Unlike many states, Arizona has long provided for the recovery of attorney fees, albeit on a discretionary basis, in contested contract disputes. See A.R.S. § 12-341.01(A). The Arizona legislature made clear, however, that the discretionary fee statute was not intended to displace contractual fee provisions of the sort commonly found in consumer and commercial contracts. Thus, § 12-341.01 states: “This section shall not be construed as altering, prohibiting or restricting present or future contracts or statutes that may provide for attorney fees.” 

The Arizona Court of Appeals, in interpreting the statue, has consistently upheld the sanctity of the parties’ contract, repeatedly finding that a mandatory fee-shifting provision supersedes the general statutory provision which might otherwise apply. See Sweis v. Chatwin, 120 Ariz. 249, 252, 585 P.2d 269, 272 (App. 1978) (applying A.R.S. § 12-341.01 instead of the contract “would in effect cancel the unqualified contractual right to recover attorney’s fees given to the successful party by their agreement” and “would clearly be an alteration of the agreement of the parties”); see also Geller v. Lesk, 230 Ariz. 624, 627, ¶ 9, 285 P.3d 972, 975 (App. 2012) (the parties’ contractual provision, “not the statute,” governs an award of fees); Lisa v. Strom, 183 Ariz. 415, 418 n.2, 904 P.2d 1239, 1242 n.2 (App. 1995) (“when a contract has an attorney’s fee provision it controls to the exclusion of the statute”); Connor v. Cal-Az Properties, Inc., 137 Ariz. 53, 55, 668 P.2d 896, 898 (App. 1983) (the statute “is not to be considered” when the parties’ contract provides conditions under which attorney fees may be recovered). 

Offer of Judgment

There now appears to be a gaping hole in that principle, resulting in somewhat of a “gotcha” to the litigants in Am. Power Prod., Inc. v. CSK Auto, Inc., 241 Ariz. 564, 390 P.3d 804 (filed March 23, 2017). In American Power, the defendant served a $1,000,001.00 pre-trial Rule 68 offer of judgment, which the plaintiff rejected.  241 Ariz. at 564, ¶ 4, 390 P.3d at 806.  At trial, the plaintiff asked for more than $10.8 million, but the jury awarded only $10,733.00 and gave the defendant nothing on its counterclaims.  Id., ¶¶ 5-6.  The trial court nevertheless deemed the plaintiff to be the prevailing party, declined to award Rule 68 sanctions, and awarded the plaintiff a substantial portion of its attorney fees as the parties’ contract had required. Id., ¶ 6. The Court of Appeals affirmed the trial court’s award of fees, but the Supreme Court reversed the award based on the $1,000,001.00 Rule 68 offer of judgment and what the Court called “the interplay between § 12–341.01 and contractual fee provisions” – in other words, the application of the statute to define (or perhaps re-define) who the prevailing party was at the conclusion of the case. Id., ¶ 7, 390 P.3d at 806-07.

The Exception

While purporting to cite at least some of the prior cases with approval, a majority of the Supreme Court discovered an exception to the principle of contractual autonomy and proceeded to read part of the statute into a private, mandatory fee provision:  

To the extent prior case law broadly precludes application of § 12–341.01 whenever the parties’ contract contains an attorney fee provision, regardless of its content, scope, and other provisions in the contract, we disagree. Rather, § 12–341.01 “is inapplicable by its terms if it effectively conflicts with an express contractual provision governing recovery of attorney’s fees.”

241 Ariz. at 568, ¶ 13, 390 P.3d at 808, citing Jordan v. Burgbacher, 180 Ariz. 221, 229, 883 P.2d 458, 466 (App. 1994) (disagreeing with Connor’s broad statement and observing that Sweis “did not hold that any express contractual provision for attorney’s fees, however worded, ‘preempts’ A.R.S. section 12–341.01”).  “Thus,” it held, “rather than being completely supplanted by any attorney fee provision in the parties’ contract, the statute, consistent with its plain language, applies to ‘any contested action arising out of contract” to the extent it does not conflict with the contract.”  241 Ariz. at 568, ¶ 14, 390 P.3d at 808.

The opening seized upon by the Court in American Power was that, while the parties’ contract provided for a mandatory award of attorney fees to the prevailing party, stating:  

In the event either party shall commence or be required to defend any action or proceeding against the other party arising out of this [contract], the prevailing party shall be entitled to recover from the other party its reasonable attorneys’ fees and costs through all levels of proceedings as determined by the court. 

