Party May Be Awarded Attorney Fees in Defending Against Claim that Contract Is Invalid

November 7, 2013 | Bulletin No. 1039887.1

A California court of appeal recently ruled that a party that successfully defends against a claim that a contract is void is entitled to be paid attorney fees by the party that unsuccessfully brought the action.

In Eden Township Healthcare District v. Eden Medical Center (2013) 220 Cal.App.4th 418, Eden Medical Center (“EMC”) was not awarded attorney fees by the trial court after it prevailed in an action brought by Eden Township Healthcare District (“District”) seeking to nullify a contract between the parties.  EMC appealed the denial of the attorney fees.

The District, by and through EMC, operated Eden Hospital (“Hospital”) in Castro Valley.  EMC was owned jointly by the District and Sutter Health (“Sutter”), a nonprofit public benefit corporation.  Faced with closure of the Hospital due to its failure to comply with seismic code requirements, the District, EMC and Sutter entered into an agreement in 2004 in which EMC and Sutter agreed to construct a replacement hospital.  However, in 2006, Sutter announced that it would not build the proposed replacement hospital.  Following negotiations between the parties, Sutter agreed to a revised agreement in 2008 in which Sutter would build the new hospital, but also would be allowed to purchase another hospital, San Leandro Hospital (“SLH”) from the District.

In 2009, Sutter exercised its option to purchase SLH with the intent of converting it from an acute care emergency services hospital to an acute rehabilitation hospital.  The District's board refused to convey SLH to Sutter because Sutter’s plan would deprive the citizens served by the District of SLH’s emergency care services.  Sutter filed suit against the District for breach of the 2008 agreement.  The District filed a cross-complaint against Sutter and EMC alleging the 2008 agreement was illegal based on an allegation that former District board members and executives had a prohibited financial interest in the revised agreement reached in 2008.

The trial court ruled that the District could not establish the elements of its case and awarded summary judgment to Sutter and EMC, which was affirmed on appeal.  However, the trial court denied EMC's motion for attorney fees and costs.  EMC appealed the denial.

The First District Court of Appeal reversed and ordered the trial court to award attorney fees to EMC.  The appellate court explained that Civil Code section 1717 provides for attorney fees to the prevailing party for an “action on a contract.”  This includes a situation in which a party wins an action by establishing a contract is invalid or unenforceable.  However, this case presented a slightly different situation:  the District claimed the contract was invalid, but lost to EMC.  Thus, the question was whether a party who successfully defends against an action in which the complaining party unsuccessfully asserts that the underlying contract is illegal and invalid is entitled to fees for “action on a contract.”

The appellate court agreed with EMC’s argument that because the District sought to invalidate the 2008 agreement, its action was an “action on a contract” for purposes of the Civil Code section 1717.  The court stated, “[c]andidly, it is difficult to think of an action that is more likely to be characterized as an ‘action on a contract’ than one in which the party bringing the action explicitly seeks to have the subject contract declared void and invalid in its entirety.”  Further, it was undisputed that the 2008 agreement contained a provision for attorney fees and costs.  The court observed that the District itself sought attorney fees against EMC in its cross-complaint, which indicated that the District meant for the action to be an action “on a contract.”

The appellate court rejected the District’s argument that EMC could not collect attorney fees because the 2008 agreement only provided for fees in an action for breach of the agreement, not for an action involving the agreement’s validity.  The court noted that EMC’s defense of the agreement was brought to keep the District from breaching the agreement.  Moreover, the court pointed out that case law holds that Civil Code section 1717 applies when a party successfully defends against a claim that a contract is void, even if the party did not initially make its own affirmative claim to enforce the contract.  Here, the court held that because the District initiated the challenge to the contract, and EMC successfully defended against that claim, Civil Code section 1717 applied.  In the court’s words, “having elected to proceed with its contractual invalidation theory, the District put the 2008 [agreement’s] attorney fees clause in play.”  

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Mark E. Ellinghouse | 916.321.4500