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, well over 90% of commercial cases resolve by settlement rather than judgment. The settlement agreement itself is a contract enforceable under general Texas contract law; in pending litigation, settlement agreements are typically coupled with a Rule 11 Agreement for additional procedural enforceability under Tex. R. Civ. P. 11.

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: confidentiality of sexual-harassment settlements has been federally limited since 2017, 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, always taxable; (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 has substantial tax consequences; settlement agreements should allocate carefully and consistently with the underlying claims.

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, sometimes require court approval depending on circumstances.

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, typically recoverable for enforcement under § 38.001 if in writing; (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, the underlying claims may be re-filed.

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. Sophisticated commercial settlements should be drafted by experienced counsel; templates rarely capture the specific dispute's nuances.