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Voluntary Dismissals’ Impact on Attorney’s Fee Provisions in California Contracts

Many contracts provide that in the event of a lawsuit the prevailing party shall be entitled to recover its reasonable attorney’s fees.  One would naturally think that the defendant is the prevailing party when a lawsuit has been dismissed.  This common-sense assumption can lead to unfortunate errors in legal strategy, however.

Section 1717(b)(2) of the California Civil Code specifically provides that “there shall be no prevailing party” when “an action has been voluntarily dismissed or dismissed pursuant to a settlement of the case.”  That Section applies to voluntary dismissals at any stage of a lawsuit prior to a final order.  Moreover, it bars recovery of attorney’s fees even when the contract expressly provides for an award of reasonable attorney’s fees in the event plaintiff voluntarily dismisses the complaint.  Santisas v. Goodin, 17 Cal.4th 599, 617 (1998).

Section 1717(b)(2) reflects a public policy decision by the California Legislature to encourage voluntary dismissals.  But it may come as a surprise to a defendant who may have spent significant sums of money over months or even years vigorously defending a breach of contract claim.  The defendant may have defended the lawsuit, at least in part, believing that it would be able to recover those fees pursuant to a bargained-for attorney’s fee provision in the parties’ contract.  In light of Section 1717(b)(2), however, such reliance would be misplaced.

Indeed, in a practice pointer, the Rutter Group suggests that a plaintiff should consider a voluntary dismissal even during trial if things are “going badly” for plaintiff, precisely because such a voluntary dismissal might save the plaintiff significant money in attorney’s fee award to the defendant if the lawsuit were to proceed to judgment without a voluntary dismissal.  Weil & Brown, Cal. Practice Guide: Civil Procedure Before Trial (The Rutter Group 2016) “Dismissals” ¶ 11:39.5.

An interesting application of Section 1717(b)(2) occurred in the recent case of Khan v. Shim, 2017 DJDAR 16 (Dec. 29, 2016).  The case arose out of the sale of a dental practice, and the parties’ agreement contained an attorney’s fee provision.  Kahn, the purchaser of the dental practice, filed a complaint asserting claims for breach of contract and related tort causes of action.  Shim, the seller, filed a cross-complaint asserting breach of contract and tort causes of action.   Shortly before trial, Kahn voluntarily dismissed her entire complaint.  The case proceeded to a bench trial on Shim’s cross-complaint, but the Court found for Kahn on all of Shim’s causes of action.

In other words, neither party recovered any money or other relief on any of their claims.  Despite Section 1717(b)(2), the trial court found that Shim was the prevailing party on Kahn’s entire complaint , awarding $140,803.25 in attorney’s fees defending the complaint, and that Kahn was the prevailing party of Shim’s cross-complaint, awarding Kahn $90,325.00 in attorney’s fees defending the cross-complaint.

On appeal, Kahn argued that section 1717(b)(2) precluded Shim from being the prevailing party on the contract claims and that the attorney’s fee provision did not allow for recovery of attorney’s fees on the tort claims that were voluntarily dismissed.

In its decision, the Court of Appeal summarized the applicable California law and noted that Section 1717 has a “very important limitation” – it only applies to “actions on a contract.”  Thus, when a plaintiff asserts both contract and noncontract claims, Section 1717(b)(2) does not foreclose an award of attorney’s fees on the noncontract claims when the plaintiff voluntarily dismisses the entire complaint if the attorney’s fee provision authorizes an award of attorney’s fees on noncontract claims.

The Court of Appeal held that pursuant to Section 1717(b)(2) there was no prevailing party on Kahn’s contract claims and that the trial court erred in awarding Shim attorney’s fees for defending Kahn’s entire complaint because the complaint included Kahn’s contract claims.  The Court of Appeal held that, however, under the usual rules of contract interpretation, the attorney’s fee provision in the parties’ contract was written broadly enough to authorize an award of attorney’s fees on Kahn’s tort causes of action.  Therefore, the Court remanded the case to the trial court to determine how much of the amount Shim spent defending the complaint should be allocated to the tort causes of action.

The Khan v. Shim decision illustrates two important points of California law.  First, on contract claims, both plaintiffs and defendants should remember that the attorney’s fee provision in the contract can be avoided pursuant to Section 1717(b)(2) if the plaintiff voluntarily dismisses the complaint.  Second, when drafting attorney’s fee provisions in contracts, the parties should carefully consider whether they want a narrow provision that only allows for recovery of attorney’s fees on contract claims or whether they want a broad provision that allows for recovery of attorney’s fees on noncontract claims.

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