Update Your Fee-Shifting Provision: The Contingency Fee Trap

If a purchase agreement has a fee-shifting provision and the prevailing party hires counsel on a contingency fee basis, does the losing party have to pay the contingency fee? The answer is yes, based on the Delaware Chancery Court’s ruling in Williams Cos., Inc. v. Energy Transfer LP. We look at the court’s ruling and suggest a modification to the fee-shifting provision to alter this result. We also offer a drafting tip regarding the calculation of interest.

Background

The Williams case is based on a dispute over the merger agreement between The Williams Companies, Inc. (Williams) and Energy Transfer LP (ETE). The deal fell through, and the court found that Williams was entitled to a $410 million judgment as liquidated damages, as specified in the merger agreement. Normally, courts follow the American Rule—each litigant pay its own attorneys’ fees—but, in this case, the parties had altered that default rule. The merger agreement provided that if Williams prevailed in the recovery of the breakup fee, Williams was entitled to recover its reasonable attorneys’ fees and expenses related to such recovery from ETE.

Williams hired its counsel under a contingency fee structure, and the main dispute in this last opinion of the Williams v. ETE saga was whether the contingency fee was reasonable.

Contingency Fee

The Chancery Court concluded that the contingency fee was reasonable in this case. Consequently, ETE had to pay the 15 percent contingency fee that Williams had agreed to pay to its counsel Cravath, Swaine & Moore LLP (Cravath). Two of ETE’s failed arguments merit a close review.

First, ETE argued that it was unreasonable for Williams to switch from an hourly arrangement to a contingency fee arrangement mid-litigation. However, the Chancery Court found this was reasonable because the change occurred when the nature of the case shifted from one seeking injunctive relief (which called for a noncontingent representation) to one seeking recovery of the breakup fee (for which contingent representation was a business option). However, the Chancery Court cautioned that a change to a contingency fee arrangement may be unreasonable in some circumstances. For example, if the litigation had progressed significantly or the uncertainty of the outcome had diminished, switching to a contingency fee in an attempt to penalize the other side would be unreasonable.

Second, ETE argued that Cravath’s fee under the contingency fee arrangement ($74.8 million) was unreasonable because it was 1.7 times what Cravath would have received based on a traditional hourly rate ($47.1 million). This disclosure came out because Williams had to provide a “lodestar”—calculated as the number of hours Cravath expended multiplied by its hourly rate—to support the contingency fee. Additionally, ETE complained that the number of hours and the billing rate of Cravath was higher than the number of hours that ETE’s counsel billed to the matter and the billing rate of ETE’s counsel. However, the Chancery Court held that the 1.7 lodestar multiple was within the range of reasonableness. The Chancery Court also found that the number of hours Cravath expended (which involved Williams having to produce approximately ten times more documents than ETE) and its billing rates (which reflected a discount and rate freeze and were at a level the market would bear for its services) were both reasonable.

Interest

This opinion also addressed two issues regarding interest.

First, how is interest computed (simple or compound) if the merger agreement is silent? The Chancery Court concluded that when parties are silent, they manifest an intent to leave that determination to the Court. The Chancery Court decided that prejudgment interest should be compounded because compounding more accurately reflects the standard form of interest in the financial market.

Second, ETE argued that prejudgment interest should be tolled because there was a delay caused by an inadvertent error by Williams’s discovery vendor. And then, because of that delay, the trial was further delayed by the COVID-19 pandemic. Although the Chancery Court has discretion to reduce prejudgment interest, the Chancery Court declined to toll the interest. The discovery error was inadvertent, and Williams didn’t cause the pandemic. Additionally, the purpose of interest is to address the lost time value of money, and here ETE had the use of the $410 million judgment during the litigation.

Conclusion

If your purchase agreement has a fee-shifting clause and the other side hires counsel on a contingency fee basis, your client would most likely be liable for the other side’s contingency fee (absent a contrary provision) under Delaware law. Thus, if your client has potential liability for a contingency fee (e.g., a buyer agreeing to a reverse termination fee or a seller agreeing to an indemnity—in each case, with a fee-shifting clause), you might want an express provision to the contrary. One approach is to provide that the contingency fee will be reduced to the fee payable had the prevailing party hired counsel on an hourly basis:

. . . provided, however, that if costs and expenses include a fee determined on a contingency or similar basis, then the contingency or similar fee must be reduced to a reasonable fee computed on the basis of an hourly rate or similar basis.

No one likes to lose in litigation. Adding insult to injury, losers that are subject to a fee-shifting provision have to pay the prevailing party’s attorneys’ fees. Don’t make it worse by allowing that fee to be a percentage of recovery due to a contingency fee arrangement. And while you are at it, consider specifying how interest will be calculated.