Vol. 55 No. 10

Trial Magazine

Theme Article

You must be an AAJ member to access this content.

If you are an active AAJ member or have a Trial Magazine subscription, simply login to view this content.
Not an AAJ member? Join today!

Join AAJ

Keeping Settlements on Track

Every negotiation is different, but preparing ahead to avoid common pitfalls will prevent your client’s case from being derailed.

Anna P Prakash October 2019

Although a settlement is necessarily a product of compromise, the path to that compromise is often riddled with obstacles that can lead to a breakdown in communication and a refusal to continue negotiations. At each step of the process—from the demand letter to negotiating terms to memorializing the agreement—you should work strategically to avoid common settlement pitfalls.1

Be Strategic About Demand Letters

Nearly all settlement negotiations start with the plaintiff making a demand. Demand letters vary, but the goal always should be to make the defendant want to come to the table to reach a resolution. Unfortunately, some demand letters can have the opposite effect, derailing a potential settlement before earnest negotiations begin. Consider sending an early demand letter that discusses damages in detail and opens up further conversation.

Make a reasonable demand early. Too many settlement discussions stall because the defendant cannot “get over” the amount of the plaintiff’s demand. While that is no reason to decrease the demand or deflate damages, sending the demand letter far in advance of mediation may give the defendant the time it needs to discuss the demand and risk of liability with decision-makers and counsel. The mediator may be a helpful resource at this stage—he or she can provide insight into the best method and time to convey your demand.

Similarly, depending on the case, defense counsel may be able to share information on how and when the defendant may be most receptive to a demand. For example, you may learn that the defendant would be more receptive to a demand that’s just a number without accompanying merits arguments or that it would be best to have defense counsel convey the number orally in advance of the written demand.

Show your work, and invite questions. Mystery over how a plaintiff reached a damages number can lead to mistrust and a refusal to negotiate. While you must avoid disclosing internal strategy and work product, the components of the plaintiff’s damages are not a secret and sharing them may move discussions along. Avoid ­misunderstandings about methodology by breaking out each component of the damages, showing the defendant how you arrived at that number, and inviting defense counsel to ask any questions in advance of a mediation or counteroffer.

For example, in a wage case, you could break out the hours worked, rate, and amount paid to show the defendant how unpaid wages were calculated. Similarly, breaking out liquidated or punitive damages and attorney fees and costs shows the defendant its total exposure in addition to compensatory damages. Keeping the lines of communication open builds trust and, ideally, a willingness to compromise.

One tone doesn’t fit all. An overly strident demand letter may turn the defendant away from the settlement table. There is a fine line between showing strength and pointing out the defendant’s vulnerabilities and inadvertently driving the defendant to pull back. The demand letter should strike a balance between the two.

For example, language focused on blame (“defendant blatantly violated plaintiff’s civil rights”) may backfire while language focused on the law (“the civil rights laws prohibit such conduct”) may help move the ­settlement ball forward. In short, while the letter should not concede any more than you and your client believe is necessary, write it with an eye toward how it will affect the defendant and truly invite discussion.

Find Balance

Settlement negotiations have many moving pieces. Potential pitfalls during the negotiation process include an inability to balance monetary and nonmonetary terms, the scope of the claims being released, and the tax consequences of settlement. Exercise careful strategy and communication in each of these areas.

Focus on what matters most to the client. In all settlement negotiations, there comes a point when the defendant refuses to give more—either monetarily or in nonmonetary terms. Negotiate in a way that emphasizes the terms that your client values most. For some plaintiffs, a negotiated apology may be more ­important than a large monetary award. Similarly, some defendants may be unwilling to pay a high settlement amount if they are also agreeing to terms that they view as particularly significant, such as changing their business practices or providing a letter of reference for the plaintiff in an employment case. Keep this in mind when negotiating.2

