The catalyst for this essay is an Oct. 1 article in the Law Journal, “Scope of Indemnification Rights Under LLC Law Limited,” which reported a decision of the Appellate Division, First Department that denied a claim for reimbursement of legal fees incurred to obtain indemnity under the indemnity provision of an LLC operating agreement. The indemnity clause under the operating agreement was silent on the subject: it did not provide for reimbursement of legal expenses incurred by a party to establish its right to indemnity. Thus, court’s ruling is clearly correct.

Though the article focuses on indemnities under LLC operating agreements, the principle applies to all indemnities: under LLC operating agreements, partnership agreements, consulting agreements, employment contracts, licenses of intellectual property, and straight on ’til morning. And this concern with indemnities is merely a portal to a broader issue: the right to reimbursement of legal costs in any dispute arising under any contract.

Here is a typical clause dealing with the reimbursement of legal fees from a contract that a client recently asked me to review: “The prevailing party in any legal action shall be entitled to its reasonable attorneys’ fees and costs.” I vigorously resist provisions such as these because surely there will be further litigation about the amount of those “reasonable attorneys’ fees and costs”; and, even more importantly, the party that is the winner is often not clear, creating yet another meal ticket for the litigators.

For example, Party A sues Party B for $250,000 and is awarded only $25,000 in damages. Who is the winner? Or, Party A sues Party B for injunctive relief and damages, but is awarded only injunctive relief or partial injunctive relief. Who is the winner?

Or, Party A sues Party B on numerous counts, and prevails, in part, on just one or two, while Party B asserts several counterclaims, winning, in part, only one. Again, who won?

When confronted by these clauses, I will propose an alternative solution: if a party asserts a claim or defense that the court or the arbitrator determines is frivolous (that is, without a good faith basis in fact and law), that party will pay the litigation expenses which the other party incurs in respect of that frivolous claim or defense. This alternative is usually accepted.

Following are samples of this type of solution, one for court cases and one for arbitration. Please note the provisions designed to limit litigation.

Court Cases: If the trial judge determines that a claim or defense asserted by a party is frivolous, that party will pay the reasonable legal expenses and other reasonable costs—all as determined by the trial judge, which the other party incurred with respect to that frivolous claim or defense. Each party will bear any costs and expenses that it incurs (a) with respect to the issue of frivolity, and (b) to determine the amount of the legal expenses and other costs to be reimbursed. The parties waive trial by jury with respect to any determination under this paragraph and waive any right to appeal from any determination by the trial judge.

Arbitration: If the arbitrator determines that any claim or defense asserted by a party is frivolous, that party will pay the reasonable legal expenses and other costs, all as determined by the arbitrator, which the other party incurred with respect to that frivolous claim or defense. Each party will bear any costs and expenses that it incurs (a) with respect to the issue of frivolity, and (b) to determine the amount of the legal expenses and other costs to be reimbursed.

Indemnity: Let’s return to the counsel given by that Oct. 1 article: if the intention is that the indemnified party recover its cost to obtain indemnification, then, in light of the Appellate Division’s decision, specific provision must be made in the agreement. True, yet what’s good for the indemnitee is also good for the indemnitor. Surely the indemnitor will require like protection if it prevails.

The argument is sound that the answer to the question of entitlement to indemnity is either “yes” or “no.” Thus, within the context of an indemnity, there will be no doubt about who the winning party is. So, below is an example of bilateral provisions dealing with indemnities, whether in an LLC agreement or any other agreement. Provisions like these should be used in addition to, not in lieu of, the “frivolity” clauses mentioned above. Of course, the sample below would have to be modified appropriately for contracts that require arbitration.

“If a dispute arises as to whether Party A is entitled to indemnity as provided in this agreement, and if, after all appeals or after the right to appeal has expired, it is determined that Party A is, in fact, entitled to indemnity as provided in this agreement, then Party B will reimburse Party A for the reasonable legal expenses and other reasonable costs that Party A incurred to obtain that determination.

“If, on the other hand, after all appeals or after the right to appeal has expired, it is determined that Party A is not entitled to indemnity as provided in this agreement, then Party A will pay Party B the reasonable legal expenses and other reasonable costs that Party B incurred to obtain that determination.

“The parties waive trial by jury with respect to any determination under the two preceding paragraphs.

“Each party will bear any costs and expenses that it incurs to determine the amount of the legal expenses and other costs to be reimbursed.”

Injunctive Relief: Below are samples, again bilateral, provisions to recover legal fees when a claim is made for injunctive relief. Note, in the first paragraph, the narrow passage that the claimant has to entitlement, which is designed to avoid litigation in case the injunctive relief that is granted differs from the relief requested. And again, provisions like these should be used in addition to, not in lieu of, the “frivolity” clauses.

“If a claim is made for injunctive relief, and if, after all appeals or after the right to appeal has expired, it is determined that the party applying for that relief (the ‘claimant’) is, in fact, entitled to exactly the same relief that it requested, then the other party (the ‘defendant’) will pay claimant the reasonable legal expenses and other reasonable costs that the claimant incurred to obtain relief.

“If, on the other hand, after all appeals or after the right to appeal has expired, it is determined that the claimant is not entitled to exactly the same relief that it requested, then the claimant will pay defendant the reasonable legal expenses and other reasonable costs that the defendant incurred to obtain that determination.

“Each party will bear any costs and expenses it incurs to determine the amount of the legal expenses and other costs to be reimbursed.”

Damages: Below are suggested provisions, but again note how narrow the passage to recovery is, which, as with the provisions above for injunctive relief, is designed to avoid litigation in case the award is less than the amount of damages demanded. Here again, the sample below would have to be modified appropriately for contracts that require arbitration, and the provisions should be used in addition to, not in lieu of, the “frivolity”clause.

“If, on a particular count, a claim is made for a specified amount of damages set forth in the complaint or in the answer, or for a greater amount of damages on that count specified in an amended complaint, and if, after all appeals or after the right to appeal has expired, it is determined that the party demanding those damages (the ‘claimant’) is, in fact, entitled, on that count, to at least the same amount of damages as requested in the complaint or, as the case may be, in an amended complaint, then the other party (the ‘defendant’) will pay claimant the reasonable legal expenses and other reasonable costs that the claimant incurred to obtain the verdict and damages requested on that count.

“If, on the other hand, after all appeals or after the right to appeal has expired, it is determined on a particular count that the claimant is entitled to less than or none of the damages requested, then the claimant will pay defendant the reasonable legal expenses and other reasonable costs that the defendant incurred to obtain that determination.

“Each party will bear any costs and expenses that it incurs to determine the amount of the legal expenses and other costs to be reimbursed.”

Of course, we could complicate these clauses further by adding claims for damages on new counts that are added under amended complaints or amended answers, and by providing a pro rata reduction of the legal expenses and other costs to be reimbursed if the award is less than the damages requested. (I guess it’s only fair to invite the commercial lawyers to the banquet.)

Conclusions and a Gripe

The clauses that abound dealing with the recovery of legal fees, at least the ones that I’ve seen, just do not penetrate the many relevant considerations. So, because of the considerations detailed above and because of the complexity and narrow passages to recovery revealed above, I recommend using just the “frivolity” clauses with a possible exception for the indemnity provisions.

My gripe is with the term “fees on fees” used, as the Oct. 1 article mentions, to describe the fees incurred to obtain coverage under the indemnity clause in an LLC operating agreement. There ain’t no compounding here! That term, “fees on fees” is just another example of the linguistic poverty of the legal profession: the inability to convey a simple idea simply and accurately, in a way that anyone can easily understand.

Peter Siviglia is a solo practitioner in Tarrytown.