January 01, 2016

Will the “Wrongful Involvement” Exception Swallow the American Rule?

An increasingly invoked exception allows the recovery of litigation fees.

Andrew J. Wronski and Gregory N. Heinen

Litigators are well acquainted with the canonical American Rule requiring parties to bear their own attorney fees in most cases. Perhaps less familiar is the increasingly invoked “wrongful involvement in litigation” exception, which allows recovery of fees incurred when a party finds itself in litigation as a result of another’s wrongful conduct. In recent years, litigants have pushed to broaden the exception’s historically narrow scope, putting a noticeable dent in the American Rule. This expansion portends an increase in fee litigation, and litigators should familiarize themselves with the wrongful involvement exception and strategies for rebuffing spurious fee claims.

Under the American Rule, parties to litigation are generally responsible for their own attorney fees. See, e.g., Fleischmann Distilling Corp. v. Maier Brewing Co., 386 U.S. 714, 717–18 (1967). This bedrock principle reflects strong policy considerations, such as ensuring that litigants are not deterred from seeking legitimate redress. The rule encourages the beneficial expansion of the law by enabling litigants to pursue trail-blazing (and therefore risky) claims and defenses. The American Rule also creates an incentive for parties to limit their legal fees, which facilitates the consensual resolution of disputes.

While the American Rule still reflects prevailing wisdom, like all rules, it has exceptions. Most are familiar. Fees may be awarded where authorized by contract or statute, or where a party has engaged in sanctionable conduct. The wrongful involvement exception, also known as the “tort of another” doctrine or the “third-party litigation exception,” is less familiar. As its name suggests, the exception permits recovery of attorney fees that a party is forced to incur due to another’s wrongful conduct. The exception finds its roots in section 914(2) of the Restatement (Second) of Torts (1979):

One who through the tort of another has been required to act in the protection of his interests by bringing or defending an action against a third person is entitled to recover reasonable compensation for loss of time, attorney fees and other expenditures thereby suffered or incurred in the earlier action.

The wrongful involvement exception is widely, though not universally, recognized. See, e.g., Rocky Mt. Festivals, Inc. v. Parsons Corp., 242 P.3d 1067, 1071 n.2 (Colo. 2010) (citing cases adopting the exception in Arizona, Colorado, Iowa, Massachusetts, Nebraska, Oklahoma, Washington, and the District of Colombia).

The prototypical example of the wrongful involvement exception arises in real estate litigation. For example, in one Nebraska case, the sellers instructed their broker to accept only cash offers for the property. Tetherow v. Wolfe, 392 N.W.2d 374 (1986). After their broker negligently used a sales contract with a financing contingency, the buyer successfully sued the sellers for the return of his deposit when he could not obtain financing. Id. After that suit, the sellers sued the broker to recover fees incurred in defending the buyer’s action, arguing that they had been involved in that litigation solely as a result of the broker’s negligence. Id. at 637–38. Citing the Restatement, the Nebraska Supreme Court endorsed the exception, affirming an award of fees to the sellers.

Despite its proper application in certain cases, courts have traditionally construed the wrongful involvement exception narrowly so as to preserve the American Rule. The primary constraint is that courts typically permit recovery only when a party incurs fees because of a third party’s tortious conduct. This limitation emanates from the Restatement, which clarifies that the claimant must have been involved in the underlying litigation “only because of the tort of another.” Restatement (Second) of Torts § 914 cmt. (b) (1979). More precisely, the exception is available only where the fee claimant “defends solely and exclusively the act of such other party, and is compelled to defend no misfeasance of his own.” O’Connell v. Jackson, 140 N.W.2d 65, 68–69 (Minn. 1966).

