Private Equity

It is the rare private equity deal professional that has not negotiated the settlement of a legal dispute.  Once the terms are agreed, a settlement and release agreement is prepared the avowed purpose of which is to fully and finally resolve the dispute so that you never have to deal with it again.  But while that purpose may be clear-cut, the language used to accomplish that purpose appears to be anything but.  Indeed, a standard settlement and release agreement is perhaps one of the better (or worst) examples of drafting with synonymic excess—why use one word to express your meaning when the English language provides so many other words that mean essentially the same thing that you can create a virtual torrent of words to express that meaning.^[1] The result is a document that may appear to some to contain of lot of plain-old gobbledygook. 

Among the many seemingly amphigoric provisions within a standard settlement and release agreement are both a release and a separate covenant not to sue.  Why one may ask would you need a promise by the releasing party not to sue you for the released claims if the release itself is clear and unequivocal in releasing those claims?  Well it turns out there is a reason, and a recent decision by the New Hampshire Supreme Court, Pro Done, Inc. v. Basham, No. 2018-0060, 2019 WL 1967686 (N.H. May 3, 2019), provides an illustration of the benefits of an independent covenant not to sue in addition to a release. But to appreciate the current benefit of a separate covenant not to sue versus the historical reason for its use instead of and not as a supplement to a release, a little background is required in some ancient common-law principles. 

A covenant not to sue was originally developed as a device to avoid the harshness of a common-law doctrine that held that a release discharged the obligation itself not just the particular settling obligor.  Thus, if you settled a claim with one of several joint obligors and granted that obligor a release you were effectively releasing the entire obligation and your right to pursue the other joint obligors for any remaining amount of the obligation not paid by the settling obligor.  But if, instead of granting the settling obligor a release, you entered into a contract with that obligor whereby you agreed not to sue the settling obligor for the obligation, you avoided the rule that treated a release as a discharge of the entire obligation.  Over time, the harshness of this common-law rule with respect to the releasing party evolved or was overridden by statute in most (but not all) states, but settling joint obligors should always use caution in settling with a releasing party that intends to pursue claims against the non-settling obligors as those other obligors may have contribution and indemnification claims against the settling obligor.^[2] Nonetheless, having created the covenant not to sue for the specific purpose of addressing a harsh common-law rule involving joint obligations, the concept began to find its way into release and settlement agreements generally, not as a substitute for a release (its original purpose) but in addition to a release and in circumstances that do not involve joint obligations. 

But because the original purpose of a covenant not to sue was to actually relieve the settling obligor of the obligation without releasing the co-obligors, many courts treated a covenant not to sue as if it was a current release of the settling obligor from the obligation (with a reservation of rights against the non-settling obligors) and not a future promise to refrain from filing suit. In other words, a covenant not to sue was viewed, like a release, as having the “primary function … to serve as a shield rather than as a sword.”^[3] The reasoning behind treating a covenant not to sue as simply a release (but one which did not invoke the harsh common-law doctrine that caused such a release to release all obligors, but instead only released the named obligor) was the concern of judicial efficiency.  If a covenant not to sue was not treated as a release that could be interposed as an absolute defense to the action commenced by the settling obligee, then the settling obligor would have no defense to the lawsuit but instead would need to counterclaim against the settling obligee for a breach of the covenant not to sue.  You would eventually get to the same place, but the plaintiff would have a judgement against the defendant for the obligation and the defendant would have a judgment against the plaintiff for the amount of that judgement, plus costs, based on the breach of the covenant not to sue.  It was more efficient to treat the covenant not to sue as a discharge of the settling obligor’s obligation vis-à-vis the settling obligee and thereby simply dismiss the lawsuit that was filed by the settling obligee against the settling obligor at the front-end.  Thus, even in situations where a settlement and release agreement contained both a release and a covenant not to sue, the two provisions were generally treated simply as redundant means of extinguishing the settling obligor’s obligation.^[4]

