The Nuts and Bolts of Settlement Agreements

McElroys recently attended a LegalWise seminar on settlement agreements. We have prepared a quick refresher on important aspects to be aware of when entering into a settlement agreement.

Settlement agreements can be effected in a variety of ways, ranging from oral agreements to a formally executed deed. The benefits and problems associated with the various forms of agreement include:

• Oral agreements – Difficulties may arise if you are required to satisfy a Court that a valid agreement has been reached and what the specific terms of that agreement are.
• Written correspondence – Settlement can be reached through an exchange of written correspondence, usually solicitors’ letters. While this is a relatively common form of settlement agreement where the issues are straightforward, where the compromise is more complex, a standalone settlement agreement will usually avoid any issues in relation to scope and performance.
• Settlement Deed – Deeds have a longer limitation period (12 years as opposed to six). They can be used where there is uncertainty over whether consideration has passed between the parties, or where the longer limitation period is required.
• Formal written agreement – Best practice when a compromise is reached is for the parties to enter into a formal written standalone agreement. While further costs will be incurred to negotiate and draft the agreement, the advantage to the parties is that the compromise and terms of the agreement are recorded plainly in one document and as such are more difficult to challenge.

The content of any settlement agreement is important, both in terms of performance and enforcement. Key aspects to keep in mind when negotiating and documenting a settlement are:

• Who are the parties? It is important that the correct parties are named in the settlement agreement to ensure that there is no future uncertainty.
• What is being settled? The parties must take care to define the compromise. It is particularly important to ensure that the settlement agreement does not inadvertently settle more or less than intended. Defining the compromise is more straightforward when legal proceedings have been issued. However, where the dispute is not defined in legal proceedings, or is settled prior to proceedings being commenced (as is often the case when settling a claim under an insurance policy) parties should refer to key factors such as contracts, events and/or time periods to assist.
• What is the effect on third parties? Carefully worded ‘carve-out’ clauses may need to be included in a settlement agreement to preserve a party’s right of recovery against the other party to the agreement, in respect of future third party claims against it. While the effect of an agreement on a party’s position with third parties may not be the key focus during settlement negotiations, it is important to keep this in mind during the negotiation process. It is also important to consider whether negotiating a ‘carve-out’ of this kind is necessary as it can prolong the settlement process and risk the agreement falling over altogether.

In addition, because settlement agreements are only binding on the parties, it is important to consider whether an indemnity is appropriate. Parties can indemnify each other against any loss that arises from a third party bringing a claim arising from the same subject matter. However, an indemnity may be considered a voluntary assumption of liability, so before an insured agrees to provide an indemnity, they need to consider any clauses in their insurance policy which exclude cover for assumed liabilities.

Ultimately, payment of a settlement sum is the key aspect of any commercial settlement. It is important to get this right. It involves careful consideration of:

• How much, by whom, to whom, when and how (method of payment).
• It is also important to consider the tax implication, particularly whether the payment is inclusive or exclusive of GST. Have the parties obtained advice on their tax liabilities?
• Settlements that are subsidised by insurance can raise particular tax issues for the party receiving the settlement funds. An issue can arise around GST when an insurer makes payment directly to a claimant, without the claimant’s knowledge that the settlement is being paid by an insurer. The insurer is able to claim a GST deduction on the payment but the claimant may be unaware of its GST obligations and fail to meet them, leaving the IRD out of pocket. The IRD is currently looking at addressing this issue and provides useful guidance on the GST implications for settlement agreements in IS3387: GST Treatment of Court Wards and Out of Court Settlements.

