Wrapping up a settlement often comes with a large sigh of relief. A settlement ends a dispute, usually in a way that is at least tolerable, if not ideal, for all sides. (A good settlement is one that neither side is completely happy about.) But when there are lingering doubts in the minds of one side to the settlement, those doubts might fester, and they can return to haunt the unwary, particularly where fiduciary obligations heighten responsibilities between the parties.
Normally, the maxim caveat emptor governs the arms-length settlement of a dispute. If you are unhappy with the results of the agreement down the road, or the agreement fails to live up to your expectations, you are nonetheless bound to the terms of the deal you struck. In certain circumstances, though, a special relationship may impose obligations that can undo a settlement agreement after the fact.
HOYT PROPERTIES – UNWINDING A SETTLEMENT AGREEMENT.
Settlement agreements are contracts. Although the law presumes that settlement agreements are valid, they generally are subject to contract defenses, including mistake, unconscionability, duress, undue influence, and fraud.
Hoyt Properties, Inc. v. Production Resource Group, L.L.C.1 offers an example of a settlement agreement undone by an alleged misrepresentation during negotiation. Hoyt began as a commercial lease dispute. As part of the settlement of that dispute, the tenant (Entolo) asked the landlord (Hoyt) to release Entolo’s parent company (PRG) from any liability. Hoyt’s CEO stated, “Well, that would be piercing the veil . . . I don’t know of any reason why [PRG] would be liable, do you?” PRG’s attorneys allegedly responded, “There isn’t anything. PRG and Entolo are totally separate.”2 Based on that representation, Hoyt agreed to release PRG as part of the settlement agreement.
Later, Hoyt learned of an unrelated lawsuit alleging, among other things, that Entolo failed to observe corporate formalities, PRG operated Entolo as a division rather than a separate corporation, and PRG undercapitalized Entolo.3 In particular, PRG allegedly used Entolo to guarantee two of PRG’s loans and then arranged for the transfer of all Entolo’s cash and accounts receivable to PRG.4 If true, all of these facts would support a claim to ignore the corporate form of Entolo, and impose liability on PRG.
Hoyt sought to rescind the settlement agreement with Entolo based on a fraudulent-inducement theory, and sought to pierce the corporate veil to hold PRG liable for Entolo’s obligations. The Minnesota Supreme Court ultimately determined that Hoyt could proceed on its fraudulent inducement theory. The statements of PRG’s attorneys were actionable, because they implied that there were no facts that would support a veil-piercing claim against PRG. That representation was arguably false, because there were, at the time, a number of facts Hoyt could have alleged to support such a claim.
The Hoyt case involved an alleged affirmative misrepresentation, but an omission or negligent misrepresentation can also invalidate a settlement agreement if the other elements of the contract defenses are established. Although nondisclosure alone will generally not support a fraud claim, an attorney or party may be under an obligation to disclose facts if (1) a confidential or fiduciary relationship exists, or (2) the party makes an affirmative representation or takes other steps to conceal the truth.5 In other words, although there is no general duty to disclose material facts to an adversary, a party could jeopardize a settlement agreement by failing to disclose the truth if a fiduciary relationship exists or a contrary affirmative representation of fact has already been made and the party does not correct it.
AVOIDING PROBLEMS DOWN THE ROAD.
This settlement nuance has significant application to trustees and to closely held businesses. Trustees and members of a closely held business owe a fiduciary duty to the trust beneficiaries and other members of the business entity.6 Moreover, in both contexts, one party will frequently have superior factual knowledge or access to information unavailable to the other side. Thus, when settling a dispute, a trustee or a member of a closely held business should take care to avoid later attempts to rescind or otherwise unwind a settlement agreement.
How? The most obvious answer is simply to tell the truth.7 And that is a good rule to follow. Certainly, each party to a settlement agreement should avoid affirmative misrepresentations and should not make statements about facts that it cannot back up or verify, particularly if the other side does not have equal access to information.
But a misrepresentation claim can — and often, will — allege an omission of material facts rather than a commission of an outright and direct lie. In a context where one party has superior factual knowledge, such as a trustee or the manager of a closely held business, such a claim can create particular exposure. Even where a fiduciary has endeavored to act forthrightly, the other side may later discover information it did not know and develop a case of buyer’s remorse. Whether such a claim has merit or not, it can lead to further litigation, which is exactly what parties to a settlement hope to avoid.
When entering a settlement agreement, consider including a representation clause in the settlement agreement. A representation clause expressly affirms, as part of the settlement agreement itself, that neither party has relied on any representations made by the other party in entering the settlement agreement. The more specific the clause, the better. This is not carte blanche to lie, but it can undercut the reasonable-reliance element of a subsequent claim that the settlement agreement was fraudulently induced or was the result of a misrepresentation by omission. Coupled with an integration clause and appropriate disclaimers, a wellcrafted settlement agreement can be a powerful tool to avoid future litigation arising out of the settlement itself.
Settlement agreements exist to resolve disputes. Fiduciaries, and participants in closely held businesses, should take care when negotiating a settlement that they avoid leaving a door open for further litigation.
1 736 N.W.2d 313 (Minn. 2007).
2 Id. at 317.
4 Hoyt Props., Inc. v. Prod. Res. Group, L.L.C., 716 N.W.2d 366, 370 (Minn. Ct. App. 2006).
5 See, e.g., L & H Airco, Inc. v. Rapistan Corp., 446 N.W.2d 372, 380 (Minn. 1989).
6 See, e.g., Thomas B. Olson & Assocs., P.A. v. Leffert, Jay & Polglaze, P.A., 756 N.W.2d 907, 914 (Minn. Ct. App. 2008) (fiduciary duty of trustee); Pedro v. Pedro, 489 N.W.2d 798, 801 (Minn. Ct. App. 1992) (fiduciary duty of partners).
7 Of course, every attorney has an ethical obligation not to knowingly make a false statement of fact or law. See Minn. R. Prof’l Conduct R. 4.1.