So far so good. But in treating a covenant not to sue as if it were a release, some of the benefits of a covenant over a release were in danger of being lost. Unlike a covenant not to sue, which contemplates future performance by the settling obligee in favor of the settling obligor (i.e., an obligation not to sue), a release is a currently effective extinguishment of the settled claims by the settling obligee in favor of the settling obligor; i.e., it is a done deal, and there is no further performance required by the settling obligee. Accordingly, while you can interpose a release as a defense to a subsequent suit brought against you based upon any released claim, you typically cannot sue the person bringing the suit for breach of the release (it’s simply not a contractual obligation capable of being breached).  And if courts were treating covenants not to sue as if they were releases for judicial efficiency, that meant there was no contractual obligation that could be breached under a covenant not to sue, just like a release.  As a result, some courts, including some of those applying New York law, suggested that in order for a covenant not to sue to be subject to a claim for damages against the settling obligee (as opposed to just interposed as a bar to the wrongfully-filed suit) it was necessary for the covenant to specifically provide that consequential damages were recoverable for its breach (primarily the costs of defending the wrongfully-filed claim).^[5]

Thus, in Pro Done, the New Hampshire Supreme Court was faced with “a question of first impression for this court: whether New Hampshire law recognizes a cause of action for breach of contract based upon a covenant not to sue where the contract does not expressly provide that the non-breaching party is entitled to consequential damages for breach of the covenant.”^[6]  The settlement agreement at issue in Pro Done contained both a release of and a covenant not to sue a specified company, and certain related persons, with respect to certain identified claims.  Nonetheless, the parties granting the release and covenant not to sue later sued certain of the beneficiaries of the release and covenant not to sue for claims covered by the settlement agreement.  Not content simply to have the court dismiss the wrongfully-filed suit based upon the release, the released parties filed a separate claim for breach of the covenant not to sue claiming damages resulting from the filing of the suit in the first instance (primarily the legal costs of defending the wrongfully-filed suit).  Based on some of the cases from other jurisdictions that had previously treated a covenant not to sue as the equivalent of a release unless there was express language providing for consequential damages for its breach, the defendants (the parties who had promised not to sue on the released claims) moved to dismiss the plaintiffs’ (the parties who had been released by the defendants from the very claims now being pursued by the defendants) suit for breach of the covenant not to sue.  And the trial court agreed with the defendants and dismissed the plaintiffs’ suit for breach of the covenant not to sue. 

But the New Hampshire Supreme Court reversed the trial court and held that there was “no reason why we should treat parties who suffer damages as a result of a breach of an express promise not to sue differently from those who suffer damages for a breach of other types of contractual terms.”^[7] After all, there is no requirement that any other contractual obligation contain an express statement that damages are recoverable for its breach, they are recoverable as a matter of law (contracts can certainly limit the damages otherwise recoverable, but without such limitations all damages designed to put the non-breaching party in the position it would have been in the absence of the breach are generally recoverable). 

The defendants further argued, however, that to permit recovery of ligation costs as damages for breach of contract violated the so-called “American Rule,” which specifies that, in the absence of a specific contractual provision or an applicable statute, parties bear their own litigation expenses in the enforcement of their contractual and other rights. But the court rejected that argument too, because “unlike defendants in other types of lawsuits, a defendant in a lawsuit brought in violation of a covenant not to sue loses the benefit of the bargain with no recourse if it is prohibited from bringing an action for breach against a party who violated an express term of a contract.”^[8] In other words, unlike the typical breach of contract action to which the American Rule applies, where a party seeks damages for the other party’s breach of performance, attorneys’ fees and litigation costs are the measure of the actual damages for breach of the promised performance  in a covenant not to sue, rather than costs incurred in pursuing damages for the benefit of the bargain based upon the breach of some other promised performance. 

So some of the supposed redundancies in a standard settlement and release agreement may make a difference after all.  But depending on the state, it may be important to add yet more additional language to your covenant not to sue so that it is clear that attorneys’ fees are recoverable for breach of that covenant—otherwise those supposed redundancies may be actual redundancies.