Court Holds Backup Withholding Required by Law Does Not Violate a Settlement Agreement



In Escano v. Innovative Financial Partners, LLC,1 a magistrate judge held that the defendants’ decision to withhold funds from a payment required under a settlement agreement when the plaintiff refused to provide a Form W-9 did not violate the agreement.

The case involved alleged violations of the Telephone Consumer Protection Act (TCPA) and the New Mexico Unfair Practices Act. The parties settled in March 2023. The court first noted the plaintiff was a pro se litigant who had filed more than a dozen lawsuits under the TCPA, and “the Court considers Plaintiff without question to be the most capable pro se litigant the Court has ever encountered.” The court noted he was “articulate, intelligent, scholarly, poised, mature, thorough, and organized,” and possessed “subject-matter expertise, familiarity and facility with civil litigation, and overall communication skills” that made “him well-matched against even the most experienced opposing counsel.”

The court then turned to the parties’ negotiations over the settlement. The plaintiff stated that he declined to provide a W-9 because his Taxpayer Identification Number was his social security number. The defendants’ counsel indicated the information would remain confidential and referred to the instructions for the Form W-9 and other IRS publications to explain why providing the form to the defendants was required at the risk of backup withholding. Eventually the defendants’ counsel emailed the plaintiff to state that it would pay the settlement without a W-9. After several changes to the agreement, the plaintiff signed it.

Based on a careful review of the record, the court found that from first communication to settlement took 38 days, the negotiations were “robust, iterative and careful” and demonstrated the “parties [had] equal bargaining power.” As such, the court concluded that the plaintiff “had a complete understanding of the language, meaning, and effect of each and every one of its individual provisions” and had “reviewed, understood, and ultimately agreed with every word that appeared in the version of the Settlement Agreement he signed.”

The defendants paid the settlement on May 15, 2023, withholding 24% that was remitted to the IRS. A cover letter with the settlement payment explained why the defendants had performed this backup withholding. Upon receipt of the check, the plaintiff was reportedly shocked that the defendants had deducted the 24% backup withholding, telling defendants’ counsel via a conference call that “‘under no circumstances would’ [he] agree to having a backup withholding deducted from the settlement check.” The defendants’ counsel again asked for a Form W-9, and stated it would provide a new settlement check without backup withholding if the form were provided. The plaintiff refused, and instead stated the deal was off and that he intended to move for a default judgment.

The defendants’ counsel sought to have the plaintiff reconsider his position, and noted that if he did not cooperate, it would seek to enforce the settlement and seek attorney’s fees for doing so. The defendants notified the court of the plaintiff’s lack of cooperation, and the court granted leave to file a motion to enforce the settlement, dismiss the case and seek fees under the settlement agreement’s fee-shifting provision. The plaintiff thereafter filed a request for entry of default, and did not withdraw his request for over five weeks after the defendants filed an answer. The plaintiff also threatened defendants’ counsel that if they did not withdraw the motions, he would file lawsuits against each of them individually in state court for malicious abuse of process. The plaintiff also sought to engage in discovery, and in effect sought to increase the settlement by $5,000 to compensate for the lack of a W-9. Defendants declined, noting “it is not appropriate to try to charge a $5,000 fee to provide a TIN per IRS requirements after a settlement has already been executed and paid, particularly given that [defendants] have already incurred the expense of moving to enforce that settlement.”

Finally, the court also found that the plaintiff had sent letters to defendants’ counsel basically instructing them to destroy his correspondence if they did not agree to it, but denied to the court that “his intention in demanding confidentiality was to ensure that the Court never saw or learned about the letter or its contents.”

Turning to the law itself, the court stated the primary issue was whether to enforce the Settlement Agreement, which in turn raised two other questions: first, whether the defendants breached the Agreement by deducting a 24% backup withholding from the settlement check; and second, whether the plaintiff breached the Agreement by refusing to dismiss this case within three days of receiving the settlement check.

Relying upon its detailed discussions of the negotiations and the plaintiff’s competence, the court first concluded that the agreement was legally enforceable. Turning then to tax law, the court found that “courts across the country have recognized that complying with federal tax law when paying a settlement does not breach the terms of the agreement.” Further, it was black letter tax law that the failure to provide a Form W-9 required backup withholding in this circumstance, and thus defendants’ withholding of 24%, remitted to the IRS, was not a breach of the agreement.

The court went further, however, in noting that even if a breach, the backup withholding “also could not have risen to the level of a material breach sufficient to discharge the plaintiff from his obligations.” The court reasoned that he was only temporarily deprived of 24% of the settlement consideration, and if he was entitled to a refund, he could seek one from the IRS. The plaintiff tried to argue about the time value of money, but could not express a clear use for the money during the period in which he asserted he was temporarily deprived of its use.

Having found that the defendants prevailed on their motion to enforce the settlement agreement, the court also found that under its fee-shifting provision, the plaintiff was liable for the costs of enforcing the settlement and awarded $144,605.43 in fees and costs (which was less than the $262,358.03 sought).

The court’s lengthy discussion of the plaintiff’s competence and conduct was clearly intended to insulate the findings that the agreement was enforceable and justify its award of attorney’s fees. While not explicit, the court appears to have taken issue with the plaintiff’s unreasonable refusal to provide a simple tax form that could have avoided the entire problem. It is also exemplifies the potential downsides to a plaintiff’s failure to cooperate with defendants about the tax reporting obligations federal (and state) law impose upon payments made in settlement. The case serves as a reminder that, like Icarus, one’s own arrogance is likely to get one burned.

Although not an employment case, Escano is a good reminder and cautionary tale for employers, which must and can enforce their legal obligations to withhold, report, and remit taxes in settlement even when plaintiffs refuse to cooperate with them by providing valid Forms W-4 or W-9 or seek to have an agreement violate federal tax law.


​1 Escano v. Innovative Financial Partners, LLC, Case No. 2:23-cv-00277 (D. N.M. Jan. 23, 2024).

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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