January 01, 2016

Making Certain the Settlement You Intend Is the Settlement You Get

Litigators should resist the pressure to close a matter and instead focus on settlement details.

Robert Hugh Ellis

A written settlement is arguably the most important document in modern litigation. As fewer and fewer cases go the distance to trial, quite often the execution of a written settlement agreement, rather than a jury verdict, is the event that signals the end of the dispute. After devoting months—perhaps years—toward a resolution of a case, it is vital that litigators approach the negotiation and finalization of settlements with the same caution and prudence they gave to the underlying dispute. Although the prospect of finally closing out the matter, client expectations, and sometimes pressure from neutral mediators or the court can encourage haste, litigators should resist the temptation and take the extra time to ensure that the settlement they and their clients want is the one they actually get. What follows are a few practical pointers and observations to keep in mind as you prepare your next settlement.

First, make it clear from the beginning that a formal written agreement is required. If you and, more importantly, your client expect that any settlement of your case will require a formal, lengthy settlement agreement, good practice dictates making this fact known early and often. While it is difficult, if not impossible, to identify the contents of a “typical” settlement agreement, it is safe to assume most are intended to be a little more involved than “Defendant will pay $X.XX, and Plaintiff will dismiss the complaint with prejudice.”

While, in some circumstances, that sentence might very well get the job done, often there are plenty of legitimate reasons that additional terms are necessary or desirable. Perhaps you intend the agreement to be enforceable under the law of a specific jurisdiction. Perhaps your client is a sophisticated entity that, over time, has developed a series of settlement requirements and terms that it wants in every case. Perhaps certain obligations in the settlement are contingent on specific triggering events, such as securing financing. Perhaps your client works in a regulated industry and certain terms and specific language must be included in any settlement. Perhaps confidentiality is important. Or, conversely, perhaps disclosure is required by law. Whatever the reason, more often than not, one sentence jotted on the back of a napkin likely is not what your client has in mind when it decides to settle a case.

An attorney should be careful, then, not to inadvertently agree to such a bare-bones settlement arrangement without intending to. How often do parties list two or three key provisions on a term sheet at a mediation, sign it, and indicate that they’ll work out the rest of the terms later on? How often do parties send proposals back and forth via email, reach an understanding of certain terms, and then plan to circulate draft written agreements later? For example, the following is not an uncommon exchange:

Plaintiffs’ Counsel: Will dismiss for $800K, payable to plaintiff and firm.

Defendants’ Counsel: Can’t do $800K. Can do $600K. Dismiss with prejudice.

Plaintiffs’ Counsel: OK. Sounds good.

Defendants’ Counsel: OK. Will draft something.

 

The question becomes: What happens when the parties are unable to agree on these additional terms? What if one party’s “standard” language is, for whatever reason, completely unacceptable to the other? For example, suppose one party’s preferred confidentiality language, which it absolutely intends to require as a condition of any resolution, is unacceptable to the other side? Is there an enforceable settlement?

Yes, there is a very real risk that there is. See, e.g., Kloian v. Domino’s Pizza, LLC, 733 N.W.2d 766 (Mich. Ct. App. 2006) (enforcing a series of emails as a binding settlement). Obviously, the issue will turn on the facts of each case and the applicable law, but if there arguably is an email making an “offer” and another “accepting” it, that could be that. You may find yourself in the uncomfortable position of informing your client that it just “settled” a case on terms far different than it intended.

A careful attorney needs to be wary of this trap. No matter what your relationship with opposing counsel, and no matter how clearly the parties intended for the final agreement to contain additional terms and conditions, you cannot simply assume there will be agreement on the additional terms you intend to include in the final settlement. If these terms—whatever they may be—are an absolute requirement, then you should say so. Consider specifying the following in your written discussions of proposed settlement terms:

  • that all discussions and correspondence are for negotiation purposes only;
  • that you lack authority to enter into any final, binding agreement on behalf of your client;
  • that there is no agreement until the ink is dry on a formal and totally final settlement;
  • that the execution of a separate, formal contract is a material term of any settlement and that there is no settlement without one; and
  • that other material terms exist and that your client will not agree to any settlement without agreement on those as well.

While you may catch the occasional bit of grief from opposing counsel for highlighting something he considers obvious, that’s a small price to pay for creating a paper trail illustrating that you need a separate, formal written agreement with additional terms signed by your client before the matter is resolved. The alternative is to risk having to tell your client that you just unknowingly settled its case for only a fraction of the terms it requires.

