The familiar "American rule" holds that a prevailing party generally cannot recover its attorney's fees from the losing party in the absence of a statute or contract provision specifically authorizing an award of such fees. Jurisdictions are divided on the issue of whether a party can recover its attorney's fees as damages, rather than costs, for the breach of a covenant not to sue the other party. In those jurisdictions that have not permitted attorney's fees to be awarded as damages, courts have reasoned that the contract containing the covenant not to sue can itself provide for attorney's fees in the event of its breach if that is the parties' intention. See Artvale, Inc. v. Rugby Fabrics Corp., 363 F.2d 1002, 1008 (2d Cir. 1966) ("Certainly it is not beyond the powers of a lawyer to draw a covenant not to sue in such terms as to make clear that any breach will entail liability for damages, including the most certain of all—defendant's litigation expense."). By contrast, other courts have determined that the American rule does not apply in "those cases in which the attorney fees are not awarded to the successful litigant in the case at hand, but rather are the subject of the law suit itself." Zuniga v. United Can Co., 812 F.2d 443, 455 (9th Cir. 1987). Virginia recently adopted the latter view.
In Bolton v. McKinney, No. 200637, 2021 WL 1220801 (Va. Apr. 1, 2021), Bolton and McKinney were partners in a business venture. Bolton later purchased McKinney's ownership interest in the company and eventually terminated McKinney as an employee of the company. McKinney then sued Bolton and the company, causing the company to lose financing and go out of business. Bolton then filed for bankruptcy and listed McKinney as a creditor. During the bankruptcy proceedings, Bolton and McKinney entered into a "Settlement Agreement and Global Mutual Release of Claims," pursuant to which McKinney relinquished all rights to sue Bolton in consideration for $25,000 and Bolton's own covenant not to sue McKinney. Less than a year after entering into the settlement agreement, McKinney breached the covenant not to sue by suing Bolton twice in state court and once in federal court for claims relating to his time at their company. After all of the suits were resolved in Bolton's favor, he sued McKinney for a breach of the settlement agreement. Bolton claimed damages of more than $80,000 based on the attorney's fees he incurred in defending McKinney's three lawsuits against him.
The trial court decided that although McKinney had breached the covenant not to sue, there were no grounds for the requested award of damages because, under the American rule followed in Virginia, attorney's fees are generally awarded only when explicitly authorized by a contract or statute. The Supreme Court of Virginia reversed. The court found more persuasive the reasoning of those courts that permit an award of attorney's fees as damages for the violation of a covenant not to sue because, unlike in most cases, attorney's fees in such a case are not costs but, rather, direct or consequential damages of a breach of this type of agreement. An award of attorney's fees is thus required to put the nonbreaching party in the position it would have been in had the breach not occurred, which is the entire purpose of contract damages. In other words, preventing Bolton from recovering his direct damages from McKinney's breach of an express term of the parties' contract simply because they happened to also be attorney's fees would have robbed Bolton of the benefit of his bargain and made his victories in McKinney's three lawsuits against him hollow. Therefore, the supreme court held that the trial court had erred in failing to award Bolton damages in the amount of the attorney's fees he incurred in defending the lawsuits wrongfully filed against him by McKinney.
The Virginia Supreme Court's ruling is a sensible one, as otherwise other parties in Bolton's position would be left in the position of having no remedy for the other party's breach of contract, which is a fundamental right of contracting parties. Even so, not all jurisdictions follow this rule, so it is good practice to include in settlement agreements containing a covenant not to sue a term providing for the award of attorney's fees if the covenant is breached.