SC Lawyer, July 2004, #6. Ethics Watch July 2004 Another reason to avoid confidential settlements: taxation.

• Author: By John Freeman

South Carolina Lawyer

2004.

SC Lawyer, July 2004, #6.

Ethics Watch July 2004 Another reason to avoid confidential settlements: taxation

South Carolina LawyerJuly 2004Ethics Watch July 2004 Another reason to avoid confidential settlements: taxationBy John FreemanSouth Carolina's judiciary, both state and federal, has done stellar work in focusing public attention on problems that secret settlements pose for lawyers, parties, judges and society as a whole. A New York Times article ascribed the genesis of this movement to an insight that came some time ago to Chief Federal District Court Judge Joseph F. Anderson Jr.:

Judge Anderson was most concerned with the selling of secrecy as a commodity, he said in an interview. He recalled being told by a plaintiff's lawyer that the lawyer had obtained additional money for his client in exchange for the promise of secrecy. "That's what really lit my fuse," the judge said. "It meant that secrecy was something bought and sold right under a judge's nose."

Adam Liptak, Judges Seek to Ban Secret Settlements in South Carolina, N.Y. TIMES, Sept. 2, 2002, at A1, A13.

The concept that secrecy can take on the trappings of a commodity for sale in the marketplace has many ethical and practical ramifications for lawyers engaged in litigation. For one thing, the confidentiality component of a secret settlement may have a high value precisely because the defendant's conduct has been egregious and has injured many other victims. Keeping those other victims in the dark concerning the existence of their claims or the true value of their claims may make good business sense to the defendant.

A potential problem with selling secrecy arises when the wrongdoer's conduct is criminal. In such a case, the law of compounding may come into play. Compounding is a crime in South Carolina. The pertinent South Carolina statute reads:

Any person who, knowing of the commission of an offense, takes any money or reward, upon an agreement or undertaking expressed or implied, to compound or conceal such offense or not to prosecute or give evidence shall:

(a) If such offense is a felony be deemed guilty of a misdemeanor and upon conviction shall be fined not more than five hundred dollars or imprisoned not more than one year, or both;

(b) If such offense is a misdemeanor be deemed guilty of a misdemeanor and upon conviction be fined not more than one hundred dollars or imprisoned not more than three months or both.

S.C. Code Ann. § 16-9-370 (1976). Because of the compounding statute, a lawyer in South Carolina cannot sponsor an agreement calling for a cover-up of criminal activity. Such an agreement would be unenforceable as against public policy. See Berkebile v. Outen, 311 S.C. 50, 53, 426 S.E.2d 760, 762 (1993) (an illegal contract has always been unenforceable . . . South Carolina courts will not enforce a contract which is violative of public policy, statutory law or provisions of the Constitution).

For example, consider In re Kasschau, 11 S.W.3d 305 (Tex. App. 2000), a Texas family court case. In Kasschau the parties settled their marital dispute at a mediation with a term of the settlement calling for destruction of tape recordings and transcripts of the wife's conversations. The conversations had been taped illegally. This provision violated a Texas statute criminalizing the destruction of evidence. Id. at 312-13. Rather than just striking the offending provision, the trial court threw out the entire settlement. The appellate court refused mandamus relief, saying:

[W]e recognize that there are competing public policy interests at stake here. On the one hand, courts are responsible for carrying out this state's policy of encouraging the peaceable resolution of disputes involving the parent-child relationship through voluntary settlement procedures . . . . On the other hand, public policy prohibits courts from enforcing illegal contracts. Here, we are unable to find the trial court violated the public policy encouraging settlements by refusing to enforce a settlement agreement that it found contained an illegal provision.

Id. at 314. A similar result was reached in EEOC v. Astra USA, Inc., 94 F.3d 738 (1st Cir. 1996). In Astra, the First Circuit voided clauses in employees' settlement agreements barring employees from "assisting in any way anyone else who files any claim, complaint, or charge nor institute any lawsuit against" the employer. It found that clauses in the settlement agreement purporting to interfere with other victims' access to witnesses were contrary to public policy and void.

Good lawyers have better things to do than cause their clients to enter into contracts that are unenforceable, much less criminal. The compounding statute plus cases like Kasschau and Astra thus furnish good reason to think twice (at least) before helping a client profit off a secrecy sale. A new case gives further support to the view that selling secrecy is dangerous.

The case is Amos v. Commissioner, T.C. Memo 2003-329 (Dec. 1, 2003), available at www.ustaxcourt.gov/InOpHistoric/Amos.TCM.WPD.pdf

Amos is a taxpayer who had the misfortune of being kicked in the groin by Dennis Rodman while serving as a television cameraman at a Minnesota Timberwolves game. Litigation ensued, with Amos bringing a personal injury claim against Rodman. The case was settled for $200,000, under terms calling for strict confidentiality:

[A]s part of the consideration for this agreement and release, the terms of this agreement and release shall forever be kept confidential and not released to any news media personnel or representatives thereof or to any other person, entity, company, government agency, publication or judicial authority for any reason whatsoever except to the extent necessary to report the sum paid to appropriate taxing authorities or in response to any subpoena issued by a state or federal governmental agency or court of competent jurisdiction * * * Any court reviewing a subpoena concerning this agreement and release should be aware that part of the consideration for the agreement and release is the agreement of Amos and his attorneys not to testify regarding the existence of the agreement and release or any of its terms.

Though the lawsuit was a personal injury action, with actual damages recovered in such actions being normally tax-free, the IRS took the position that Amos really had not been hurt, making the entire $200,000 received by Amos a taxable payment for his sale of secrecy. The tax court disagreed, but only in part. It held that $80,000 of the settlement proceeds reflected a payment for the settlement's confidentiality component, making Amos liable for taxes on that amount.

Amos thus furnishes yet another reason for plaintiffs' lawyers not to let their clients enter into secrecy sales. The more prominently featured secrecy is in the settlement agreement, the greater the risk that the secrecy component may yield an IRS assessment. A personal injury client blind-sided by such an IRS attack is apt to be very unhappy with his or her lawyer if the lawyer failed to explain in advance the tax risk being shouldered by the client for selling secrecy along with the injury claim.

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