Confidentiality in Sexual Harassment Settlements: To Include or Not To Include?

Confidentiality is one of the hallmarks of settlement agreements in sexual harassment cases. Both employers and employees frequently desire to keep such settlements confidential, albeit for different reasons. Employers like to keep settlement amounts, and sometimes even the fact that a settlement occurred, confidential in order to protect their public image and reputation, and so as not to encourage other employees to bring their own lawsuits. Employees often wish to maintain confidentiality as well, sometimes due to embarrassment or concern about being labeled a "victim," and sometimes because they simply want privacy. Employees may also wish to avoid having to discuss a sexual harassment case against a prior employer with a current or prospective employer.

The recent #METOO movement has highlighted a major concern with including confidentiality provisions in settlement agreements. That is the "culture of secrecy" that can result from keeping an offender's conduct quiet, and the potential for future victimization of other employees who are unaware of the perpetrator's prior actions. One provision of the newly-enacted Tax Cuts and Jobs Act of 2017, Pub. L. 115-97, sec. 13307, seeks to rectify that concern. Labeled by some as the "Harvey Weinstein Rule," the provision in question modified Section 162 of the Internal Revenue Code in a way that could fundamentally change sexual harassment settlements.

Section 162 permits a deduction for all "ordinary and necessary expenses" paid or incurred in carrying on any trade or business. Pursuant to this section, employers have long deducted settlement payments made to resolve lawsuits. The Act revised section 162 to add subsection (q), which prohibits deductions "under this chapter" for 1) any settlement or payment related to sexual harassment or sexual abuse if the settlement or payment is subject to a nondisclosure agreement or 2) attorney's fees related to any such settlement or payment. As is often the case, however, missing from the Act is any interpretation as to how this new language should be applied. One looming question, among many, is whether the provision will operate to bar deductions not only for the employer / defendant, but for the sexual harassment plaintiff as well.

While employers generally pay their attorneys by the hour, plaintiffs' attorneys usually handle sexual harassment cases on a contingent fee basis. Typically, a plaintiff's attorney's fees will be between 30% and 40% of the plaintiff's total recovery. While the plaintiff must claim 100% of his/her recovery as gross income[1], he/she is entitled to take an "above-the-line" deduction for the legal fees.[2] Section 62 of the Internal Revenue Code, which defines "adjusted gross income," states this explicitly. It is not clear, however, whether that will still be the case in light of subsection (q). Both Section 62 and Section 162 are located within Chapter 1 of the Internal Revenue Code. Subsection (q) is clear in prohibiting deductions "under this chapter." If in fact a plaintiff can no longer deduct the attorney's fees from income, that plaintiff may owe tax on income that he/she never received. This would substantially reduce the plaintiff's net recovery from settlement.

This new language may therefore make settlements more difficult to reach. Parties settle cases for a lot of reasons, even when they do not believe they will ultimately be adjudged to be liable. One main reason is cost effectiveness. It can be much less expensive for a party to settle a case than to litigate the case to conclusion. The ability to deduct the settlement payment and attorney's fees is a major factor. If that ability is removed, there would likely be less incentive to settle cases that might otherwise be resolved. Plaintiffs may look to defendants to make up this loss with higher settlements. Likewise, if the ability to keep a settlement confidential is removed, an employer may be more willing to take a case "to the mat," especially where there is a potential for a very large verdict.

The very term "nondisclosure agreement" is itself subject to interpretation. Can the parties avoid the effects of the provision by disclosing that a payment was made, but without disclosing the actual amount? In cases involving multiple claims, can the parties reveal the details regarding the sexual harassment claim but keep the details of the remaining claims confidential?

Many cases assert multiple theories of liability. The new provision does not define what constitutes a settlement "related" to sexual harassment and how the provision will apply to cases involving numerous claims, only one of which involves sexual harassment or abuse. For example, if the employer is found not liable for sexual harassment, but is found to have retaliated against the plaintiff for making the complaint, and the case is settled during a subsequent appeal, is the retaliation claim "related" to sexual harassment? What if an employee's resignation is negotiated following an allegation of sexual harassment or abuse? Is a severance payment "related to" the sexual harassment? The same concern arises from the "attorney's fees related to such a settlement of payment." Does that mean all attorney's fees for the case, or only those that arise from the sexual harassment allegations? It is often most difficult to parse fees out in such a fashion. Presumably some guidance will be forthcoming as these issues arise in real cases. In the meantime, though, attorneys on both sides are left to employ whatever means of avoiding subsection (q) as they can agree upon. This might include creative settlement language, including specific breakdowns of settlement funds based on percentage, by cause of action. Whether the IRS will even honor such provisions is anyone's guess. Stay tuned.

[1] Commissioner v. Banks, 543 U.S. 426 (2005)

[2] American Jobs Creation Act of 2004, Pub. L. 108-357, sec. 703; 26 U.S.C. ยง 62(a)(20).