Settlement Agreement

A settlement agreement is a contract resolving a dispute, typically (though not exclusively) in connection with pending or threatened litigation. Settlement agreements are the principal mechanism for ending lawsuits short of trial. The settlement agreement itself is a contract enforceable under general Texas contract law; in pending litigation, the agreement must also satisfy Tex. R. Civ. P. 11 (in writing, signed and filed with the papers, or made in open court and entered of record) to be enforced. A court may enforce a compliant agreement after one side withdraws consent, but only as a contract after notice and hearing, not by agreed judgment.

Standard settlement agreement components

Comprehensive commercial settlement agreements typically include: (1) recitals, describing the dispute and the parties' agreement to settle; (2) consideration, payment terms (lump sum, installment, structured settlement) or other performance; (3) releases, mutual or unilateral release of claims; (4) covenants not to sue, promises not to bring future actions on released matters; (5) confidentiality, restrictions on disclosing settlement terms or facts; (6) non-disparagement, restrictions on disparaging statements; (7) representations, authority to enter the agreement, no other claims, satisfaction of conditions; (8) indemnification, covering breach of representations or third-party claims; (9) choice of law and forum, typically Texas law and Texas venue; (10) integration, entire agreement clause; (11) amendment requirement, written amendment only; (12) specific performance, equitable remedies; (13) fees and costs, typically each party bears own.

Confidentiality provisions

Settlement confidentiality is heavily negotiated. Standard provisions: (1) terms confidentiality, settlement terms and amount cannot be disclosed; (2) fact confidentiality, underlying facts cannot be disclosed; (3) permitted disclosures, to attorneys, accountants, tax advisors, family members, court order, regulatory requirement; (4) liquidated damages for breach, given difficulty of proving damages, often a fixed amount per disclosure. Note: since 2017, federal tax law has attached a cost to confidentiality in sexual-harassment settlements. Under 26 U.S.C. § 162(q), settlement payments and related attorney fees are not deductible if the settlement is subject to a non-disclosure agreement covering sexual harassment claims. Several states have also enacted statutes limiting confidentiality in similar contexts.

Tax treatment of settlements

Settlement tax treatment depends on the nature of the underlying claims: (1) physical injury settlements, generally excluded from gross income under § 104(a)(2); (2) employment discrimination settlements, typically taxable as wages or other income; (3) contract settlements, tax treatment depends on what the payment substitutes for (lost profits taxable, return of capital not); (4) punitive damages, taxable except in a narrow class of wrongful death cases covered by § 104(c); (5) attorney fees, often taxable to plaintiff even if paid directly to attorneys (above-the-line deduction available in some categories). Allocation of settlement payments among different claim categories can have substantial tax consequences.

Court approval requirements

Most commercial settlements do not require court approval. Exceptions: (1) class actions, court approval required under Rule 42 (Texas) or Rule 23 (federal); (2) minor or incompetent plaintiffs, guardian ad litem and court approval typically required; (3) bankruptcy proceedings, bankruptcy-court approval under Bankruptcy Rule 9019; (4) shareholder derivative suits, court approval required; (5) certain government-involvement settlements, DOJ or agency approval; (6) structured settlements, a later transfer of structured settlement payment rights requires advance court approval under Tex. Civ. Prac. & Rem. Code § 141.004.

Enforcement of settlement agreements

If a party breaches a settlement agreement, enforcement options include: (1) specific performance, court order requiring compliance; (2) contract damages, for breach; (3) liquidated damages, if specified; (4) attorney's fees, generally recoverable under Tex. Civ. Prac. & Rem. Code § 38.001(b)(8) on a claim for breach of an oral or written contract, subject to the presentment requirement of § 38.002; (5) reinstatement of underlying claims, in some cases, breach of a settlement permits restoration of the underlying claims (often subject to credit for amounts paid). The proper enforcement procedure depends on whether the underlying litigation is dismissed: if dismissed with prejudice, the new claim is for breach of settlement; if dismissed without prejudice, refiling is possible only to the extent the settlement and its release do not bar the claims.

Common drafting issues

Recurring sources of settlement disputes: (1) scope ambiguity in releases, see Release; (2) missing affiliated parties, release covers signatories but not affiliates; (3) contingent obligations, payment conditioned on events that prove difficult; (4) tax allocation, disputes over characterization of payments; (5) confidentiality scope, what's covered, what's permitted disclosure; (6) competing interpretation of operative terms.