241 Ariz. at 567, ¶ 8, 390 P.3d at 807, it did not define the term “prevailing party.”  Given that omission, the Court might have looked to the parties’ intent, or to the ordinary meaning of the words used, or to analogous case law under the Arizona taxable costs statute, A.R.S. § 12-332.  See, e.g., Ahwatukee Custom Estates Mgmt. Ass’n, Inc. v. Bach, 193 Ariz. 401, 402-03, ¶ 7, 973 P.2d 106, 107-08 (1999) (Court essentially read the limitations on taxable costs found in A.R.S. § 12-332 into the parties’ attorney fees contract provision). Instead, relying on a boiler-plate provision incorporating Arizona law as governing “the rights and remedies of the parties,” id., the Court discovered a hitherto unknown link between the statue and private fee provisions.

The Court determined that, absent a definition of the term “prevailing party” in the contract, and despite the statute’s express disclaimer that it “shall not be construed as altering, prohibiting or restricting present or future contracts …,” it would look to A.R.S. § 12-341.01(A) to fill that gap.  241 Ariz. at 568, ¶ 14, 390 P.3d at 808.1  Specifically, the Court, equating “prevailing party” with the statutory term “successful party,” held that the contractual provision was to be interpreted in light of the second sentence of the statute, which states:  

If a written settlement offer is rejected and the judgment finally obtained is equal to or more favorable to the offeror than an offer made in writing to settle any contested action arising out of a contract, the offeror is deemed to be the successful party from the date of the offer and the court may award the successful party reasonable attorney fees.

A.R.S. § 12–341.01(A).

This ruling, according to the Court, is nothing out of the ordinary.  The law is well settled, for example, that the statute fills the gap created by a unilateral attorney fee provision by allowing for an award of fees to the prevailing party omitted from the provision. 241 Ariz. at 568, ¶ 14, 390 P.3d at 808, citing, e.g., Tucson Estates Prop. Owners Ass’n, Inc. v. McGovern, 239 Ariz. 52, 54-56 ¶¶ 7-14, 366 P.3d 111, 113-15 (App. 2016); Pioneer Roofing Co. v. Mardian Constr. Co., 152 Ariz. 455, 470-72, 733 P.2d 652, 667-69 (App. 1986). “Thus, rather than being completely supplanted by any attorney fee provision in the parties’ contract, the statute – consistent with its plain language – applies to ‘any contested action arising out of contract’ to the extent it does not conflict with the contract.”  Id.

Besides, the Court explained, the general rule in Arizona is that “contracts are read to incorporate applicable statutes.”  241 Ariz. at 568, ¶ 15, 390 P.3d at 808, citing Banner Health v. Med. Sav. Ins. Co., 216 Ariz. 146, 150, ¶ 15, 163 P.3d 1096, 1100 (App. 2007). It therefore held:  

Because the [contract] here did not define ‘prevailing party’ and expressly provided that Arizona law shall apply and govern ‘the rights and remedies of the parties,’ and because the second sentence of § 12–341.01(A) does not directly conflict with the [contract’s] attorney fee provision, that statutory provision is ‘incorporated by operation of law’ into the [contract] for the limited purpose of defining ‘successful party’ under the circumstances presented here.  

241 Ariz. at 568-69, ¶ 15, 390 P.3d at 808-09, again citing Banner.That seems to make sense, particularly given the specific procedural posture of the case. 

The Pretrial

In the specific procedural posture of the American Power case, where the pretrial offer was so much and the outcome at trial was so little, it makes intuitive sense to extract some form of meaningful punishment beyond Rule 68 against a plaintiff who, at least in hindsight, really should have accepted the defendant’s pretrial offer. Thus, from a policy standpoint, the Court’s decision to extract that punishment based on the fee-shifting provisions of A.R.S. § 12–341.01(A) seems laudable, regardless of its apparent intrusion upon what the parties may have intended when they crafted the prevailing party attorney fee provision in their contract.

Justice Timmer in dissent, however, exposed the logical gap in the decision, criticizing the majority for ignoring the controlling rule of interpretation – that “the ordinary meaning of language be given to words where circumstances do not show a different meaning applicable.”  241 Ariz. at 571, ¶ 27, 390 P.3d at 811. According to Justice Timmer, the term “prevailing party,” as used the contractual fee provision is clear and unambiguous: “‘The’ indicates a particular party, and ‘prevailing’ identifies that party as the one that wins the lawsuit.” 241 Ariz. at 564, ¶ 27, 390 P.3d at 811, citing Smith v. Melson, Inc., 135 Ariz. 119, 121, 659 P.2d 1264, 1266 (1983) (noting that “the” is “a definite article used in reference to a particular thing”); Webster’s Third New International Dictionary 1797 (3d ed. 2002) (defining “prevail” in part as to “win,” “triumph,” or to be “successful”); Black’s Law Dictionary 1298 (10th ed. 2009) (defining “prevailing party” as the one “in whose favor a judgment is rendered”). Accordingly, Justice Timmer concluded, the majority used A.R.S. § 12–341.01(A) “to impermissibly alter the meaning of ‘the prevailing party’ in the parties’ contract” contrary to the intended meaning or use of those words in the statute.  241 Ariz. at 571-72, ¶ 28, 390 P.3d at 811-12.  She pointed out that the words “successful party” in the statute are no more defined than “prevailing party” is defined in the contract, and so there is no need to, and no reason to, import any provision of the statute into the contract as a matter of law.  Id.  And, she noted, it was surely not the parties’ intent to redefine the words “prevailing party” in their contract or to import wholesale the provisions of the statute into their contract.  241 Ariz. at 572, ¶29, 390 P.3d at 812.