Stick to an approvable and ethical scope of relief. Settlements with improper consideration or an overly broad release are subject to attack and, for the parties, confusion at the payment or post-payment stages. Avoid problems by seriously studying the requested scope of the release at the negotiation stage. Defendants often seek a broad release of claims to try to limit future litigation. Make sure clients understand what would be released through settlement and, practically speaking, what that means they would be giving up. Also evaluate whether the consideration offered is sufficient for the claims being released. In cases when court approval of settlements is required, tailor releases to what the jurisdiction allows. For example, with respect to class action settlements, courts generally will approve a release based on the same “factual predicate” as that underlying the claims in the action.3 You should be mindful not to run afoul of ethics rules that prohibit an agreement in which a restriction on your right to practice is part of the settlement.4

Understand the tax consequences. Settlement payments may have tax consequences, and failing to consider those consequences when negotiating terms could lead to unwelcome surprises or disagreements about payment obligations. For example, when back wages are part of the damages award, you should negotiate terms related to whether those wages are accompanied by a W-2 form. If so, clarify that the employer-defendant will be obligated to pay associated payroll taxes unless the parties agree otherwise.

Notably, while settlement payments typically are considered taxable gross income to the plaintiff,5 significant categories of compensation are excluded from gross income. With the exception of certain medical expenses, gross income generally does not include amounts received under workers’ compensation acts for personal injuries or sickness or non-punitive damages received for personal physical injuries or physical sickness.6 With certain employment-based exceptions, amounts received through accident or health insurance for personal injuries or sickness also generally are not gross income.7

Pension or annuity allowances for personal injuries or sickness resulting from active armed forces service generally are not gross income.8 Attorney fees, too, generally are not considered income to class members in a class action settlement,9 and in certain individual discrimination cases, attorney fees can be deducted above the line.10

The actual tax rules are complex and riddled with exceptions, so be sure to consult with or refer your client to an accountant or tax counsel for a thorough analysis of whether settlement proceeds in a given case are considered income or can be deducted. Be aware of these types of issues, and refer the plaintiff or defendant to appropriate accountants or tax counsel for specific financial implications to help eliminate confusion down the line.

Make the Most of Mediation

Parties usually set aside a day or two to mediate their case, but that time passes quickly. By setting expectations in advance of mediation and coming prepared to deal with common issues, such as varying damages scenarios, you can help maximize your time.

Set expectations early. One of the biggest obstacles to settlement is the parties’ differing expectations. A defendant may refuse to negotiate if the plaintiffs are not present at mediation. A plaintiff may refuse to negotiate if the defendant comes to mediation and announces that certain terms or claims are off the table. Accordingly, to the extent possible, use the weeks before mediation to set expectations about the actual day.

Through the mediator, communicate to the other side about: who will be attending mediation for the plaintiff, which claims the plaintiff expects to settle, and any other housekeeping or procedural issues that should be handled before mediation. In class actions, also discuss the class representative’s expectation of a classwide, as opposed to individual, settlement. Seek the same information from the other side so that at the start of mediation everyone is on the same page about the goals for the day.

Many mediators will have templates for mediation statements or a list of items that should be included. They often will ask that parties describe the factual and legal basis for the claims or defenses; relative strengths and weaknesses; the status of litigation (how much discovery has been taken, whether the court has issued any rulings, what remains to be done before trial); and anticipated barriers to settlement. Providing a detailed statement on these issues will educate mediators and arm them with information to assist in the negotiation.

Be able to work with the numbers or bring someone who can. Last-minute damages scenarios and calculations commonly come up in mediation. This is particularly important in complex cases when damages depend on large volumes of data, such as class actions involving thousands of consumers or employees or ­single-plaintiff cases when the length of the parties’ relationship resulted in a large trail of financial or related data. If you cannot work with shifting damages information to assess settlement offers, mediation will be a slow and inefficient process. To engage fully in a discussion about alternative scenarios and value your client’s claims accordingly, be conversant with the damages methodology, and be able to manipulate data through a spreadsheet or other system accessible at mediation—or bring someone with you who can do this in real time.

