[authors: James J. Sienicki and Eric H. Spencer]

A recent Arizona case will significantly impact settlement tactics, settlement offers and which party will be awarded its attorneys’ fees in contract-based disputes. This was a case where the attorneys’ fees drove the case and far exceeded the value of the underlying dispute. Its effect should ripple through many attorneys’ fees disputes in construction cases, since “successful party” is a term used in A.R.S. § 12-341.01, which governs disputes arising out of contract. The facts in the case are summarized below. In 1999, Jane Hall purchased a previously owned house. Soon thereafter, Hall experienced various structural problems with the house. In 2004, Hall filed suit against the original contractor, alleging breach of the implied warranty of habitability and requesting “rescission of the purchase,” or damages for the cost of repair in the alternative.

The trial court ruled that Hall was not entitled to rescission because, as a subsequent purchaser, Hall did not have a direct contract with the original contractor.   Later, the jury found in favor of Hall on her breach of implied warranty claim and awarded $30,000 in damages. Both parties then requested their attorneys’ fees pursuant to A.R.S. § 12.341.01(A).   Hall cited the court’s discretionary ability, in absence of a contractual provision addressing attorneys’ fees, to award the “successful party” its reasonable attorneys’ fees in any action arising out of contract. The original contractor, citing past settlement offers, based its request for fees on the statutory provision stating “if a written settlement offer is rejected and judgment finally obtained is…more favorable to the offeror…, the offeror is deemed to be the successful party from the date of the offer and the court may award [that party] reasonable attorney fees.”  Hall countered that the original contractor’s prior $40,000 and $126,000 settlement offers did not exceed the “judgment finally obtained,” because the judgment finally obtained consisted of the $30,000 verdict plus Hall’s attorneys’ fees and costs. The trial court agreed: since Hall would be awarded $225,000 in fees and $10,757.79 in costs as the “successful party,” the aggregate amount, including the $30,000 in damages awarded by the jury, exceeded the contractor’s prior settlement offers.

The Arizona Court of Appeals upheld the trial court’s decision to include attorneys’ fees and costs in the “judgment finally obtained,” but on different grounds. As a preliminary matter, the court agreed there can be two competing “successful parties” in a contract-related case—(1) the overall successful party in the litigation, based on the jury’s verdict, and (2) the party whose offer was rejected and never beaten by the “judgment finally obtained,” but that party is deemed “successful” only from the date of the offer forward. (If this analysis results in there being competing “successful” parties,  the trial court should offset these amounts when awarding fees and costs—for example, if plaintiff is the overall successful party and incurred $100,000 in total fees and costs, but the defendant is deemed “successful” from the date of its settlement offer and incurred $70,000 in fees and costs after that date, the court has discretion to award the plaintiff net $30,000 in fees and costs).

The court clarified that the amount of fees and costs the trial court should consider in determining what the “judgment finally obtained” are those fees and costs incurred up to the date of the offer, not through the date of the judgment. In this case, the original contractor made a $40,000 settlement offer in January 2007 but, at the time of that offer, Hall had incurred $69,396.50 in fees. Later, about one month before trial, the original contractor made another settlement offer for $126,000—however, Hall had incurred $206,692.81 in fees as of that date. In both cases, the “judgment finally obtained”—Hall’s pre-offer attorneys’ fees and costs along with the $30,000 damages award—exceeded the original contractor’s various settlement offers and therefore precluded the original contractor from being a “successful party” from the date of the offers. Therefore, since Hall was the only “successful party,” the trial court’s $225,000 fee award and $10,757.79 cost award in Hall’s favor was upheld.

The Arizona Court of Appeals also agreed that Hall could not seek rescission of her home purchase. Although the Supreme Court long ago eliminated any privity requirement for subsequent homeowners to maintain a breach of implied warranty of habitability claim against the original builder, privity of contract is nonetheless required for any homeowner seeking rescission of the contract. The remedy of rescission “undoes” a contract from the beginning—the parties are not merely released from further performance, but rather the contract is annulled and the parties are to be restored to their relative positions as if no contract had ever been made. The court could not effectively restore these parties to the status quo because they never contracted with each other; doing so would require the original contractor to return funds to Hall even though Hall never paid the original contractor for the home. Thus, a subsequent purchaser like Hall is limited to the remedy of recovering damages for any breach of the implied warranty of habitability.

Hall v. Read is significant because it should (and has) caused construction attorneys to modify their practice of crafting settlement offers in contract-based cases.  In particular, the decision effectively requires one to ask the other side how much it has spent in fees and costs to date and to evaluate whether that amount is reasonable before making any intelligent settlement offer—at least if one hopes to use that rejected offer to mitigate against the risk of an adverse attorneys’ fee award later on. Attorneys should now expect to be routinely asked to provide this information to the other side as well (although there is no legal obligation to provide it). Hall v. Read is still subject to appeal to the Arizona Supreme Court so further changes could be coming, but in the meantime, expect this case to have a significant impact on settlement tactics, settlement offers and the award of attorneys’ fees under A.R.S. § 12-341.01 going forward.