A New Boost for the Rights of Creditors: Court Rules Third Party Litigation Expenses May Be Recovered as Contract Damages

Unless a statute or contract provides otherwise, a party to a lawsuit is responsible for its own litigation expenses, including attorneys’ fees. This is known as the “American rule.” It contrasts with the “English rule,” under which the losing party pays the prevailing party’s costs and attorneys’ fees. As its name suggests, the American rule is ubiquitous in the United States.
 
There are exceptions to the American rule. One such exception—known as the “third party litigation exception”—occurs where “wrongful acts” by one party cause another party to incur legal expenses to protect its interests against a third-party. Fraud, breach of fiduciary duty, and other tortious conduct may qualify as wrongful acts for this purpose. For example, where a seller of real property is sued by the buyer because of misrepresentations made by the seller’s realtor, the seller may recover from the realtor the litigation expenses paid to resolve the buyer’s claim. It is not solely tortious acts or omissions, however, that may lead to such an award.
 
In the recently decided case of Talmer Bank and Trust v. Jacobson, the Wisconsin Court of Appeals rejected the notion that only tortious conduct may qualify as a wrongful act under the third-party litigation exception. In Talmer, the bank filed a commercial foreclosure action against the defaulting borrowers, also naming the tenants as interested parties. The tenants had previously entered into a land contract with the borrowers to purchase the mortgaged property. Under the terms of the land contract, the tenants were to make payments to the borrowers who, in turn, would continue making mortgage payments to the bank. While the tenants made the required payments under the land contract, the borrowers breached the contract by failing to pay the bank. The foreclosure action ensued.
 
As the lawsuit progressed, the tenants negotiated a settlement with the bank and then pursued a claim against the borrowers under the third-party litigation exception seeking to recover the attorneys’ fees they had paid for being drawn into the foreclosure action. The tenants argued that the attorneys’ fee award was justified by the borrowers’ wrongful act of breaching the land contract by failing to pay the mortgage. The borrowers admitted that they were in breach of the land contract, but they argued that only certain tortious conduct could amount to a wrongful act under the third-party litigation exception to the American rule. The trial court agreed with the borrowers and dismissed the tenants’ claim for attorneys’ fees.
 
The Wisconsin Court of Appeals disagreed and reversed. The appellate court noted that it was undisputed that the tenants were drawn into the foreclosure lawsuit solely because the borrowers had breached the land contract. Indeed, when they made the land contract the borrowers should have foreseen that a subsequent mortgage default by them would necessarily force the tenants into litigation with the bank. Given these circumstances, the Court of Appeals found that the borrowers’ breach of contract easily sufficed as a wrongful act justifying a fee award under the third-party litigation exception, and ordered the trial court to enter such an award on remand.
 
Talmer serves as a cautionary tale for contracting parties and is summarized with the maxim, “think before you breach.” Not only is a party in breach of a contract liable for nonperformance, but he or she may also be liable for expenses paid by the aggrieved party to resolve third-party claims that flow from the breach, including litigation costs and attorneys’ fees.
 
If you have questions about claims for attorneys’ fees, contact Attorney Zach Whitney at (414) 962-5110 or zwhitney@kmksc.com.