Breaking Up Is Easy to Do: Avoiding Mistakes That Unravel Settlements

• Publication year: 2004
• Author: By Shirley L. Kovar

BREAKING UP IS EASY TO DO: AVOIDING MISTAKES THAT UNRAVEL SETTLEMENTS

By Shirley L. Kovar^*

"It is not impossibilities that fill us with the deepest despair, but possibilities [that] we have failed to realize."

- Robert Mallett, 1915

I. INTRODUCTION

Most litigation (and arbitration) settles before trial. We (and our clients) are typically happy with a settlement either because it is favorable or because the conflict is over. The lawyer may say to the client: "The case has settled. It's done. You can put this dispute behind you." But all is in fact not yet done. A settlement agreement remains to be drafted. Then comes the signing, frequently followed by court approval.

To be sure, sometimes the case really is over when the lawyers agree on the phone, or by fax or e-mail, that they have a deal. Some settlement agreements seem fairly pro forma. Grab your form, change the names and the facts, everyone signs promptly, and the court gives you "pre-approved" over the internet. What could be easier?

If the case goes awry, however, the deal that your client agreed to may turn out to have as many problems as the initial dispute. No matter how patient the client has been up until now, once the lawyer says the case is over, the client may take out her frustration on the lawyer if it is not. The buyer, the client thinks, has somehow let this settlement slip away.

This article will discuss (1) preventing errors during negotiations that can disturb the stability of the settlement you thought you had; (2) enforcing an agreement if your opponent reneges; and (3) avoiding claims by your client for malpractice in reaching the settlement.^†

II. BEFORE NEGOTIATIONS BEGIN

A. Consider a "Facilitation Agreement"

You usually know when the parties are ready to begin negotiations. Either your client says to pick up the phone and call opposing counsel "just to talk" or the other attorney starts to send signals his client is "ready to deal." Before settlement discussions begin, step back from the heat of battle and PREPARE not only for the negotiation process, but for the settlement agreement.

B. Types of Facilitation Agreements

Before negotiations begin, you and opposing counsel may want some type of agreement, referred to by the author as a "facilitation agreement." Such agreements can facilitate effective settlement negotiations. A "facilitation agreement" may take the form of a standstill agreement; a tolling of a statute of limitations; an agreement concerning preliminary tax strategy; or any other condition that precedes settlement of the underlying dispute.

1. Standstill Agreement

A standstill agreement sets forth what pleadings, discovery, or other actions will or will not take place during settlement negotiations. Settlement negotiations between the parties without a standstill agreement can create a dilemma: stop discovery, readily give continuances or stipulations, or take other actions that may prejudice your client if the other side does not reciprocate, or continue the same level of litigation and expense that was in place prior to settlement discussions. Continuing litigation at the same pace during settlement discussions with attendant hostile actions and distractions can hinder the possibility of settlement. Ergo, the standstill agreement.

2. Tolling Agreement

A tolling agreement includes a provision that a party will refrain from filing suit against another interested person on the condition such party "tolls" the statute of limitation that would otherwise apply to prevent the filing of a lawsuit. A tolling agreement is frequently used when a potential plaintiff would otherwise file a claim for malpractice against an attorney who drafted the document that is now in dispute. The period for the tolling allows the dispute over the document to be resolved and damages to be mitigated prior to instigation of the malpractice claim.

3. Other Preconditions

A standstill agreement is one type of precondition to settlement discussions. If your client has sufficient leverage at this stage of litigation, or if a certain requirement is essential to your client's well-being, you may want to seek other preconditions. The following are a few examples of the preconditions you may want to consider:

• If your client is a beneficiary under a discretionary trust, you may seek a certain level of distribution for your client or a limitation on distributions to other beneficiaries;
• Your client may require another party to return cash, tangible personal property, or possession of a residence;
• If there is a discovery dispute over a crucial document, you may require production of that document;
• Your client may want an agreement that no party will sell or otherwise transfer assets of the trust, estate, or other assets owned by the decedent;
• There could be a sales agreement or other instrument you want another party to sign;
• You may want to ask for a voluntary restraining order of some type; or
• There may be a procedural problem or other issue you want resolved before negotiations begin. For example, in California, you may want a stipulation that a proposed action for a family allowance, or a probate homestead or other issues would not violate a no contest clause.

