Code of Civil Procedure Sec. 998 cost-shifting applies to settlement agreements

Statistics show that 95% of civil cases filed in the State of California resolve other than by trial. The State has an interest in having cases resolve as soon as practicable, reducing the time and cost spent in litigation.

To encourage parties to resolve their disputes by settlement, the Legislature in 1851 enacted the so-called carrot and stick provision of Code of Civil Procedure Section 998. That section allows either party to make an offer to have judgment entered on specified terms and conditions. It also sets a time for the other party to accept the offer to compromise. If the offer is not accepted by the set deadline, "it shall be deemed withdrawn, and cannot be given in evidence upon the trial or arbitration." To bolster the incentive for early settlement, the Legislature attached a penalty to a party's failure to avail themselves of a section 998 offer made by the opposing party. If a party rejects or fails to accept a section 998 offer, and "fails to obtain a more favorable judgment or award," the court in its discretion applies a shifting of the costs incurred by that party post offer. As such a plaintiff, who reject's a defendant's section 998 offer and recovers less at trial or arbitration, will lose the right to collect its costs post offer even though they are the prevailing party for purposes of cost recovery. In addition, the plaintiff may be responsible to pay the defendant's post offer cost and such post offer costs are deducted from any judgment or award in favor of the plaintiff. Same applies to a defendant that rejects a plaintiff's offer to settle and fails to achieve a better result at trial.

The policy behind the penalties is "to encourage settlement by providing a strong financial disincentive to a party-whether it be a plaintiff or a defendant - who fails to achieve a better result than that party could have achieved by accepting his or her opponent's settlement offer," Bank of San Pedro vs. Superior Court (1992) 3 C.4th 797, 804. Litigants have understood the cost shifting implication in a sure fashion over the years. The cost-shifting motions are filed after a verdict has been rendered at trial or arbitration.

However, often one party rejects or fails to accept a 998 offer and the case proceeds in litigation, but then is resolved by way of settlement prior to or at trial, and before a judgment or award is rendered. These settlements essentially require that in exchange for performance of certain acts or payment from the defendant, plaintiff will dismiss the action with prejudice. Both sides often assume that the settlement would supersede any effect of the rejection of the 998 offer to compromise, and have never litigated the issue of the application of the cost shifting provision of section 998 to a settlement that was reached after the rejection or expiration of a section 998 offer to compromise. That was until Madrigal vs. Hyundai Motor America (2023) DJDAR 3121, April 12, 2023.

In that case, the Third Appellate District was called upon to decide the "question of whether section 998's cost-shifting penalty provisions apply when an offer to compromise is rejected and the case ends in settlement." at 3122.

Madrigal vs. Hyundai Motor America is a lemon law case out of Placer County. Madrigal sued the defendant alleging a defect in a vehicle that he purchased. Early in the litigation, defendant made an offer to compromise, which the plaintiff allowed to expire. Defendant made a second section 998 offer to compromise, which the plaintiff again allowed to expire. No other section 998 offer was made by the defendant. The last offer that expired was to pay the plaintiff "the total amount paid by the plaintiffs for the vehicle, including incidental or consequential damages, plus 'an amount equal to one times the amount of actual damages.' Alternatively, plaintiffs could elect to accept a flat sum of $55,556.70, plus attorney fees of $5,000, or as determined by the trial court upon motion."

On the morning of trial, after the court gave tentative rulings to grant defendant's motions in limine to exclude some of plaintiffs' damages claims, the parties resolved the case by way of settlement. In addition to other terms, defendant agreed to pay plaintiffs $39,000 and plaintiffs could seek their costs and fees by motion to be filed within six months of the date of settlement. After the payment of the $39,000 and the fees assessed by motion, plaintiffs will file a request for dismissal of the action with prejudice. The settlement was subject to CCP 664.6 and was confirmed on the record by the court.

Plaintiffs then filed their motion for costs and fees as prevailing parties. In opposition, defendant filed a motion to strike or, in the alternative tax plaintiffs' costs and expenses. The basis of the motion to strike or tax cost was that plaintiffs' settlement amount of $39,000 was $16,556.70 less than the amount of the defendant's second 998 offer to compromise that was rejected by the plaintiff. As such, plaintiffs failed to obtain a more favorable judgment than the second 998 offer to compromise. Defendant sought to tax or strike all costs and fees incurred by the plaintiffs post the second 998 offer.

This must obviously have come as a shock to the plaintiffs and the court too. No such contention has been made since the more than 170 years of the existence of CCP 998. The trial court "summarily rejected Hyundai's section 998 arguments, explaining that '[t]he purpose of the statute is to encourage settlement of lawsuit prior to trial. [citation.]' In this case, the parties settled the case prior to trial, and as there was no trial, no judgment or award was rendered. Accordingly, ... section 998 does not apply." At 3123. Hyundai appealed.

"The principal issue before [the court] is whether the penalty provisions of section 998 apply when a case ends, not with a judgment after trial, but with a settlement that provides for payment of money by defendant in exchange for a dismissal with prejudice by the plaintiff." At 3123. After an examination of the legislative history of section 998 and judicial decisions interpreting the meaning of judgment as it relates to section 998, a majority of the court (Krause and Duarte) answered the question in the affirmative. According to the majority, "the only question asked by subdivision(c)(1) .... is whether the plaintiff who rejected the offer obtained, or failed to obtain, a 'more favorable judgment' through continued litigation. It says nothing about the timing or form of the judgment, whether after trial, summary judgment, settlement, or otherwise." At 3124-3125.

