In response to the #MeToo movement, a number of state legislatures and Congress have enacted legislation to address their concerns regarding sex-based inequities in the workplace. One area of particular focus has been the use of non-disclosure provisions in settlement agreements that resolve allegations of sexual harassment, other forms of harassment, and discrimination. Critics of non-disclosure provisions argue that employers who have used these types of provisions may inadvertently promote a culture of silence around sexual harassment and sex-based discrimination in the workplace, thus enabling the individual perpetrators of harassment and discrimination to avoid accountability. On the other hand, many employers legitimately use non-disclosure provisions to protect the victims of harassment and discrimination, as well as to avoid negative publicity resulting from non-meritorious claims. Without the protection of a non-disclosure agreement, employers may more frequently elect to contest such non-meritorious claims of discrimination or harassment to avoid negative publicity emanating from a publicly disclosed settlement.

The federal government and several state governments have enacted legislation concerning non-disclosure provisions in settlement agreements, adopting varied approaches to the issue, in ways that affect an employer’s incentives and strategic options. In this article, we review the federal tax legislation concerning the deductibility of settlement payments for sexual harassment claims. Next, we review the varied legislative approaches that several states have taken to the issue of non-disclosure provisions in settlement agreements. Finally, we offer a number of practical considerations for employers in light of the current legal landscape.

Federal Tax Deductibility

In the 2017 Tax Cuts and Jobs Act, Congress amended federal tax law regarding the deductibility of costs associated with settlements and attorney fees concerning certain types of claims. 26 U.S.C. §162(q). Specifically, the tax law now states that, “no deduction shall be allowed under this chapter for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement …” 26 U.S.C. §162(q)(1) (emphasis added). The law also prohibits deduction of any “attorney’s fees related to such a settlement or payment.” 26 U.S.C. §162(q)(2). The IRS has yet to issue guidance on the reach of the “related to” language in this section. For example, does this language encompass a general release of claims, which may include a release of sexual harassment claims, even when the employee has never asserted any specific allegations of sexual harassment? Even if the prohibition applies only to instances in which the employee has made a specific claim of sexual harassment, employers face greater expense in resolving such claims if the settlement involves employee non-disclosure obligations than if the employer resolves such claims without such obligations.

Varying State Approaches

A number of states have passed legislation geared towards prohibiting the enforcement of non-disclosure provisions in settlement agreements that resolve allegations of sexual harassment, other forms of harassment, or discrimination. These states have taken different approaches towards the issue.

For example, New York enacted the first state-wide law in the nation concerning this subject, mandating that “for any claim or cause of action … the factual foundation for which involves sexual harassment … no employer … shall have the authority to include or agree to include in [a settlement agreement] any term or condition that would prevent the disclosure of the underlying facts and circumstances to the claim or action unless the condition of confidentiality is the plaintiff’s preference.” N.Y. Gen. Obligations Law 5-336 (emphasis added). Earlier this month, New York enacted additional legislation expanding this provision to cover all claims of “discrimination,” and not just “sexual harassment.” 2019 NY S.B. 6577/2019 NY A.B. 8421.

To satisfy the “plaintiff’s preference” exception, an employee “shall have twenty-one days to consider” an agreement containing a non-disclosure provision, and even where the employee executes the agreement because such a provision “is the plaintiff’s preference,” the employee will be permitted to “revoke the agreement” for a period of seven days after the employee’s execution. N.Y. Gen. Obligations Law 5-336. New York state’s website containing answers to Frequently Asked Questions about this provision states that “the parties will need to enter into two separate documents providing for nondisclosure: (1) an agreement that memorializes the preference of the person who complained, and (2) whatever documents incorporate that preferred term or condition as part of a larger overall resolution between the parties[.]” While the New York law offers employers the opportunity to secure a binding non-disclosure commitment from their employees, there are still a number of procedural hurdles required to satisfy the elements of the “plaintiff’s preference” exception.

On March 18, 2019, New Jersey enacted a law stating that, “[a] provision in any … settlement agreement which has the purpose or effect of concealing the details relating to a claim of discrimination, retaliation, or harassment … shall be deemed against public policy and unenforceable against a current or former employee … who is a party to the … settlement.” N.J.S.A. 10:5-12.8(a). The New Jersey law extends beyond claims of sexual harassment, to include all claims of “discrimination, retaliation, or harassment,” thereby encompassing a wider array of unlawful conduct concerning non-sex-based forms of harassment and discrimination. Significantly, the New Jersey law contains no exceptions to this prohibition, meaning that there are no circumstances under which an employer can bind an employee to non-disclosure obligations in a settlement agreement resolving these types of claims.

