Put up or shut up: the basics of economic based settlements

During the recent mediation of a lawsuit by a limited partner against the general partner of a failed real estate general partnership I was discussing the plaintiff's latest demand with the defendant general partner and told him that I thought it would take more than three times what he was offering to get the case settled. He let me explain why and then he said: "You're making an assumption here that isn't supported by the facts." I asked him what he meant and he said: "I don't have any more money than what I have already offered. It doesn't really matter if they want three times as much, I just don't have it."

As you might imagine, the discussion made a sharp turn from the merits of the case to the economics of his financial situation. After several more hours of discussion with the disappointed limited partner plaintiff, who was skeptical that his former partner had no money, the case was finally settled with a down-payment and a pay-out over many months.

This got me thinking about how often it occurs that the settlement of disputes is economic based and not merit driven, and how many factors must be considered in reaching such a settlement and to the extent possible, making sure that the promised payments are actually made. For definitional purposes, an economic based settlement is a settlement that is based purely on how much money is available. In an economic based settlement, the amount paid has virtually no relationship to liability or damages - it is strictly based on what the defendant can pay, not whether the facts dictate that he or she "should" pay more or whether the defendant's exposure in the case greatly exceeds the settlement amount. To be clear, an economic based settlement can only occur when the defendant truly doesn't have the ability to pay. A plaintiff generally will not consider making an economic based settlement when the defendant merely claims he cannot pay (as many defendants customarily do as a negotiating strategy).

The first consideration when a defendant says that they don't have the ability to pay to either settle a case for an amount that would otherwise be appropriate given the merits, or to satisfy a judgment should a judgment be rendered, is how to convince the distrustful plaintiff that the defendant is actually telling the truth about their finances. In my experience, nothing less than total transparency is required to overcome this lack of trust. Total transparency, in this context, usually means that the defendant will have to provide a statement of assets and liabilities along with a declaration signed under penalty of perjury in which the person attests to the completeness and accuracy of the information supplied. In certain cases, additional information might be required, such as personal or corporate tax returns. One additional way to "test" the reliability of the information is to request copies of any recent loan applications made by the individual. If the information on the loan application doesn't match the financial statement given by the defendant, there's obviously a problem. Also, the defendant should be prepared to have a rational answer why he or she has been able to afford counsel when there's no money to pay the plaintiff.

The second consideration is that as counsel for the defendant, you must think long and hard before proposing an economic based settlement. It is invariably the case that if a defendant who claims poverty is asked to provide a sworn financial statement or other proof and he or she refuses to do so, the defendant's credibility on this issue vanishes faster than a teenager who is asked to do the dishes. The refusal to supply this basic information, and, in fact, any other information that the plaintiff demands under the heading of total transparency is a death sentence to further discussions about an economic based settlement. Worse, this lack of credibility spills over into all the other aspects of the negotiation. Or, to put it more simply, the plaintiff usually refuses to believe anything that the defendant or the defense counsel have to say after they refuse to produce the financial information. This usually leads to a total disruption of the mediation process and it is rare to settle a case where the plaintiff feels that the defendant has been untruthful about finances in order to escape the payment of a larger amount of money.

Third, once everyone is satisfied that the defendant can only pay "x" amount, there is the question of terms and how to best secure the payment. Typically, the plaintiff wants a "down-payment." Often the plaintiff insists upon a down-payment because (even though the plaintiff won't say this out loud) the plaintiff believes that the down-payment is the only money that will ever be paid, no matter how many promises are made that all the remaining payments will be made. The rest of the settlement amount will have to be paid over time.

What are some typical ways to help insure that the payments will actually be made? The most common is the stipulation for entry of judgment. In this scenario, in a litigated matter (if there's no lawsuit, the defendant must "confess" to a judgment, which requires compliance with an elaborate and difficult statutory scheme, including an attorney-affidavit of merit), the defendant stipulates that under certain circumstances a judgment can be entered in a given amount. The terms usually include: (1) judgment in an amount which is considerably higher than the amount that the defendant has agreed to pay, in order to "motivate" the defendant to make the payments; (2) the judgment will be held and not entered unless there is a default; (3) the defendant will receive credit against the amount of the judgment for all amounts paid before default; (4) judgment can be entered upon an ex parte application, by submitting the stipulation and proposed judgment to the court; (5) the plaintiff will be entitled to attorneys' fees and costs if it becomes necessary to apply for a judgment; (6) the defendant will waive the right to appeal from the entry of judgment; (7) the defendant will receive notice of default and have an opportunity to cure before the plaintiff seeks entry of judgment. A copy of the proposed judgment should be attached as an exhibit to the stipulation for entry of judgment so that there can no argument that the defendant did not know to what he or she was stipulating.

Of course, there are other approaches, all of which usually require collateralization of some asset of the defendant. For example, the defendant could provide a trust deed in the plaintiff's favor, or execute an assignment or transfer (conditional or otherwise) of other assets, such as stocks or bonds, or assign the right to collect a promissory note, or assign a partnership interest (a cautionary note - not all partnership interests are transferable).

Fourth, it is rarely the case that the parties will have sufficient time in the mediation to prepare all of the documents to effectuate the pay-out protections. In order to resolve the case, and to avoid controversy and conflict, the essential terms of the pay-out and manner of protecting the plaintiff's entitlement to the pay-out should be stated in detail in a Memorandum of Settlement, or short form of settlement agreement at the mediation. The parties can thereafter prepare the actual stipulation or other documents and circulate them for signature, knowing that they have an enforceable settlement agreement.

Economic based settlements are among the most difficult of all possible resolutions in mediation. Among other reasons, plaintiffs are universally upset that the defendant waits until the mediation to disclose that he or she has no ability to pay (after the plaintiff has spent a great deal of time, money and effort prosecuting the case with the expectation of reaching a resolution that will reflect, at least in part, the merits of the dispute). Thus, you start with an upset plaintiff who feels that he or she is being forced to accept much less than they would otherwise be entitled to receive, and all based on a claim of poverty which in the plaintiff's mind is likely untrue. The plaintiff's lawyer may be similarly (or even more) upset, especially if the matter is being handled on a contingency basis.

The reality is, however, that if a party doesn't have any money, the plaintiff and the plaintiff's counsel need to accept that reality and make the best settlement possible given the economics of the situation. In order to achieve an economic based settlement, the defendant must be totally transparent and provide all of the information that might be reasonably necessary to prove the lack of funds. Once the amount has been determined, if there is a pay-out, counsel need to craft the best possible protections for that pay-out and document the terms to have an enforceable settlement agreement.