The “Loser Pays” Clause is the Entrepreneur’s Friend

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“John, we’ve got a potential strategic partner coming in tomorrow and I need to get them a draft NDA tonight!”  My client had a standard form of NDA, 99% of which is identical to the NDAs that you’ve signed at one time or another.  But, in my opinion, in this situation the NDA needed more teeth.

Why?  Because my client was disclosing some sensitive technical information to someone who could at some point become a competitor.  The potential partner was a large firm with extensive resources, and my client is a startup with limited funds.  If the partner wanted to use my client’s information in a way that harmed my client, their calculation would probably go something like this: “If we use this information, do we really think that they would sue us?  Probably not, because they couldn’t afford it!”

So, in addition to my usual recommendation that my client disclose the minimum information necessary to achieve her business purpose (see my prior post on this point), I suggested that she add a “loser pays” or “fee-shifting” clause to the NDA.  In essence it says that, in the event of a lawsuit, the loser pays the winner’s expenses and legal fees.  With this clause, my client would have to incur fees throughout the litigation but, if she won, would get all her legal fees and expenses reimbursed by the other party.  Absent a clause like this, those amounts would most likely not be reimbursed.

I think a loser pays clause is a good idea for any entrepreneur who is entering into contracts (any kind of contract; not just an NDA) but doesn’t have the resources to enforce them.  While you might not want to fund a litigation even if you thought you’d get your money back, the other side doesn’t necessarily know this.  Because a loser pays clause makes your implicit threat to litigate more credible, it may (a) deter the other side from intentionally breaching the contract, and (b) improve your leverage in settlement negotiations if litigation does ensue.  Plus, there’s no downside to negotiating for one (unless you think that you’d likely be on the losing end of a dispute).

The loser pays clause is especially useful where the amounts at issue are small in relation to the potential legal fees.  For example, if winning a suit would bring you $80,000 in damages from the other side, but the cost of litigating it would be $70,000, absent a loser pays clause, you’d have little incentive to pursue your rights, even if you thought you’d win!

Here’s some good language: “If any action or proceeding is commenced to enforce or interpret any of the provisions of this Agreement, the prevailing party in any such action or proceeding shall be entitled to recover its reasonable attorneys’ fees, expert witness fees, costs of suit and expenses, in addition to any other relief to which such prevailing party may be entitled. As used herein, “prevailing party” includes without limitation, a party who dismisses an action for recovery hereunder in exchange for payment of the sums allegedly due, performance of covenants allegedly breached, or consideration substantially equal to the relief sought in the action.”

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