The majority, responding to Justice Timmer’s dissent, insisted that their decision does not “change the meaning of ‘the prevailing party’ in the [contract].”  241 Ariz. at 568-69, ¶¶ 28-29, 390 P.3d at 811-12. Furthermore, they defensively (and rather unpersuasively) assert a claim that the “dissent also downplays the [contract’s] broad, unqualified choice-of-law provision, under which the parties agreed that Arizona law would govern their rights and remedies under the [contract].”  Id.  Logically, the contract choice of law provision has nothing to do with how the law should be applied in this case, especially given the Court’s abrupt, and arguably unforeseen, change in the law that it applies in the case.

The Decision

The important point to all of this, and what we may assume is the driving force behind the majority’s decision, is the Supreme Court’s desire to expand the fee-shifting provision and policy of the second sentence of § 12-341.01 to encourage settlement in all contract cases.  Justice Timmer correctly points out, however, that the majority’s decision overrides the parties’ intended use of the words “prevailing party” to, in effect, create two kinds of successful parties defined by the statute – one who prevails and one who does not prevail, but does better than a rejected settlement offer. 241 Ariz. at 572, ¶29, 390 P.3d at 812. The majority counters that, “[a]s for there being two prevailing parties … that paradigm is implicitly contemplated and permitted by § 12–341.01(A)’s second sentence, which supplements, but does not alter, the [parties’ contract].”  241 Ariz. at 569, ¶16, 390 P.3d at 809. “And such a result is permissible even though § 12–341.01(A), like the [contract], limits attorney fee awards to ‘the successful party.’”  Id.

And there’s the rub!  The core issue is not whether applying the statute subverts the parties’ contract – it clearly does to the extent doing so is contrary to what the parties’ likely intended – but whether applying the statute, in the absence of a contract provision to the contrary, is a desirable and sound judicial policy. The majority has elevated the policy over the parties’ likely intent, whether expressed or unexpressed in their contract. 

Thus, in the final analysis, the sound judicial policy of encouraging settlement and discouraging unreasonably protracted litigation in all contract cases has won the day.  The imported second sentence of A.R.S. § 12–341.01(A) is essentially a Rule 68 cost-shifting/sanctions provision with now added teeth.2  One may agree or disagree with the analysis, but it is difficult to disagree with the outcome from a policy standpoint – or is it really that clear?  

We may reasonably assume that, being on notice of the American Power decision, litigators will be mindful of the risks involved in proceeding with litigation after rejecting a written settlement offer – whether the case is governed by a contractual fee provision or  § 12–341.01(A).  But consider how easily the decision, or at least the Court’s reasoning, can be overridden by careful drafting: 

• Crucial to the Court’s analysis is the absence of a definition of “prevailing party.”  As a result, all that is necessary to reverse the outcome is to insert a contractual definition; e.g., following Black’s Law Dictionary, “‘prevailing party’ means the party in whose favor a judgment is rendered.’”
• Alternatively, given the clear legislative command that the statute is not intended to replace contractual fee provisions, a prudent lawyer wishing to avoid judicial second-guessing might simply insert a provision stating that “fee awards under this provision are to be made without reference to A.R.S. § 12-341.01.”  

What is the Ultimate Takeaway?

For the parties to that case, and for future litigants, the lesson may be that the Arizona Supreme Court is not immune to the temptation to choose a favored policy result over the outcome dictated by simple logic and close textual analysis.  For lawyers practicing in Arizona, the message is that all attorney fee provisions are not the same; given the crucial weight given by the American Power court to the absence of specific language defining “prevailing party” and adopting (or rejecting) the written offer provisions of the statute, lawyers involved in drafting and negotiating contracts should, and must, give careful attention to the outcome preferred by their clients. In practice, it may be expected that stronger parties – those with greater bargaining power and economic resources – will likely want to draft the second sentence of A.R.S. § 12–341.01(A) out of their contracts and thus retain more flexibility in how they litigate a dispute in court.  A weaker party may resist that and thus retain the ability to leverage a successful settlement of that dispute before being outspent by the stronger party.  Of course, in many contract situations, whether one can actually negotiate such issues is largely theoretical. What actually occurs will depend on the parties and the circumstances of their negotiation, if there even is a negotiation.