[Page 36]

If the other side has indicated an interest in settlement or has made a preliminary offer, or if you refuse to negotiate without such precondition, you may be successful in obtaining preconditions to settlement negotiations.

C. Planning a Tax Strategy in Light of the Estate of Bosch

The failure to address tax issues from the outset of a dispute can sabotage a settlement. Determining after settlement that your client (or your opponent) has a big tax problem will unravel an otherwise well thought out settlement plan. Federal taxes (income tax, federal gift and estate tax, or GST tax) may loom large in the client's eyes. However, also be sure to identify state tax issues, including property taxes.

Tax issues vary. Is tax due? Who pays? From what source? Does apportionment apply? Is there an applicable deduction or credit? Does the trust or will have a tax clause? Are they in conflict?

Tax strategy is usually time sensitive. Tax returns have due dates, and large sums may be due. Penalties and interest may be a concern. Moreover, there may be actions that, if taken by one or more parties, would either enhance or prejudice desired tax treatment of one or more parties. For these reasons, one would think that a tax planning strategy would be a major candidate for a precondition agreement. Unfortunately, there may be an impediment to this approach because cooperation among the parties may be interpreted as prohibited collusion by the IRS.¹ "In the case at bar . . . the Tax Court found that the allocation was not entered in a bona fide adversary proceeding. Further, it found that the state trial court simply 'rubber stamped' a judgment drafted by the . . . attorneys."² Proceed with caution when tax is at stake.

Ideally counsel would give tax advice at the onset of the matter. However, there may have been other priorities that absorbed the focus of counsel and client, or new disputes may have given rise to new tax issues during the course of litigation. For whatever reason, if tax consequences have not been at the forefront before settlement negotiations are about to begin, now is definitely the time to do the tax analysis and to give tax advice to your client.

It is essential to keep in mind Estate of Bosch³ when you contemplate any type of federal tax strategy. Because there is no federal property law,⁴ federal tax law looks to state law to determine the ownership of property that gives rise to federal tax consequences. The path to settlement of state property issues may nevertheless conflict with the maze required to achieve favorable tax results.⁵ Bosch determined that a trial court [probate court] order that determines an issue of state property law is not binding for federal tax purposes when the IRS was not a party in the trial court proceeding.⁶

As a practical matter, the IRS rarely participates in a trial court proceeding, and giving notice to the IRS of your petition is likely to be a futile gesture. Nevertheless, some practitioners give notice to the IRS with the intention of gaining potential leverage during a subsequent examination. Although Bosch also stated that federal courts should give "proper regard" to lower court judgments, sixty percent of federal courts from 1967-2001 refused to interpret state law in the manner determined at the lower court level.⁷ Four federal circuit courts (first, second, fifth and seventh) have ruled on state court judgments based on whether there was adversity at the lower court level.⁸ Moreover, the IRS, notwithstanding Bosch, typically assesses the lower court order based on whether there was adversity between the parties reflected in the court proceeding.

Bosch also is usually treated as determining that federal courts are bound by rulings of the "highest court of the state." Again, notwithstanding comments to the contrary in Bosch, the IRS has claimed that " . . . the Bosch court did not intend for the federal courts and agencies to give binding effect to non-adversary state Supreme Court proceedings . . ."⁹

It is from the perspective of Bosch and the IRS that you determine what tax strategy to pursue during the course of settlement negotiations and the extent to which you and opposing counsel desire to or should cooperate. Ahmanson Foundation v. United States¹⁰ has held that the Estate of Bosch applies to settlement agreements.

The strategy will depend on the particular circumstances. There are three basic tax situations:

• Both or all parties would benefit from the same tax results;
• Each party claims that the other is liable for whatever tax is in issue; or
• Each party believes the tax consequences that affect her are clear or for whatever reason wants to deal with the tax authorities independently of other parties.

When each party wants to deal independently with the tax...