November 01, 2012

Confidentiality in Settlement Agreements Is a Virtual Necessity

In all fairness to the fine writer asked to provide the “con” side of this argument, being asked to espouse the positives of including confidentiality clauses in a settlement agreement is akin to being asked to take the “pro” position in a debate titled “Chocolate Chip Cookies—Yes or No?” Including a confidentiality provision in a settlement agreement is generally not only good practice for both sides, but for a defendant, it’s a virtual necessity.

The most obvious purpose for including confidentiality clauses in settlement agreements is to keep the parties (generally the plaintiff but sometimes both) and their counsel from sharing the outcome of a settlement with “the world”—other potential plaintiffs and counsel.

Why Defendants Want Confidentiality

Defendants settle cases for a variety of reasons. Sometimes there is liability, and it makes sense to shut down the litigation quickly. As most plaintiffs’ attorneys will admit, good cases settle and bad cases get tried. This is why most potential public relations litigation nightmares are kept under wraps by means of settlements with well-drafted confidentiality agreements.

However, more often than not, liability, or lack thereof, is just one of many factors examined when determining whether to settle a case. Litigation is costly, and a defendant company might elect to have its executives and employees working on other, productive matters instead of spending time defending a lawsuit. Similarly, a defendant may make the decision to offer perceived costs of defense, accepting a known present cost rather than an unknown future expense. Insurance carriers regularly move back and forth between periods where they are more (or less) willing to put money into settlement versus defense costs. These decisions are understandable, and thus a decision to settle a matter usually is not correlated to possible liability.

Another reason, nearly as important, for defendants to insist on settlement confidentiality is that the appearance of successful litigation breeds further litigation. The best example is the McDonald’s “hot coffee” case. The splashy news version of the case centered on the $2.9 million verdict making a rich woman of poor Stella Liebeck. A flood of copycat lawsuits followed. Few people knew that Liebeck’s final recovery was only a small percentage of the verdict amount, but in such cases the perception of the payout is more important than the facts. Had the matter been settled and confidentiality imposed, the final outcome would not have been available for public scrutiny, and the subsequent avalanche of “me, too” litigation would have been averted.

As the typical settlement agreement consists of only a short recitation, if any, of the background facts of the case, the public learns only the fact that a claim or lawsuit has resulted in a given outcome, generally a cash payout. The public is blissfully unaware of what factors—either in fact or at law—may have influenced the decision to settle. The public is equally unaware of issues separate and apart from the lawsuit that may have influenced settlement. As noted above, cases settle for issues completely or significantly unrelated to the present litigation. Some are more obvious, such as venue or potential public pressure. And this goes both ways. For example, Wikipedia lists and describes more than 60 potential claim incidents occurring at Walt Disney World, yet an Internet search shows that only a few of the matters were litigated and only a few were subject to public release of settlement information.

Because only a small portion of the facts are included in settlement agreements, failing to keep settlement agreements confidential also leads other, potential litigants to form unreasonable expectations of what their own “case” might be worth. These unrealistic expectations make matters much harder to resolve. Anyone who has practiced law for more than a couple years is certainly familiar with clients who have unrealistic expectations and the potential issues that arise in such a scenario.

Allowing settlement agreements to be shared also invites this information to be used in future settlement negotiations. The use of prior settlement agreements to facilitate future negotiations can have a chilling effect on effectuating a settlement when, again, the particular facts or relevant law of prior litigation are not reflected in the settlement agreement; all that is shown is that the parties have agreed to settle for a given amount. Using prior settlement agreements based on nothing more than the settlement amount therefore would do little to encourage settlement but could unalterably terminate meaningful negotiations.

A defendant’s desire for confidentiality in settlement can also assist in settling litigation with multiple defendants. Most states recognize the right of non-settling defendants to offset judgment proceeds by amounts paid by settling defendants. This would, of necessity, mean that even if there was a confidentiality agreement between the plaintiff and a single settling defendant, the basic terms of that settlement (how much the settling defendant paid) would be a matter of public record when the final judgment is entered. Rather than negotiate a very short-lived confidential settlement, a defendant truly desiring full-and-forever confidentiality would have an interest in helping the plaintiff move the entire piece of litigation to settlement—including potentially paying more to induce others to join in a global settlement.

Why Plaintiffs Want Confidentiality

Plaintiffs have their own reasons for desiring confidentiality in a settlement. Not being able to agree on a confidentiality clause may force defendants to vigorously defend themselves to clear or keep clean their good name—severely limiting settlement opportunities. This not only raises the risk of a plaintiff getting nothing rather than the proceeds of a settlement, but it also drives up costs for both sides, one of the very purposes a swift settlement attempts to avoid. In addition, a party’s refusal to enter into a confidentiality clause places additional stress on an already overburdened court system.

Similarly, the concern that non-confidential agreements could be used in future settlements is a door that swings both ways, and it provides impetus for plaintiffs to desire confidentiality, too. In many practice areas, a plethora of issue-specific litigation is being handled by multiple law firms—both plaintiff and defendant. To allow each plaintiff’s lawyers to share among them their clients’ settlement information—essentially to create a warehouse of information—invites attorneys to ignore the facts of their individual cases, leading to injustices on both sides, with cases settling not for their own intrinsic value but for the value of unrelated causes of action.

Another reason for plaintiffs to seek or allow (depending on one’s view) a confidentiality clause is the potential added value for settlement. Although an individual plaintiff may not be able to appreciate the desire of a defendant to include a confidentiality provision, the mere fact that a defendant desires to have the clause included may add additional consideration to the final settlement—something even the plaintiffs themselves can appreciate. Keeping this in mind, defendants should make known their intention of demanding confidentiality early in the negotiation process. Too often the discussion of including a confidentiality clause becomes an afterthought, potentially killing an otherwise-settled matter.

There are also non-financial reasons for plaintiffs to seek confidentiality. They might simply want to prevent the facts of the case from becoming public knowledge. A plaintiff’s malpractice claim could involve a personal medical condition; an employment claim could involve harassment or being fired from a job. In such cases, the plaintiff may see confidentiality as a way to avoid embarrassment or damage to reputation. A confidential settlement is a private agreement between the parties, and thus the terms of a settlement agreement and the underlying facts of the case are not anybody’s business other than the parties, their families, and, possibly, taxing authorities.

Effective Confidentiality Clauses

How do you draft an effective confidentiality clause? We have found the best approach is to:

  1. Make it clear that both the agreement and its terms are strictly confidential;
  2. Clarify that the underlying dispute (if a public complaint has not been filed) and negotiations about resolution/settlement of the claim are confidential;
  3. Specifically identify the few exclusions under law (enforcement of the agreement, information to attorneys and accountants, or disclosure after lawful process);
  4. Specify that breach of the confidentiality clause will be deemed a material breach;
  5. Note that in the event of a breach, the breaching party will pay a liquidated damages amount; and
  6. Include specific language directed to any other questions regarding resolution of the lawsuit, such as: “Notwithstanding the foregoing, if any party is asked to publicly comment on the settlement, the following statement (or words to that effect) may be made and shall not constitute a violation of this agreement: The parties to the lawsuit decided that it would be in everybody’s interest to resolve their disputes amicably and focus their attention on (other/business) matters.”

Finally, when relevant, a settlement agreement should address the return or destruction of documents that had been turned over during litigation and otherwise covered under presettlement confidentiality agreements or orders. The settlement agreement should provide that all such documents have been returned or destroyed, and that the existence of such documents, and any information contained therein, will remain confidential.