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How to Draft Your Shareholder Agreement for the Professional Law Corporation so You’re Not Left Holding the Bag – The Attorney’s Fee Provision

As California attorneys should already know, California follows the “American Rule” when it comes to awarding attorney’s fees in litigation, meaning that each party in a dispute pays their own attorney’s fees. The rule is embodied in California Code of Civil Procedure Section 1021, which provides: “Except as attorney’s fees are specifically provided for by statute, the measure and mode of compensation of attorneys and counselors at law is left to the agreement, express or implied, of the parties; but parties to actions or proceedings are entitled to their costs, as hereinafter provided.” Of course there are statutes which specifically provide that the prevailing party is entitled to recover its attorney’s fees, such as when a plaintiff is successful in a suit against one who has been convicted of a felony resulting in the plaintiff’s damage (California Code of Civil Procedure Section 1021.4), and every prevailing party is always entitled to certain “costs” pursuant to California Code of Civil Procedure Section 1032. But, how does a shareholder in a California professional law corporation shift the burden of its attorney’s fees to the losing party in a suit between shareholders? The answer, of course, is by ensuring that the shareholders sign a shareholder’s agreement which contains a properly drafted attorney’s fees provision.

When drafting the attorney’s fees provision for inclusion in the professional corporation’s shareholder’s agreement, several factors should be considered including, but not limited to:

  • What type of practice does the professional corporation engage in? Consider that certain areas of representation carry with them increased probabilities that the corporation’s clients will bring a malpractice claim against the corporation or individual shareholders.
  • Does the corporation represent plaintiffs, defendants, or both?
  • What type of professional liability insurance does the corporation carry and what does it protect against?

Of course all lawyers in California are liable for their own professional negligence and cannot enter into an agreement with any client to prospectively limit the member’s liability for professional misconduct (see California Rules of Professional Conduct, Rule 3-400). Consequently, one would expect that any litigation arising out of the professional law corporation would arise solely out of the contractual relationship between the shareholders, or between the shareholders and corporation. If true, California Civil Code Section 1717 would allow the prevailing party in a shareholder dispute to recover their attorney’s fees, provided the agreement contained an attorney’s fees provision. However, Section 1717 is specifically limited to actions arising in contract. So what happens when one shareholder or the corporation is accused of malpractice by a client and a battle between the shareholders ensues over who is actually responsible for the malpractice? In that case, one might expect that tort claims as well as contractual claims might arise between the shareholders or between the shareholders and the corporation.

To ensure that the shareholders are entitled to shift their attorney’s fees claims to the losing party, the attorney’s fees provision must include language making it clear that the recovery is not limited solely to contractual claims. See Maynard v. BTI Group, Inc., (2013) 216 Cal.App.4th 984. When drafting the provision, the language describing the types of disputes to which it applies should be broad enough to encompass non-contractual claims as well as contractual claims. Language such as “in any dispute,” “in all disputes,” or phrases such as “the prevailing party in any mediation, arbitration, litigation, appeal, or similar proceeding and arising out of any dispute, whether arising in contact, tort, or otherwise” should be used to make clear to a court the shareholders’ intentions.To ensure your shareholder agreement will shift the burden of attorney’s fees to the unsuccessful litigant, you will need to seek the services of an attorney like Michael Leonard, Esq., named “Best of the Bar” by the San Diego Business Journal in 2016. If you would like to arrange for a consultation to discuss your shareholder agreement, your professional law corporation, or if you would like to discuss any other business-related matter with a rising star, Michael Leonard, Esq. of San Diego Corporate Law should be your first call. He has the experience and knowledge to ensure all of your business agreements are enforceable in the California Courts. He can be contacted by visiting San Diego Corporate Law or by telephone at (858) 483-9200.

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