Memorialize All Key Terms Before Leaving Mediation

Insist that the parties memorialize all of the key settlement terms and sign a binding terms sheet or memorandum of understanding (MOU) before leaving mediation. While it is tempting to rely on memory and goodwill after spending the day coming to an agreement, the extra time spent memorializing terms will be worthwhile to avoid backtracking or misunderstandings after the fact.11

Don’t forget any sticky issues. Push to have the terms sheet or MOU cover all potentially hot-button issues. This could include terms that might otherwise be overlooked at mediation, such as coverage for medical expenses occurring after mediation, monitoring or reporting in the case of injunctive relief or changed business practices, press releases related to settlement, what to do with uncashed settlement checks, cy pres, or future deadlines. Waiting to put potentially controversial terms in a more formal or full-length agreement can lead to headaches after mediation and, worse, a failed settlement.

Set deadlines. Mediation is not the end point of a successful settlement. The parties typically still have to make sure the settlement is effectuated. Avoid delays by building future deadlines, including the timing of payment, into the terms sheet or MOU signed at mediation. In class action settlements, for example, include deadlines for drafting and finalizing a full-length settlement agreement and approval papers. If there is not enough time to do all of this at mediation, you should make sure to schedule prompt follow-up calls with defense counsel and the mediator so that all issues are resolved while mediation discussions are still fresh in the parties’ minds.

Communicate before signing. Miscommunication can delay or defeat settlement. Before the terms sheet or MOU is signed, speak with your clients or class representatives about all key terms and, directly or through the mediator or counsel, make sure decision-makers and any other relevant players to whom the parties agree settlement can be disclosed (insurance carriers, spouses) understand these key terms before the parties and counsel sign.

By thinking ahead and communicating openly with the other side, you can avoid common obstacles and efficiently reach a resolution that makes sense for your clients.


Anna P. Prakash is a partner at Nichols Kaster in Minneapolis and can be reached at aprakash@nka.com.


Notes

  1. Generally, the tips in this article come from a class action perspective, but they’re not necessarily limited to those cases.
  2. Relatedly, in class actions, “fees should not be negotiated between class counsel and defendant’s counsel until after a settlement of the class’s claims has been agreed upon.” 4 William Rubenstein, Alba Conte & Herbert B. Newberg, Newberg on Class Actions §13:2 (5th ed. 2011).
  3. Saleh v. Valbin Corp., 2018 WL 6002320, at *4 (N.D. Cal. Nov. 15, 2018) (quoting Reyn’s Pasta Bella, LLC v. Visa USA, Inc., 442 F.3d 741, 748 (9th Cir. 2006)); see, e.g., Jones v. Singing River Health Servs. Found., 865 F.3d 285, 302 (5th Cir. 2017) (as to releasing claims against nonparties); Gehrich v. Chase Bank USA, N.A., 316 F.R.D. 215, 231 (N.D. Ill. 2016) (quoting Williams v. Gen. Elec. Capital Auto Lease, Inc., 159 F.3d 266, 273–74 (7th Cir.1998)); Berry v. Schulman, 807 F.3d 600, 616 (4th Cir. 2015) (citing In re Literary Works in Elec. Databases Copyright Litig., 654 F.3d 242, 248 (2d Cir. 2011)).
  4. See Model R. Prof’l Conduct 5.6 (ABA 2016).
  5. See, e.g., Ahmed v. Comm’r of IRS, 498 F. App’x 919, 922 (11th Cir. 2012); Allum v. Comm’r of Internal Revenue, 231 F. App’x 550, 551 (9th Cir. 2007); Arkow v. Comm’r of Internal Revenue, 2016 WL 7377286, at *3 (T.C. Summ. Op. Dec. 20, 2016).
  6. See 26 U.S.C. §104(a) (2018).
  7. See id.
  8. See id.
  9. I.R.S. Priv. Ltr. Rul. 200625031 (June 23, 2006), www.irs.gov/pub/irs-wd/0625031.pdf. Note that IRS private letter rulings cannot be cited as precedent.
  10. 26 U.S.C. §62(a)(20) (2018). 
  11. See 28 Richard A. Lord, Williston on Contracts §70:229 (4th ed. 1990) (“While the law encourages compromises, such settlements should promptly be reduced to writing so that they may be treated as binding and contractual.”).