This fundamental limitation is both logical and necessary. After all, where the claimant incurred fees defending its own acts or omissions, it cannot be said to have been “wrongfully involved” in litigation. For example, in Farr v. Armstrong Rubber Co., one joint tortfeasor (a tire distributor) sued another (the tire manufacturer) for attorney fees after both were found liable for injuries following a blowout. See 179 N.W.2d 64, 67–68 (Minn. 1970). The distributor, initially sued for breach of warranty, was found to be entitled to complete indemnity from the manufacturer. Armed with this ruling, the distributor sought to recover its fees, arguing that they were incurred only as a result of the manufacturer’s negligence. The Minnesota Supreme Court disagreed, holding that the distributor had been “required to defend claims arising out of another’s wrongful conduct and also to defend accusations which encompass his separate wrongful acts.” Id. at 68.

Thus, the critical question is whether the claimant was defending its own conduct in the underlying litigation, not whether that conduct ultimately gave rise to liability. This principle is demonstrated in Estate of Kriefall v. Sizzler, in which diners at a Sizzler Steak House contracted E. coli and sued Sizzler (the franchisor), its franchisee, a meat-processing company, and the local distributor of the allegedly contaminated food. See 342 Wis. 2d 29, 816 N.W.2d 853 (Wis. 2012). After the jury apportioned zero liability to Sizzler, it brought a new claim against the meat processor whose contaminated product, Sizzler argued, was the sole reason Sizzler became embroiled in the underlying litigation. Id. at 69. The Wisconsin Supreme Court rejected Sizzler’s argument that the jury’s refusal to apportion liability to Sizzler made it an “innocent” third party for purposes of the wrongful involvement exception. Rather, the court held that Sizzler, as the franchisor of the restaurant where the plaintiff was injured, was defending itself against “potential liability for the alleged breach of a claimed duty of due care.” Id. at 72. As a result, Sizzler was not sued solely because of the meat processor’s wrongful acts; therefore, the wrongful involvement exception did not apply.

These limitations find further foundation in the early view that requests for attorney fees presented, at least in part, a moral issue for courts to decide. See Daskam v. Ullman, 74 Wis. 474, 479, 43 N.W. 321 (Wis. 1889) (“There is no ground in law or morals for denying him the right to recover [attorney fees] as a part of the expenses necessarily and properly incurred.”); Union Nat’l Bank v. Mead Mercantile Co., 151 Mo. 149, 159, 52 S.W. 196, 199 (1899) (“[T]here was nothing contrary to good faith or good morals in providing for reasonable attorney’s fees in the deed of trust.”). The wrongful involvement exception continues to reflect that “moral” component by requiring that the claimant be truly innocent. It is not enough to be absolved of liability—the claimant must be an “unrelated third party” whose own conduct did not put it in a position to be sued and have to defend that conduct. Kriefall, 342 Wis. 2d at 72–73.

Push for Broader Scope

Recently, fee-seeking litigants have pushed to broaden the scope of the wrongful involvement exception. The attempts have taken two primary paths. First, fee claimants have tried to import traditional tort concepts of causation, asserting that recovery should be permitted if another’s conduct was a “but for” cause of, or a “substantial factor” in causing, the claimant’s fees, even if the claimant was also defending its own conduct in the underlying litigation. Thus, claimants seek to cast their fee claims as traditional tort claims, rather than as fitting within a narrow exception to the American Rule. Second, fee claimants have asserted claims alleging “wrongful involvement” by other defendants in multi-defendant cases, seeking recovery of their fees when they are eventually found not liable in the underlying litigation.

A recent Third Circuit decision illustrates both approaches well. See Marshall Invs. Corp. v. Krones A.G. & Krones, Inc., 572 F. App’x 149 (3d Cir. July 10, 2014). In Marshall, both the plaintiff and the defendant were codefendants in previous litigation over an alleged fraudulent scheme involving the sale of bottling equipment. Krones was a manufacturer that provided bottling equipment to the fraudster’s beverage company, while Marshall arranged the lease financing for that equipment by syndicating it to various investors through an offering memorandum. Id. at 150. After Marshall circulated the memorandum, it received a tip from a third party that the fraudster had inflated the price of the equipment to extract additional lease financing. Marshall concluded (incorrectly) that the tip had no merit and proceeded with the lease financing. Notably, Marshall never told any of the participating financial institutions about the tip.