Second, add contingency plans to avoid subsequent disputes. A settlement is intended to create finality. It should represent the end of the dispute and can often be the culmination of the expenditure of significant time and money. While your mediators will stress the old adage that a good settlement is one neither side is completely happy with, at least one thing the parties agree on is their mutual desire to just be done with it. But what happens when one party fails to perform? Do the parties now need to mount up again, enter another lawsuit, and litigate the breach? Or what if the settlement is complex and involves a series of obligations, each of which is a condition precedent to another? Is the entire deal undone? Whenever possible, you should attempt to include a framework for what will happen if things fall apart so you can avoid—or at least narrow—the matters at issue.

Some Potential Examples

Here’s an example: You represent a plaintiff minority shareholder in an oppression suit concerning a closely held corporation. After one year of hotly contested litigation, the parties elect to settle the case through an agreement under which the defendant agrees to buy out your client within 30 days of the entry of an order dismissing the claims against him. You draft an agreement, the parties sign, and your client dismisses her claims with prejudice. Thirty days later, however, the majority shareholder’s counsel calls and says his client’s financing has fallen through. He can’t buy your client out yet, but he’s still looking for alternative financing. A month goes by. Then another. Then another. It becomes painfully clear the defendant is not going to be able to perform. Meanwhile, your client, in reliance on the agreement, has already performed her obligations and dismissed the case.

Your client is not without options, of course. The defendant failed to perform under the settlement agreement, so your client can bring a breach of contract claim. But this will probably require the initiation of yet another lawsuit, increased costs for your client, and possibly complex valuation issues surrounding the damages caused by the defendant’s failure to purchase your client’s interest. Alternatively, your client could attempt to reopen the original case and argue that the settlement should be rescinded or perhaps declared void, but even if that approach is successful, your client now faces the prospect of litigating the very same claims she thought she had resolved.

Here’s another example: Your client sells rare books, and he agrees to sell a 17th-century edition of Don Quixote to a collector. Before Don Quixote is pulled from the inventory, however, one of your client’s employees sells it to someone else. The collector sues, seeking specific performance and demanding your client sell him a 17th-century Don Quixote at the agreed-upon price. As there aren’t many 400-year-old copies of Don Quixote floating around, the collector agrees to dismiss the litigation if your client will instead sell him an 1865 edition of Alice’s Adventures in Wonderland at a $30,000 discount. Your client agrees. The collector dismisses his claims, your client sets Alice’s Adventures in Wonderland aside and waits for the collector’s wire. It never comes. The collector is never heard from again. The claims against your client have been dismissed, your client is stuck holding an extremely valuable book, and he’s not certain of what—if anything—he can do with it. Does he need to set Alice’s Adventures in Wonderland aside for the collector and, if so, for how long? Suppose he sells it but the collector comes calling a few weeks later? The settlement is completely silent on what to do in these situations. Your client is left to take his chances by selling the book to someone else or possibly file a declaratory action to determine the rights and obligations of the parties.

To the extent possible, you should try to foresee these types of situations and attempt to include solutions for them in the agreement. The more complicated the settlement, the more variables you’ll have, and the more variables you have, the more likely something will not work out as intended. Of course, you’ll probably never be able to imagine every conceivable way a deal could fall apart, but if you happen to catch and plan for some of the more likely candidates, you could save your clients grief down the road.

For example, in the bookseller case, the bookseller agreed to sell Alice’s Adventures in Wonderland to the collector at a $30,000 discount in exchange for the dismissal of the case, but the settlement agreement did not contemplate what would happen if the collector never tendered the money. One possible solution would have been to require the collector to tender the purchase money in 30 days. In the event the collector failed to do so, he would lose any claim to the copy of Alice’s Adventures in Wonderland, and the bookseller would be free to sell it to someone else as he saw fit. As the purchase of Alice’s Adventures in Wonderland at a $30,000 discount would have represented a net benefit of $30,000 to the collector, the bookseller could then simply tender a check in that amount to the collector. In that event, the collector would obtain the same net benefit ($30,000), the bookseller would still “pay” essentially the same amount (a $30,000 check instead of a $30,000 loss on the book), and, what is most important, the settlement would be completed and the matter finalized. No more uncertainty. Your client has the finality he had hoped to obtain when he agreed to settle in the first instance.

