ABA Section of Labor and Employment Law Equal Employment Opportunity Committee 1999 Annual Meeting March 25, 1999 Atlanta, GA

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1 ABA Section of Labor and Employment Law Equal Employment Opportunity Committee 1999 Annual Meeting March 25, 1999 Atlanta, GA SETTLING CLAIMS - THE PLAINTIFF S VIEW By Randy A. Fleischer, Esq. Most attorneys from both sides of the fence would agree with the mantra Settlement is good, trial is bad. It is always in the best interest of all parties and the judicial system to settle cases. As an attorney representing the Plaintiff in an employment discrimination action, settlement negotiations should be encouraged early and often. Once you agree to settle the case there is one final hurdle that needs clearing, a written settlement agreement. The tax laws have changed over the last few years and drafting settlement agreements which maximize the non-taxable income for your client can be difficult and dangerous. IMPORTANT DISCLAIMER: The best advise is to get a good tax attorney to review all settlement agreements and discuss taxability questions. No intelligent employment attorney, myself included, would claim to be an expert on taxability issues unless they really were. Even a self-proclaimed expert on taxability issues cannot foresee how the Internal Revenue Service may rule in the future. The cases cited in this article are generally long, convoluted and should be reviewed before citing. Be forewarned! I. ALLOCATION OF DAMAGES AND TAX CONSEQUENCES The big question: What is taxable and what is excluded from gross income? A. Damages for Physical Injuries Are Non-Taxable The Small Business Protection Act of 1996 changed the Tax Code by adding the word physical to the definition of personal injuries and personal illness in Section 104(a)(2). This combined with the Supreme Court s decision in Commissioner v. Schleier, 515 U.S. 323 (1995) has made damage awards taxable 1

2 under most discrimination statutes, unless there is some physical injury to the Plaintiff as a result of the employers discriminatory conduct. The physical injury needs to be more than just headaches, insomnia or stomach disorders according to the legislative history of the Small Business Protection Act. The best way to take damages out of gross income is to assert a claim for battery, assault or some other tort where the facts show some type of contact and resulting injuries. A sexual harassment case or a hostile environment case where the Plaintiff was hit, shoved, disabled, raped, grabbed, gassed, burned or otherwise physically injured are examples of cases in which an assault or battery claim would provide claims whose compensation would be excluded from gross income and therefore non-taxable. Another case to cite in arguing for exclusion from taxation is Knevelbaard, et ux. V. Commissioner, T.C. Memo (1997) which relied on U.S. v. Burke, 504 U.S. 229 in interpreting section 104 of the Tax Code. Knevelbaard allowed the exclusion of a twenty million dollar recovery to a class of 1,000 diary farmers who alleged emotional distress as a result of loan policies from several banks. BE WARNED, these cases were decided using the pre-existing interpretation of Section 104 and existing law prior to the enactment of the Small Business Protection Act and are subject to reinterpretation. Emotional distress damages without a physical injury are probably not excluded under the new law. B. Failure to Hire - Not Subject to Withholding If the claim is that the Plaintiff was not hired because of protected status then the Plaintiff was never an employee. Therefore any damages awarded does not constitute wages and is not subject to withholding. In Newhouse v. McCormick & Co., 11 EDR 57, 10/14/98, No. s and (8 th Cir. 10/2/98) the appellate court found no basis for finding that the plaintiff was an employee of the company after it failed to rehire him because of his age. The Court awarded Newhouse front pay and back pay but found that since he was not an employee that the award would not be subject to withholding from the company. This follows Redfield v. Insurance Co. of North America, 940 F.2d 54 (9 th Cir. 1991) and Lisec v. U.S., 10 Cal.App. 4 th 1500 (1992) finding that the defendants could not withhold taxes from settlement agreements. C. Wages, Severance, Interest, Liquidated, Punitive - Taxable It is clear that wages and severance payments are subject to withholding and are taxable as gross income. However if the settlement agreement provides more than the customary severance payment, then the excess over the normal severance is not wages and not subject to withholding and is excluded from gross income. 2