After the fraudster’s company collapsed, both Krones and Marshall (as well as others) were sued by various claimants, including the lease financing participants, who alleged that they were complicit in the scheme. When the underlying litigation was on the verge of settlement, Marshall filed a new action against Krones, alleging claims for fraud and negligence and seeking to recover the fees it incurred in the underlying litigation as damages. Marshall argued that “but for” Krones’s alleged fraud, there would have been no equipment transaction for Marshall to finance in the first place and that, as a result, Marshall was dragged into the underlying litigation due to Krones’s wrongful conduct, entitling Marshall to recover its fees from that litigation.

Krones moved to dismiss, arguing that the allegations against Marshall in the underlying litigation demonstrated that Marshall was defending its own conduct (statements in the offering memorandum and failure to disclose the tip), at least in part, and therefore had not been “wrongfully” involved in the case. The district court granted the motion. On appeal, Marshall argued that the proper test for the wrongful involvement exception was whether Krones’s alleged misconduct was a “proximate cause” of Marshall’s alleged damages (attorney fees) and that a focus on Marshall’s conduct was misguided. Further, Marshall contended that the court could not determine whether the wrongful involvement exception applied at the motion to dismiss stage. Krones, in turn, relied on the exception’s traditionally narrow scope and pointed out that Marshall’s approach would result in a proliferation of fee litigation, particularly in complex multi-defendant cases in which cross-claims for fees would become standard practice. Id. at 154.

The Third Circuit affirmed, rejecting a “proximate cause” approach, emphasizing that Marshall’s claim required a departure from the American Rule, and endorsing a narrow construction of the wrongful involvement exception. Looking to the underlying complaints against Marshall, the Third Circuit found no doubt that Marshall had defended its own conduct there, and the court held that the exception did not apply because Marshall had not been drawn into litigation “solely because of the tortious conduct of a third party.” The Third Circuit also made clear that the issue could be resolved through a motion to dismiss because Marshall’s argument “would effectively convert the third-party litigation exception, which requires a determination of whether [Marshall] was sued for its own misconduct, into a determination of whether [Marshall] was ultimately responsible for the alleged misconduct.” The court succinctly concluded: “Liability under the third-party litigation exception is based on allegations, not the ultimate apportionment of liability.”

Door Opened to Additional Fee Litigation

Another attempt to push the limits of the wrongful involvement exception can be found in Rocky Mountain Festivals v. Parsons Corp., 242 P.3d 1067, 1069 (Colo. 2010). There, a town sued a fair operator after a water usage consultant concluded that the town had been substantially under-billing the fair operation for water and wastewater charges. Concluding that the operator had underpaid for water but overpaid for wastewater, the trial court entered a small judgment for the town. The trial court also found, however, that the consultant’s usage analysis was badly flawed. The fair operator then sued the consultant, contending that it had been wrongfully involved in litigation due to the consultant’s faulty analysis. The consultant argued that, because the operator had been found partially liable in the underlying litigation, the wrongful involvement exception did not apply as a matter of law. The trial court and the court of appeals agreed with the consultant.

Before the Colorado Supreme Court, the operator argued that, even if barred from recovering fees for those claims on which it had been found liable, it could nonetheless recover fees attributable to claims on which it was wholly successful. The court agreed, holding that a claimant’s fault will not completely bar a claim for fees under the exception if the claimant can prove a distinct and discrete subset of fees caused solely by another’s misconduct and not the claimant’s own conduct. Id. at 1073. Three justices vigorously dissented, reasoning that the exception could not apply because the operator had been at fault to some degree and had not been sued “solely” on account of another’s wrongful conduct. Id. at 1076 (Eid, J., dissenting). This holding has been narrowly construed in Colorado. See Chimney Rock Pub. Power Dist. v. Tri-State Generation & Transmission Ass’n, 2014 U.S. Dist. LEXIS 26811 , *3–4 (D. Colo. Mar. 3, 2014) (finding claimant’s argument for a “distinct and segregable” subset of claims “entirely speculative” and denying recovery of attorney fees). However, Rocky Mountain opens the door to additional fee litigation by introducing apportionment as another issue to be resolved in deciding whether the wrongful involvement exception applies.

