Drafting a Valid Settlement Agreement

The basic requirements for a valid contract include offer, acceptance, consideration, parties with the capacity to enter into a contract, legality of subject matter, etc. Local laws, including a Statute of Frauds, may impose additional requirements. Thus, when drafting a settlement agreement, it is vital to ensure that the requirements for a valid contract are met.

The consideration requirement in a contract has traditionally been summarized as “a bargained-for benefit,” and can include forfeiting a legal right. Promising to give up the right to sue for damages is a legal right which can suffice as consideration.

EXAMPLE (1): Greg sues Melissa for damages stemming from their agreement to share a house and split the cost of rent, utilities, etc. Greg claims that Melissa breached the agreement by refusing to pay her share of the costs. Before a final court determination, Greg offers to settle the case and forego any future right to bring a cause of action for damages stemming from the relationship if Melissa will pay him $1,000 for back rent. Melissa agrees, and the settlement agreement is drafted and signed. Before mailing the check, Melissa changes her mind. She hopes that she can argue that the contract is invalid for lack of consideration – after all, what is Greg giving her in exchange for the money she is giving him? Because he is promising to give up a legal right, he has given adequate consideration for the contract to be valid.

Compromise of even a doubtful claim is sufficient consideration for a settlement agreement. Vulgamott v. Perry, 154 S.W.3d 382, 390 (Mo. Ct. App. 2004) (citing Holt v. Jamieson, 847 S.W.2d 194, 197 (Mo. Ct. App. 1993) which held that “Consideration based on the forbearance of a valuable right exists although the right later is determined to be invalid, provided that plaintiff had a reasonable, honest belief in its validity.”) So long as Greg has a reasonable and honest belief that he is giving up a legal right, their settlement agreement will not fail for lack of consideration.

EXAMPLE (2): After living in a house together for over a year, during which time Melissa paid her share of the rent, Greg and Melissa marry. For two years between their wedding and the split-up and lawsuit, Melissa does not pay rent. Greg knows that in the state in which they live, a wife has no obligation to share household expenses, regardless of any agreement to the contrary. Therefore, by agreeing to settle the suit based on the unenforceable agreement Greg is not giving up any valuable right. Any settlement agreement will be unenforceable against Melissa for lack of consideration. See Mallory v. Eyrich, 922 F.2d 1273, 1279 (6th Cir. 1991) (courts apply contract principles to settlement agreements).

EXAMPLE (3): Neil owns a boat which he permits his friend Sandy to use whenever she likes. Sandy takes the boat out one weekend and invites her friend Norman along. While on the boat, Norman slips and falls. He promptly calls his attorney who tells him that there is some question in Westernstate as to whether or not the boat owner can be held liable, and that the state courts have not clearly decided the issue. They therefore call Neil and offer to settle in exchange for $5,000. Because the claim might be valid, the promise not to sue Neil is adequate consideration for the settlement contract to be valid.

Settlement agreements are special kinds of contracts, and because they involve disputes which are already in the court system, courts have some oversight over the content of these agreements (such as in the case of “Rule 68” style settlement offers discussed below). When plaintiffs might not be fully able to represent their own interests, for example, courts take a greater interest in the settlement agreement. Cases involving minor plaintiffs or plaintiffs who lack capacity in some other way, as well as class-action lawsuits, often require the judge’s approval before a settlement agreement can be finalized. Similar to class action suits, other cases which   involve more people than may be present in the courtroom garner increased scrutiny from the court. Among these are criminal cases and antitrust cases, both of which affect the public at large.

EXAMPLE (1): Hank is a career criminal who has been in and out of prison since the age of sixteen. He was recently arrested for armed robbery. His attorney has negotiated with the District Attorney to reduce the charge to assault if Hank pleads guilty. Before the settlement agreement can be finalized, a court must give approval of the terms.

EXAMPLE (2): Hank, Jr., is sixteen. He was recently injured in a car accident. The other driver’s insurance company has offered to settle for $500,000. Before the agreement can go through and the court case dropped, the judge in the case might want to review the settlement agreement to ensure that Hank, Jr., is being treated fairly.

Traditional contract defenses apply to settlement agreements, and these must be considered in the negotiation and drafting of the agreement. Excessively strong negotiation tactics might be used in the future as evidence of duress, which would make the agreement unenforceable against the aggrieved party. If a party secures a settlement only through the use of fraud or coercion, that settlement will be unenforceable. Similarly, if the agreement is too one-sided it might be considered unconscionable.

EXAMPLE (1): Alex, a tenant, sues Irwin, his landlord, who refused to return Alex’s security deposit when Alex left the apartment at the end of his lease. During settlement negotiations, Irwin presents a bill from a carpet cleaning company for $500. Alex knew the carpet had been left somewhat dirty, but never imagined it would cost so much to clean. The eventual settlement agreement, whereby Irwin returned $250 of the $1,000 deposit, was agreed to by Alex in part because of the cleaning bill. As it turns out, Irwin did have the carpet cleaned, but at a cost of only $50; the bill presented during negotiations was fake. Because Irwin fraudulently induced Alex to enter into the settlement agreement, the agreement is unenforceable.

EXAMPLE (2): Alex’s friend, Sharon, lived in another apartment owned by Irwin. She sued Irwin even before she moved out, because he had promised to pay for the installation of her high-speed internet connection when she moved in and one year later had still not made good. For fear of eviction, she wisely opted to file suit rather than withhold rent. When she tried to move out at the end of her lease, with the lawsuit still pending, Irwin intentionally parked his car in a way which prevented the moving company hired by Sharon from removing the larger pieces from her apartment, such as her bed and her sofa. He then approached Sharon and presented her with a contract whereby she would agree to settle the outstanding suit for $50. He told her that if she signed it, he would get in his car and drive to the bank to get the $50. Otherwise, said Irwin, he would stick around the apartment complex and catch up on some work he needed to do. Because of the undue pressure exerted on Sharon, the settlement agreement she signed that day is unenforceable.

Unconscionability, however, is a fairly high hurdle to clear for a party seeking to render a settlement agreement unenforceable. Simply because one party suddenly realizes he has agreed to a bad bargain does not mean he can use unconscionability as a defense. Some showing of fundamental unfairness is required. See Pursley v. Pursley, 144 S.W.3d 820, 827 (Ky. 2004).

EXAMPLE (1): Terry Cleese and John Gilliam are business partners. Among other investments, they are equal co-owners of a television production company, MPFC Inc. MPFC Inc. is worth approximately $400 million. Terry decides that he no longer wants to be in the television business and asks John to buy him out. Thinking this a joke, John offers Terry $100,000 for Terry’s half of the company, which Terry impulsively accepts. After the contract is signed but before getting paid, Terry changes his mind. The mere fact that he agreed to accept a price incommensurate with the value of his share is insufficient to render the contract unenforceable.

EXAMPLE (2): Imagine instead that Terry is visiting his mother in the hospital. She has a terrible disease, and he is her only relative. He has been contemplating selling his share of MPFC Inc. in order to pay for her hospital bills and spend more time with her. The doctor has just told him that his mother will need an operation which costs $100,000. Overhearing this, and knowing that Terry is broke, John enters the room and offers Terry $100,000 for his half of MPFC. Terry agrees, and they sign the contract on the spot. After his mother’s (successful) operation, Terry realizes that John took advantage of him. This contract might be unenforceable based on unconscionability.