Consider Whether the Promise of a Bird in the Hand is Better Than Two in the Bush

by Proskauer - Minding Your Business

When drafting settlement agreements, most lawyers give due attention to the scope of any release clause. And for good reason: for defendants, the extent to which the release protects against future litigation is critical, and for plaintiffs, the extent to which it preserves future claims may be equally critical. But lawyers – and particularly those representing plaintiffs – should also give thoughtful attention to the timing of a release clause in any settlement agreement. Otherwise, a plaintiff may find that its “compromise” was nothing more than a unilateral agreement to reduce the value of its claim.

Take this simple example:  Plaintiff sues Defendant for breach of contract claiming $100,000 in actual damages. Defendant offers to pay $50,000. Plaintiff, preferring the certainty of payment over litigation and collection costs, agrees to settle. The settlement agreement executed by the parties is simple:  it provides (i) that Defendant shall pay $50,000 to Plaintiff within 20 days of execution of the agreement; and (ii) for mutual general releases between the parties.  Day 20 comes and Defendant doesn’t pay. What rights and remedies does Plaintiff have?

The answer depends on when the release became effective.  And that, in turn, may depend on whether the settlement agreement is construed to be (i) a “substituted contract” wherein Plaintiff accepted the promise to perform the compromise as satisfaction of its underlying claim or, alternatively, (ii) an “executory accord” wherein Plaintiff accepted actual performance of the compromise as satisfaction of its underlying claim. See, e.g., Rucker v. Rucker

For example, in Rucker v. Rucker, the parties settled an action on a promissory note. The settlement agreement included mutual releases of all claims between the parties and a remedy in the event of default under the agreement (i.e. a confession of judgment). Based on the terms of the settlement agreement, the Rucker court found that the parties intended their settlement agreement to extinguish the obligations under the promissory note and replace them with the obligations under the settlement agreement: “the settlement agreement was a substituted contract that extinguished the promissory note and became the operative agreement between the parties.” When defendant breached the settlement agreement, the plaintiff was precluded from suing for the full amount of the underlying promissory note. That claim had been released by the settlement agreement. Plaintiff had only the right to sue for breach of the settlement agreement.

Similarly, in the hypothetical above, Plaintiff’s remedy for Defendant’s breach would be limited to enforcing the settlement agreement: a $50,000 claim. Thus, by entering into a “substituted contract” (without preserving its underlying claim in the event of a breach) Plaintiff would have lost half the value of its claim! By contrast, Plaintiff’s rights would not be so limited if the settlement agreement conditioned release on receipt of payment or otherwise preserved Plaintiff’s right to pursue the underlying claim upon breach.   See, e.g., Boulware v. Baldwin. Under such circumstances, Plaintiff would have the option to pursue the original $100,000 claim or to enforce the settlement agreement (but couldn’t obtain a judgment on both).

“Settlement agreements may have the effect of immediately and permanently extinguishing one party’s claims in exchange for the other party’s promise to perform.”   See Rosen v. Ascentry Technologies, Inc. (emphasis added). As shown above, this can result from a release clause that takes effect too soon, i.e., before receipt of the compromise consideration. Counsel drafting and reviewing settlement agreements should thus consider the timing of release clauses when drafting and reviewing settlement agreements to ensure that the deal that has been papered is the deal the client intended to make.

There may be circumstances where parties intend to make releases effective immediately. For example, parties may be unwilling to wait when the settlement agreement provides for the exchange of consideration to take place years after execution. Alternatively, there may be value in and of itself to liquidating the amount of a claim through a settlement agreement (particularly in states, like California, that offer an expedited procedure for enforcement of settlement agreements, see California Code of Civil Procedure § 664.6). Either way, the timing of a release can have significant consequences, and should be considered when drafting or reviewing any settlement agreement.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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