3 Greer v. U.S., E.D. Ky., No (9/23/98). This exclusion is only effective where the employee asserted a claim against the employer. If there is no claim made, then there can be no exclusion. Taggi v. U.S., 835 F.Supp. 744 (S.D.N.Y. 1993) aff d, 35 F.3d 93 (2d Cir. 1994). McCelary v. Armstrong World Industries, Inc., 913 F.2d 257 (5 th Cir, 1990). In employment or personal injury cases interest is always taxable. Kovacs v. Commissioner, 100 T.C. 124 (1993), aff d, 25 F.3d 1048 (6 th Cir. 1994) found that the interest portion of a personal injury award was not on account of personal injuries and therefore the interest was not excluded from gross income. In settling discrimination cases the simplest way to avoid taxation on interest is not to characterize any portion of the award as interest. However, if it is undisputed that some portion of the settlement is interest, then specify some amount as interest and treat it as taxable by filing a Form 1099-INT. If there is some rational basis for the interest calculation, the IRS will most likely decline from challenging it. Rozpad, et ux.,v. Commissioner, 1 st. Cir., No , 8/25/98. Similarly it is clear that liquidated and punitive damages are taxable after Schleier. In the vast majority of settlement agreements it is standard for the employer to insist that a clause be included stating that the claims are disputed and that the employer denies liability. This is beneficial for the Plaintiff as there can be no claim that the settlement is for punitive or liquidated damages where there is agreement that there are no willful violations. D. Attorney Fees There is a First Circuit case Alexander v. Internal Revenue Service, 72 F.3d 938, that states that the plaintiff s attorney fees are included in the plaintiff s gross income and are taxable under section 61(a) of the Internal Revenue Code. However, this case is based on an IRS private letter ruling and is directed only to the taxpayer who requested it. It should not be used as precedent and therefore, I would argue that it does not apply. Most attorneys will agree to separate the legal fees and send separate checks to the attorney and the client. This will reduce the award to the client for tax purposes. The settlement agreement should state who the checks are being made payable to and the amounts of each check. II. RELEASES, CONFIDENTIALITY AND OTHER PROVISIONS There are many items in a release that are standard. The employer will almost certainly insist that there is no admission of liability, they will insist on confidentiality, that the employee agree not to seek rehire, that the employee not make comments critical of the company, that all rights to sue are waived and that the 3

4 employer gets specified damages for breach of the agreement. Of course the requirements of the Older Worker Benefit Protection Act must be satisfied and the compensation package must be acceptable. A. Older Workers Benefit Protection Act The OWBPA has certain requirements to make a severance agreement valid. Be sure that when a settlement agreement is reached, all the requirements of the OWBPA are satisfied. Those requirements include: 1) notification of right to have counsel review the agreement; 2) a twenty-one day period to review the document before signing; 3) a seven day period to revoke the agreement after it is signed. An agreement that does not include those items may be invalidated by the Court. The 21 day review period may be waived if the employee voluntarily and knowingly signs early. Generally payment of whatever is agreed to will not be due until after the seven day revocation period. Be sure to include a date certain for payment of settlement monies. B. What to Fight For, What to Accept. In attempting to settle cases it is important to know what is important and what may be trivial. All circumstances are different and clients must be consulted as to what is important to them and what may occur as a result of clauses they might not understand. For example, the defendant will never admit liability, the case is being settled, why argue about a non-admission of liability? Confidentiality is always a consideration. The big questions are: Who is excluded? And what is confidential? There should always be an exclusion for the wife and/or immediate family, the tax advisor, the attorney, and in case of subpoena or governmental inquiry. Again, check with the client to see who else might be needing this information. Second, what is confidential? Is it the fact of the agreement itself, just the amount of money agreed to or the underlying facts of the case? If there is already a case filed, then some information is already in the public record. Anything that is already in the public record cannot be suddenly agreed to be confidential. EEOC and other agency records are not public record, so confidentiality can be maintained up to the close of the administrative process. The amount of money and other benefits in the contract can be made confidential and there is generally no use arguing that point. One exception is if the defendant is a government entity, in which case the settlement agreement might be subject to public records disclosure and therefore cannot be kept confidential. Also be wary of agreements which prohibit the employee from making negative comments about the company. These are often ambiguous and may subject the client to a lawsuit for a comment that is relayed back to the company 4