The court acknowledged the novelty of the question. While the term "judgment" in subdivision (b) of section 998 has been interpreted by the court, no court has ever interpreted the meaning of "favorable judgment" in subdivision (c). The majority reasoned that the same interpretation given to "judgment" in subdivision (b) should apply with equal force to subdivision (c). The court must give a broad interpretation to the term "judgment" based on a practical, rather than a literal definition, so as to advance the statute's purpose of encouraging parties to make and accept reasonable offers to compromise. At 3125. Under this "practical" reading of the statute, the court concluded that "judgment" includes a dismissal of an action with prejudice. It agreed with Goldstein vs. Bank of San Pedro (1994) 27 C.A.4th 899 at 907 that "a compromise agreement contemplating payment by defendant and dismissal of the action by plaintiff is the legal equivalent of a judgment in plaintiff's favor," as approved by the Supreme Court in Desaulles vs. Community Hospital of Monterey Peninsula (2016) 62 C.4th 1140 at 1155.

The court opined that the agreement between the parties contemplated a final resolution of the dispute and the insertion of a 664.6 language shows an intention on the part of the parties, that the settlement was to effect a final judgment. The court stated that its conclusion furthers the goal of section 998. It clarified that the goal of section 998 is "not to encourage pre-trial settlements generally, but specifically to encourage the acceptance of offers to compromise within the parameters of the statute by using the stick of post offer costs and fees against reluctant offerees." At 3127.

Justice Robie in a vigorous dissent concluded that the cost-shifting provision of section 998 applies only when a plaintiff, through unilateral actions, obtains a less favorable judgment than a previously rejected 998 offer. At 3131. According to him, a settlement is not a unilateral action, but an action reached by both parties. "A settlement does not result in a winner or a loser." "A settlement does not prove anything regarding a legal claim, nor does it prove the amount of damages; a settlement thus does not result in a plaintiff failing to establish a greater claim than a previously rejected or withdrawn section 998 offer." "A plaintiff can only fail to establish a greater claim if the plaintiff abandons the effort to do so by dismissal of the case or fails to prove the claim in adjudication." At 3134. This interpretation aligns with the view held by lawyers over the years. According to the dissent, the fact that this question has not arisen in the so many years since the enactment of the statute "is indicative of the overall historical understanding that section 998 (c)(1) applies when a less favorable result is obtained while the parties act in their respective litigant roles, e.g.' as adversaries at trial or arbitration." At 3135.

Citing several passages from Martinez vs. Brownco Construction Company (2013) 56 C.4th 1014, the dissent reasoned that the opinion of the majority will stifle rather than encourage the settlement of disputes. Practically, parties assess cases as they develop. Discovery may unearth facts which make a case worth more or less. Parties should not be afraid to resume settlement discussions when such facts surface, just because there had been a prior section 998 offer to compromise that was rejected. Going with the majority view will probably lead to parties going all out, by taking their cases to trial, once a 998 offer has been made and expires. Both sides face a dilemma. What incentive does a defendant who has rejected a prior 998 offer from the plaintiff have to make a better offer, if new evidence dictates so, if they know they will be tagged with the post offer cost of the plaintiff. Conversely, what does a plaintiff gain by settling for less after the expiration of a 998 offer, if the settlement itself will be whittled down by a post offer reduction for defense costs. Sometimes those post-offer costs may wipe out the amount offered to settle the case. Such a plaintiff has little to lose by continuing with the litigation. This in turn clogs the courts and burdens the system with cases that should have been taken off the docket via settlement.

The majority took time to offer a practical tip to address this issue thus, "Under the rule we adopt, a plaintiff need only factor any operative section 998 offer into a comprehensive settlement, and either try to negotiate a fixed amount of costs or attorney fees, or bargain for a waiver of any rights under section 998 from the defendant." At 3128. This is sound advice, but it just puts an unnecessary second layer on the negotiations, which in itself may scuttle the first part of the settlement already agreed.

Even if the majority is right on its legal conclusion, it is my opinion that it reached the wrong result on the facts. The court overturned the award of costs to the plaintiff, when it should properly have remanded the case back to the original court to determine how much pre-offer cost and fees the plaintiff should have been awarded. The motion to strike filed by the defendant only requested the court to strike the post-offer cost and attorney fees. After all, the settlement allowed the plaintiff to file a motion for cost and fees within six months of the settlement. Everyone agrees that the plaintiff was entitled to its pre-offer costs and fees. It is only after such pre-offer costs and fees are determined and then added to the $39,000 damages amount, can it be truly known if the plaintiffs' total recovery was more or less than $55,556.70. If that analysis results in plaintiffs obtaining more than the 998 offer in total, then plaintiffs would be entitled to the rest of their costs and fees post-offer, because they would have achieved a more favorable result than the 998 offer. The majority recognized this fact when it noted at 3126 "The only 'nonfinal' aspects of the stipulated resolution were the amount of attorney fees and costs owed and the delayed filing of the request for dismissal with prejudice ... ." It was thus error for the court to overturn the entire award of fees and costs without remand to determine how much costs and fees the plaintiffs may be entitled to.

It is unclear how expansive the reach of this decision will be. In certain portions of the judgment, it seems it is limited to the facts of this case. The dissent pointed out how it could create confusion in more complex cases, to which the majority responded that "the hypotheticals employed in that analysis ... are far afield of the question we decide today." At 3128. It may well be that this analysis is limited to lemon law cases. The opinion of both the majority and the dissent are long and well reasoned in support of their positions and the reader is referred to the full opinion for further insight.

It is hoped that there will be a petition for review and that the Supreme Court takes up the invitation to clarify this far reaching decision. Until then, the practitioner is advised to follow the practical tip from the court and clarify the application of section 998 to the settlement agreement when a prior 998 offer has been rejected or withdrawn.