struggled with the question, with a 3-to-2 split among the reported cases.

The Supreme Court's very active questioning of the parties' counsel seemed aimed at a more detailed analysis of the issue, and perhaps a ruling that will answer the question.

What Happened in Reno Didn't Stay There

The Mountain Air case arose from transactions involving the Sundowner Hotel and Casino property in Reno, Nevada. Its owners contracted to sell the hotel's south tower to an investor for $7 million, then separately contracted to later repurchase the tower from him for the same price plus 12 percent. The investor assigned his rights under the contracts to Mountain Air Enterprises, LLC, of which he was the sole owner.

A year later, Mountain Air and Sundowner's owners entered into an option agreement, giving the owners an exclusive option to purchase the south tower. They did not exercise the option, and Sundowner later refused to repurchase the tower from Mountain Air.

Mountain Air filed suit against Sundowner and its owners for breach of the repurchase agreement. After a bench trial in Marin County, the court ruled for Sundowner based on two of its affirmative defenses: The repurchase agreement was void under both California and Nevada law, and the option agreement was a novation of the repurchase agreement. Sundowner then sought an award of $750,000 in attorney fees and costs, arguing that the novation defense was contractual.

Of note, neither party asserted that the attorney fees clause was ambiguous, nor did they introduce extrinsic evidence to give it a different meaning than its plain terms. The court denied the fee motion.

The fee clause in the option contract stated: "If any legal action or any other proceeding, including arbitration or an action for declaratory relief, is brought for the enforcement of this Agreement or because of an alleged dispute, breach, default, or misrepresentation in connection with any provision of this Agreement, the prevailing party shall be entitled to recover reasonable attorney's fees, expert fees and other costs incurred in that action or proceeding, in addition to any other relief to which the prevailing party may be entitled."

On appeal from the denial of the fee award, the 1st District Court of Appeal reversed the trial court, the majority finding that the affirmative defense of novation was an "action or proceeding" within the meaning of the fee clause. A dissenting justice did not treat the novation defense as an attempt to enforce the option contract.

In the Supreme Court oral argument last week, Chief Justice Tani G. Cantil-Sakauye asked counsel almost immediately after the case was called to "focus on the language of the contract rather than whether an affirmative defense is an action."

Counsel for Mountain Air emphasized that the above fee clause does not refer to affirmative defenses, thus giving a defendant a choice to raise a contract term as an affirmative defense without running the risk of having to pay the plaintiff's fees under the terms of the contract or California Civil Code Section 1717, which makes fee clauses automatically reciprocal.

The associate justices' pointed questions directed to counsel for both parties appeared to be heading to a ruling that would allow fee awards based on affirmative defenses in some circumstances:

Justice Carol Corrigan asked whether the distinction between a cross-complaint and affirmative defenses making the same contractually based plea is "artificial."

Justice Goodwin Liu asked, "Isn't the point of an attorney's fee clause to reward bringing a theory that is meritorious and resolves the case?"

Justice Mariano-Florentino Cuéllar asked whether Mountain Air, as plaintiff, "made the contract an issue" by suing for its breach.

Justice Ming Chin asked each side whether the fee clause is identical to the one found in a standard contract published by the California Association of Realtors. When both counsel demurred to the question, Chin held up a copy, saying, "It is. I have it right here." He later commented that the clause "isn't the most obvious way to include an affirmative defense."

Justice Kathryn Werdegar echoed Chin, asking whether an affirmative defense is an "action or proceeding," and whether it is "brought."

Counsel conceded that a fee clause could be written that explicitly awards attorney fees and costs to a defendant who prevails on a contract-based affirmative defense. There also seemed to be agreement that if the Court of Appeal's decision is upheld, a remand will be needed to allocate the $750,000 in claimed fees between the successful affirmative defense and other defense efforts.

Analysis

The court appeared to be divided between a literal interpretation of the fee clause at hand and a functional view of the outcome of the case. A divided opinion would not be surprising, especially in light of the struggle the courts of appeal have had with this issue.

It is not necessary for the court to deliver a ruling that applies to all fee clauses. In this case, the plaintiff put the repurchase contract at issue, without pleading the option contract's vitiating effect. Doing so made inevitable the defense's resort to the novation issue, which could have been pleaded as a cross-complaint for declaratory relief. Sundowner was the prevailing party in the "action or proceeding" that Mountain Air "brought ... because of an alleged dispute ... in connection with this Agreement." It so happens that "this Agreement" was a novation of the repurchase agreement, though the principals of the parties and subject property were the same.

This case and DisputeSuite.com, which was decided after briefing in Mountain Air was complete, illustrate the central role that fee clauses can play in commercial disputes. More explicit wording might avoid the devotion of so much appellate energy to deciding who pays for lawyers' services in such cases.