California has taken a similar approach, enacting legislation which states that, “a provision within a settlement agreement that prevents the disclosure of factual information related to a claim filed in a civil action or a complaint filed in an administrative action, regarding [certain types of claims] is prohibited.” Cal. Civ. Pro. §1001(a). The types of claims covered by this prohibition involve “[a]n act of sexual harassment,” “[a]n act of workplace harassment or discrimination based on sex,” “failure to prevent an act of workplace harassment or discrimination based on sex,” or “an act of retaliation against a person for reporting harassment or discrimination based on sex.” Cal. Civ. Pro. §1001(a)(2) and (a)(3). To the extent that an employer includes such a provision, that provision will be “void as a matter of law and against public policy.” Cal. Civ. Pro. §1001(d). Unlike the New Jersey law, the California law applies only to harassment, discrimination, and retaliation related to an employee’s sex, as opposed to harassment, discrimination, and retaliation based upon other protected characteristics. The California law also requires the employee to have asserted the claim in a civil or administrative action, whereas the New Jersey law does not.

The California law also contains another important distinction from the New Jersey law. Similar to the New York law, the California law states that “a provision that shields the identity of the claimant and all facts that could lead to the discovery of his or her identity … may be included within a settlement agreement at the request of the claimant.” Cal. Civ. Pro. §1001(c) (emphasis added). While the law provides little clarity as to what it means by “all facts that could lead to the discovery” of the employee’s identity, or the “request of the claimant,” at minimum, this language creates the possibility for binding employee non-disclosure obligations in settlement agreements under certain circumstances.

Effects of Legislation

Needless to say, all employers, especially those with operations in multiple jurisdictions, should stay current regarding legislative developments that affect their ability to secure non-disclosure commitments from their employees in settlements agreements. These developments will influence both the structuring of settlements concerning certain types of claims as well as the ultimate decision of whether to settle those claims in the first place.

For example, in light of the ambiguity concerning whether §162(q) of the 2017 Tax Cuts and Jobs Act applies to a general release of claims, employers should consider adding language in their settlement agreements to address the question whether any portion of the consideration paid in a settlement constitutes “any settlement or payment related to sexual harassment or sexual abuse.” If an employee has never asserted such a claim, employers may consider adding an acknowledgement that only a de minimis portion of any payment to the employee is consideration for a release of any claims of sexual harassment or sexual abuse. To the extent a settlement does include a release of any claims of sexual harassment or sexual abuse, the employer may seek to segregate the consideration paid to the employee for the settlement of the sexual harassment or sexual abuse claims. Such an arrangement will permit the employer to require a non-disclosure commitment from the employee but also will allow the employer to continue to deduct at least some portion of the settlement cost from its federal taxes.

Because employee non-disclosure commitments may be included in settlement agreements in California or New York only if included “at the request of the claimant” or “plaintiff’s preference,” employers in those states may need to reassess their negotiating approach towards complaining employees concerning the mutual desirability of non-disclosure commitments in settlement agreements. In many instances, employees will be amenable to non-disclosure provisions for privacy or other reasons. In cases where the parties agree to confidentiality, New York employers should consider presenting and executing a separate non-disclosure commitment from the employee before negotiating and executing the overarching settlement agreement. In cases where executing a separate agreement is impractical, employers should consider whether the directive in the FAQs is actually consistent with New York law, which contains no requirement for a separate agreement. If the parties agree that no separate agreement is required, parties to a settlement in New York should consider a simple acknowledgement in the settlement agreement that confidentiality is the employee’s preference, that the employee had 21 days to consider the confidentiality provision, and that the employee had 7 days to revoke it.

Because the California law limiting the enforceability of non-disclosure provisions only applies once an employee has filed a civil or administrative action, if possible, California employers should assess the desirability of settlement earlier. If a California employer is able to settle a claim before the commencement of an action, the employer will have much greater flexibility with respect to employee non-disclosure obligations than it would have after the commencement of an action.

Finally, because New Jersey employers cannot, under any circumstances, secure non-disclosure commitments from their employees in settlements of discrimination, retaliation, and harassment claims, the risk of negative publicity associated with such claims will exist even if the parties reach a settlement. As a result, New Jersey employers may wish to assess with their counsel the viability of their employees potentially waiving the New Jersey law prohibiting confidentiality and/or the parties choosing the law of a different state to govern the agreement where a reasonable basis for such other jurisdiction exists. Absent the protection of a confidentiality provision, New Jersey employers should understand that their settlements may become public. In those cases, New Jersey employers will need to weigh the new calculus regarding the pros and cons of settlement with the risk of negative publicity in mind.

Jeffrey S. Klein and Nicholas J. Pappas are partners in the employment litigation practice group at Weil, Gotshal & Manges. Justin M. DiGennaro, an associate at the firm, assisted in the preparation of this article.