5 where someone finds it offensive. Fight to get such language removed from the agreement or have it amended to include a specific forum to address the comments and insist that no damages will be available until ruled on in that forum. The client should not be subjected to damages for slander until it is proven before a court or arbitrator. The right to rehire is an issue that clearly needs to be explored with the client. Does the client want to return at some point? Will the employer expand and take over other potential employers? Would the client have to resign from a new position if the old employer takes over the new employing company? These questions must be asked. If the client understands the consequences and has no desire to return to work for that company, then there is no problem. If the client has concerns then fight to have that clause modified or removed. Often the employer will insist on an amount of damages being specified in the agreement in case of a breach. This can be helpful as it will limit the client s liability. Be sure that the specified damages adequately reflect what the client is receiving, less attorney fees and other expenses. The employer may also insist that the plaintiff pay attorney fees in case of a breach. Be sure that the language states the prevailing party is entitled to reasonable attorney fees and costs. The employer must prevail to have its fees paid, and the employee must have the same right if they prevail. Finally the employer will insist that the client gives up all rights, known and unknown, to sue under a laundry list of federal and state statutes. This is acceptable so long as the client understands the rights being waived. Be sure that the client is only giving up rights to actions for previous conduct and not future conduct. The right to sue for events that have not yet occurred cannot be waived. III. THE SEVEN DON TS OF NEGOTIATING SETTLEMENTS No. 1: Don t take bad cases! If you don t follow no. 1, then nothing else you do will make you successful at negotiating settlement. If you discover after the fact that you have a dead dog on your hands, do your best and move on. Good case evaluation is the best insurance to negotiating good settlements. No. 2: Don t be afraid to open negotiations. It is in everyone s best interest to settle cases. The client must be made aware of the costs of litigation, emotional as well as financial. Early settlement avoids administrative involvement, costs and time. The first thing I do with a new client is call the other side and make a reasonable settlement demand. Most times I am 5

6 referred to legal counsel. But once in a while I can get someone s job back or a decent severance package, or a reasonable settlement. It s worth the effort at any stage to discuss settlement, before filing suit, after initial disclosure, following depositions, after summary judgment, etc. However, if the other side absolutely refuses to discuss settlement, be prepared for trial! No. 3 Don t Make Unreasonable or Unsubstantiated Demands Not even in Las Vegas could you find prognosticators who could accurately calculate damages a jury could award in a discrimination case. Understand the client s real economic damages and base the settlement demand on those calculations. Again, you must consult with the client to determine those damages and make the client understand what his real damages are. The client must provide his annual salary, value of benefits, stock options, insurance, value of salary denied, years of employment, estimated retirement age, post employment income and estimated future earnings. Based on those numbers you can approximate his damages. Whether you make an initial offer of two year s pay or salary through retirement age is a situational decision. Again, consult the client. No. 4 Don t Be Afraid to Twist Your Client s Arm! It is very important to prepare your client for settlement. If you have painted a rosy scenario to this point and your client has half a dozen zero s floating in their head, then you will not be settling that case with a contented client. You must always ground your client s expectations in reality. At your initial consult with the client if they are expecting a multimillion dollar award based on media hype and you don t explain the reality of federal litigation to them, you are in trouble! When you finally do a get a reasonable settlement offer and you don t think any more is coming, that s when you may need to twist your client s arm. As the attorney you must have a better understanding of the pitfalls of trial. The time, the summary judgment, the costs, the agonies, the appeals, the time, the possibility of losing, an adverse cost award, the time. Recognize the value of your time and take the time to make your client understand the value of the reasonable offer. There will come a time when there is no more for the other side to put on the table. Don t let that time pass your client by. No. 5 Don t Be Unprepared for Mediation It is essential to prepare for mediation with a thorough summary for the mediator which is given to the defendant representative. Mediation might be the one 6

7 chance you get to see the defendant company s decision-maker. If you can provide that decision-maker with a copy of the mediation summary and convince them that the plaintiff can prevail, you have gone a long way towards getting a good settlement offer. No. 6 Don t Be Afraid to Walk Out Of Negotiations Or Back In All too frequently the defendant will make low-ball offers and refuse to make an a reasonable counter-offer. When this happens, and it is happening more frequently, don t be afraid to walk out of negotiations. If you believe the other side is not dealing in good faith, get out and prepare for trial. However, if at some point the other side comes to its senses and wants to reopen negotiations, then listen to their offer and decide whether it warrants a return to the bargaining table. But don t go back or respond unless you feel the offer is made in good faith. No. 7 Don t Ever Let Em See You Sweat Okay, so you don t have a good case... you believe the Court is about to grant summary judgment... the client is getting on your last remaining nerve... your in-laws are staying at your house for an extended vacation... the defendant s counsel is obstructionist, obnoxious, unrelenting and despicable... what do you do? When all else fails, BLUFF! Let them know you will whatever is necessary to secure justice for your client. Of course if they don t buy it, explain to the client why he cannot prevail and try to get something for the client. Anything is better than getting thrown out of court and having to avoid defendant s being awarded costs or fees. The client is much better off getting a few thousand dollars then fighting a cost judgment of tens of thousands of dollars. If they cannot understand that, then there is little more you can do. 7

Date: July 17, In Re: Dear

Date: July 17, In Re: Dear Department of the Treasury Index No.: 104.03-00 Washington, DC 20224 Number: 200041022 Release Date: 10/13/2000 Person to Contact: Identifying Number: Telephone Number: Refer Reply To: CC:IT&A:2 PLR-101732-00