DOES CIVIL CODE 1717’S MUTUALITY POLICY TRUMP CHOICE OF LAW CLAUSES WITH GOVERNING LAW THAT IS MORE RESTRICTIVE FOR PREVAILING PARTY RECOVERY?

Appellate Courts Come to Differing Results on Which State Law Governs, But Do Not Dispute That Civil Code section 1717 Is a Fundamental State Policy.

            “State’s rights” is not just a constitutional issue. It also enters into play when construing fee entitlement in contracts having foreign state choice of law provisions.

Many times, California courts are faced with a situation where a litigant in its system has sued or been sued and won, then seeks to enforce a contractual attorney’s fees clause governed by the law of another state.  However, California has enacted Civil Code section 1717 in the attempt to take out the oppression in one-sided drafted clauses.  For example, fee clauses that are unilateral in nature—stating that only one side is entitled to fees as the winner—are to be construed as being reciprocal, such that the other side also is entitled to a fee award, if it prevails, even though the clause is not worded that way.  (See Trope v. Katz, 11 Cal.4^th 274, 289 (1995) [Civil Code section 1717’s legislative purpose is to ensure evenhanded enforcement of contractual attorney’s fees provisions].)

            So, what happens when section 1717 runs into fee clauses with non-California choice of law provisions more restrictive in scope?  That now brings us to the discussion of the case law on the subject.

            The seminal case, which is not that old, happens to be ABF Capital Corp. v. Grove Properties Co., 126 Cal.App.4^th 204 (2005), rev. den., which pitted a New York choice of law clause and unilateral attorney’s fees clause against Civil Code section 1717’s reciprocity policy.   The operative contract, governed under New York law, only allowed fees to the plaintiff in enforcing the contract.  Defendant won, and the trial judge denied an attorney’s fees motion by refusing to give effect to section 1717’s reciprocity provisions.  On appeal, the Fourth District, Division Two reversed.  Although finding that New York had a substantial relationship to both the parties and the transaction, the Grove Properties court found California has a “fundamental policy” in giving reciprocity to fee provisions—an interest that overrode applying New York law instead. (Id. at 217 [section 1717(a) “represents a basic and fundamental policy choice by the state of California that nonreciprocal attorney’s fees contractual provisions create reciprocal rights to such fees ….”].)

            ABF Capital, the losing party in Grove Properties, did not give us that easily.  Similar contractual provisions came up for review by the Second District, Division One in ABF Capital Corp. v. Berglass, 130 Cal.App.4^th 825 (2005), rev. den.  However, this appellate court determined that New York law applied in any event, notwithstanding that it was the choice of law in the contract between the parties.  This made it unnecessary for the Second District to determine if the New York law contravenes a fundamental public policy of California, even though it did agree that California had “a significant interest in the issue.”Id.at 839.)  The Second District did go further, indicating “[w]e do not agree with the Grove Properties court, however, that California’s interest is materially greater than New York’s” and “[a]t best, New York and California have equal interest in the issue”—California in preventing the use of one-sided fee provisions and New York in enforcing strictly the parties’ intent under the contractual fee clause (even if it is unilateral in nature).  (Ibid.)

            Although one can make fine distinctions, sounds like a difference in opinion.  True, Berglass found New York law applied regardless, based on the circumstances attending negotiation of the contract and its subsequent execution.  Also true, it did not directly decide the “fundamental interest” issue.  However, the reasoning in Berglass seems to be in sharp contrast to that in Grove Properties.

            No published decision has yet to serve as a tiebreaker.  But, there is the tantalizing result and discussion in Kim v. Hayes Lemmerz International, Inc., 2007 WL 1566713 (4^th Dist., Div. 3 May 31, 2007) (unpublished) (authored by Justice Aronson by a 3-0 panel), which provides fertile grounds for further litigation on the issue.

            In Hayes Lemmerz, defendant won a judgment from the court, after it rested, based on plaintiff not proving its breach of contract case.  The underlying contract had a Michigan choice of law clause as well as an attorney’s fees clause which allowed recovery by defendant in the event of a default by plaintiff—which was not the basis of the suit that went to a defense judgment.  The trial court denied a fee motion brought by defendant, determining that they were unavailable under Michigan law.  This determination was reversed on appeal.

            Our local Santa Ana-based court found that section 1717 would have allowed plaintiff to recover had it won, so that the mutuality principle also means defendant could recover under California law.  Even though determining that Michigan had a substantial relationship with the defendant, the appellate court then concluded that enforcement of Michigan law with respect to the fee provision was contrary to a fundamental policy of California, siding with Grove Properties’ analysis on the issue.  (Id.at *5.) 

            Appellant then made the argument that  Berglass “disagreed with Grove Properties that California had a fundamental interest in ensuring reciprocity of attorney fee provisions.”  Not a bad argument based on Berglass dicta and reading in between the lines of that prior decision.  Justice Aronson said “no,” based on a very technical (but correctly technical) reading of Berglass—which refused to reach the fundamental interest issue and found New York law would have applied even if there had been no choice of law clause.

            However, the Hayes Lemmerz panel did decide that the unilateral Michigan fee clause did violate section 1717’s reciprocity principle and that California has a greater interest than Michigan in determining the fee issue.  Justice Aronson reasoned that even though plaintiff was the California resident in the case before it (contrasted with the defendant being the California resident in Grove Properties), this was inconsequential because the reciprocity principle extended past mere residency status as a matter of public policy.  He also made a cogent point that Michigan likely had little interest in enforcing its law on fee clauses in a foreign venue.  (Id. at *6.)

            We believe that this issue will be a fertile area for litigation in the future given how the published decisions are not exactly consonant with each other.  With Hayes Lemmerz considered in the mixture (although not citable), it appears, for now, that California courts have found that Civil Code section 1717 reflects a fundamental public interest that can trump a narrower construction of a fee clause had the restrictive choice of law provision been enforced with respect to the fee issue.