But why stop at fees that have already been incurred? A recent Tennessee case demonstrates how far litigants will push to expand the wrongful involvement exception. Lick Branch Unit, LLC v. Reed was yet another chapter in a nearly 18-year-long “slog through the legal system” that centered on an oil field owner’s development efforts. 2014 U.S. Dist. LEXIS 16259 at *1 (E.D. Tenn. Feb. 10, 2014). The owner, a defendant in much of the earlier litigation, got fed up with Reed’s use of litigation to interfere with operation of the oil field and filed suit to recover the fees it incurred. The owner did not, however, limit its claim to past fees; it argued that Reed’s conduct might require the owner to commence future litigation against (unnamed) third parties and sought to recover the future fees as well! Id. at *20–21. The court rejected the claim, holding that Reed was not a third party, making the exception inapplicable, and that the owner could not cure that defect by positing potential future litigation with third parties caused by Reed’s alleged conduct.

Resist Expansion

Courts should resist attempts to expand the wrongful involvement exception beyond its historical parameters. A narrow exception preserves the primacy of the American Rule. Awards of attorney fees as damages should be the exception rather than the rule. Indeed, there is something incongruous about permitting a claimant who has been wrongfully involved in litigation by a third party to recover fees but disallowing recovery of fees from an adversary who could equally be said to have wrongfully involved the claimant through a meritless claim. Preservation of the American Rule requires that this line, however fine, be maintained.

A narrow exception also restrains the proliferation of fee litigation. Otherwise, defendants in tort cases would have an incentive to sue or cross-claim against every other defendant for attorney fees, dramatically increasing the amount of satellite fee litigation and delaying the final resolution of disputes. See, e.g., Weinhagen v. Hayes, 190 N.W. 1002, 1004 (Wis. 1922) (“The temptation to institute litigation for the purpose of recovering from the opposite party generous fees would be very great and no doubt lead to great abuses.”). The last thing an overtaxed court system needs is more fee litigation, particularly in already complex and lengthy multi-defendant cases.

Finally, a narrow wrongful involvement exception comports with sound public policy. If suing defendants who may ultimately escape liability could result in liability for significant attorney fees (plus additional fees to defend a separate suit brought on that ground), plaintiffs might hesitate to bring potentially meritorious claims. While courts have a strong interest in deterring frivolous litigation, they have the tools, such as Rule 11 and similar sanctions, to do so, and that concern must be balanced against the importance of ensuring access to justice and the development of new, meritorious causes of action and defenses.

To conclude, the recent uptick in wrongful involvement claims means that litigators must be prepared to confront such claims and to assess potential exposure to the client. Parties faced with a wrongful involvement claim should keep the following in mind:

  • The law is on your side. The majority of cases that address the wrongful involvement exception have endorsed a narrow construction and rejected “substantial factor” or “but for” causation tests.
  • Defendants should aggressively highlight any applicable facts showing that the fee claimant was involved in the underlying litigation because of its own acts or omissions. The fact that the claimant avoided liability in the underlying litigation is irrelevant; the salient question is whether it incurred fees to answer for its own conduct. Where that is apparent from pleadings in the underlying litigation, a motion to dismiss is likely to be successful.
  • Courts take the American Rule as a given. Reminding them why it remains the rule—and a good one at that—will prove useful, and illustrating the barrage of fee litigation that expansion of the exception portends will make the point powerfully. Be sure to emphasize the policy considerations that support the American Rule and militate in favor of a narrow wrongful involvement exception.

The traditional approach to fees has served our legal system well for more than a century. These arguments should help lawyers avoid substantial exposure for their clients and prevent the wrongful involvement exception from swallowing the American Rule.

Andrew J. Wronski and Gregory N. Heinen

The authors are with Foley & Lardner LLP, Milwaukee.