There are a number of other terms that can easily be overlooked, but are key to ensuring an effective settlement:

• Preconditions – Are there any requirements to be fulfilled prior to the payment of the settlement sum?
• Discontinuation of proceedings – If proceedings are on foot, consider when the proceeding should be discontinued. There may be benefits in not discontinuing until payment is made, or alternatively relying on the ability to sue for breach of the settlement agreement, if necessary.
• The consequences of non-payment/breach of the agreement – Will non-payment render the agreement null and void or will it leave open the possibility of a claim for breach of the settlement agreement? If there are concerns about payment being made, one option is to require an admission of claim, which can be filed in Court on default of payment.
• Release – Where the settlement is full and final, it is important to include a clause in the agreement which provides that the parties will not commence future proceedings arising from the same subject matter. Specificity of wording is important and may differ depending on the nature of the settlement. Where you are settling with an insured under a policy, consider whether the breadth of the release contravenes the no contracting out provisions in consumer legislation. While settlement agreements are excepted, care needs to be taken to ensure that the agreement complies with the requirements of the exception. Rachel Scott discusses this issue in detail in her recent article on the CGA and Insurance Services.
• Confidentiality of settlement – this will typically be sought by all parties. It is important to ensure that they are all aware of what this entails to avoid inadvertent breach of the settlement agreement through subsequent disclosure of its terms, as this could lead to the entire agreement being overturned.

Once an agreement is reached it is important to ensure that it is executed correctly. This will include considering:

• Who should sign? The party or someone authorised to sign on their behalf?
• Are there any formalities around execution? This will depend on the form of the document. An ordinary contract can be signed without a witness and, ordinarily, electronic signatures will be sufficient. A Deed will need to be witnessed. It is common for settlement agreements to include a “counterparts” clause which provides that each party to the agreement is permitted to execute it by signing separate but identical copies.

Illegitimate pressure – If a party is pressured into entering the agreement (through duress or undue influence) then the agreement may become void, on election of the victim.

Incapacity – The parties must have mental capacity to enter into an agreement. It is important to pay particular attention to the elderly and vulnerable.

• Restraint of trade clauses – It is commonplace for settlement agreements concerning employment disputes to include such clauses. As a general rule, if the restraint is unreasonable it will not be enforced.
• Ouster clauses – A party cannot prevent another party to an agreement from seeking redress through Courts. However, a dispute resolution clause can be used to provide for an alternative dispute resolution mechanism/forum.
• Disparaging comments clauses – Care should be taken not to make such a clause so broad as to prevent a party from legitimately reporting matters to authorities/regulatory bodies if necessary.

While parties to settlement agreements do not expect them to be revisited, and public policy supports the finality of settlement agreements, agreements can be set aside, or ‘re-opened’ on certain grounds including (but not limited to) mistake, misrepresentation, frustration, or undue influence. It will be important to keep these concepts in mind as there will be circumstances where a party may wish to call on these grounds if circumstances relating to the settlement change in the future. Alternatively, certain clauses should be included where finality is sought.

Settlement agreements may be set aside on the basis that a party makes a mistake about the law or facts (not including mistakes in the interpretation of contracts), and/or where a party to a settlement agreement has been induced to enter into it by a misrepresentation made by another party.

The leading cases for mistake, Prattley Enterprises Ltd v Vero Insurance New Zealand Ltd and misrepresentation, Dodds v Southern Response, both occurred in the insurance context and have been covered in detail by McElroys in previous case law updates:

Dodds HC
Dodds CA
Prattley CA
Prattley SC

In Planet Kids v Auckland Council [2013] NZSC 147, the Supreme Court found that in order for a settlement agreement to be set aside on the basis of frustration it must be shown that the main purpose of the settlement agreement had been defeated, i.e. there was an impossibility or radical difference in performance.

In Oberlechner v Tower Australia Ltd [2002] NSWSC 814, the New South Wales Supreme Court found that a party arguing that they entered into a settlement agreement on the basis of undue influence must show that the transaction was not the result of the free exercise of their independent will.

Negotiating and concluding settlement can take many different forms. How a settlement agreement is best effected will be determined in large part by the nature of the dispute, the amounts involved and the relationship between the parties. Our summary of key aspects of settlement agreements should assist you to determine what you need to consider and when you might need further advice (such as specialist tax advice) or assistance.

This publication is intended as a general overview and discussion of the content dealt with. It should not be used in any specific situation, in which case you should seek specific legal advice.