Pocket Consent Judgments

For the minority shareholder, the settlement could have included an alternative form of recovery in the event the defendant fails to buy out your client. For example, the agreement could require the majority shareholder to sell his interest to your client in the event he is unable to complete the purchase. Or the agreement could instead include an alternative form of recovery for your client in the form of financial compensation. One commonly used option is the execution of a “pocket” consent judgment. In this situation, the parties execute consent judgments entitling one party to a sum certain, plus applicable interest. Typically, the parties sign the document but don’t file it with the court. Instead, the beneficiary keeps the judgment set aside—i.e., in the beneficiary’s pocket—and files it only if the other party fails to perform its obligations under the settlement. In the example above, the parties could have agreed that, in the event the majority shareholder did not buy the minority shareholder out within 30 days, the minority shareholder would be entitled to file a monetary judgment in a previously agreed-upon sum with the court. Obviously, collecting on a monetary judgment has its own sets of challenges—particularly against a defendant who has just shown that he lacks the creditworthiness to obtain financing—but at the very least, it provides a clear, finite end to the underlying dispute. There is no need to reopen the case. There is no need to litigate the damages caused by any breach. Your clients already have their judgment, and this, usually, is not something that can be appealed.

It should be noted that pocket consent judgments are not without their own risk. The other side may seek to unravel the deal by suggesting the pocket judgment is an unenforceable penalty. For example, assume that there is a simple monetary settlement. The defendant agrees to pay the plaintiff $2 million over the course of several months in exchange for dismissal of the case. The defendant also agrees to execute a $6 million pocket consent judgment, which the plaintiff will enter and collect if the defendant fails to timely pay the $2 million. Note that the consent judgment is three times the size of the amount the plaintiff would receive if the defendant performed as required under the agreement. Of course, that serves as motivation for the defendant to make timely payments.

But a potential issue arises: whether that additional $4 million is intended as a liquidated damages provision compensating the plaintiff for the defendant’s breach of the settlement agreement and, if so, whether it will be upheld as such or invalidated as an unenforceable penalty. A few courts have held that similar pocket consent judgments were unenforceable. See Checkers Eight Ltd. P’ship v. Hawkins, 241 F.3d 558 (7th Cir. 2001); Greentree Fin. Grp., Inc. v. Execute Sports, Inc., 163 Cal. App. 4th 495, 78 Cal. Rptr. 3d 24 (Cal. Ct. App. 2008). Granted, though, the plaintiffs in Checkers and Greentree both conceded that the consent judgments were intended to be liquidated damages compensating the underlying plaintiffs for the breach of the settlements. Still, such provisions could provide an enterprising party with an arguable basis to seek to avoid a previously agreed consent judgment.

Thus, when including a pocket consent judgment in a settlement, you should be cognizant of how you are characterizing it. Returning to the $2 million/$6 million example, rather than structuring the arrangement as a $2 million settlement that increases to $6 million in the event of a breach of the settlement agreement, it may be helpful, if possible, to structure the deal as a settlement for a $6 million judgment that the plaintiff will refrain from entering or collecting on if $2 million is timely paid. While seemingly a distinction without a difference, in the former circumstance a party could attempt to argue that the extra $4 million is an unenforceable penalty, while in the latter circumstance such an argument is probably unavailable because the breach did not increase the defendant’s obligation; instead, it cost the defendant a discount. See Scavenger Sale Inv’rs, L.P. v. Bryant, 288 F.3d 309 (7th Cir. 2002) (distinguishing Checkers and upholding a consent judgment under the “discount” framework). On a practical level, how this sort of deal is structured often depends on outside variables and factors that may mandate one approach over another—but the point is to proceed cautiously and know the potential risks.

There are countless strategies and structures you can use while seeking to bring finality to your settlements. Naturally, you need to be mindful of the fact that every jurisdiction is different and that something acceptable in one may not pass muster in another. But keeping that limitation in mind, the key is to be creative. Try to imagine the various ways in which a deal might fail to come to fruition and see if you can devise an escape route or two. Otherwise both you and your client may end up right back where you started.

Robert Hugh Ellis

The author is a senior attorney in the Litigation Group of Dykema Gossett PLLC, Detroit.