With a few minor tweaks here and there, your company has probably relied on the same severance and employment-related settlement agreements for years. Sure, you touch base with your friendly neighborhood employment lawyer from time to time to ensure there haven’t been any significant legal developments that necessitate revisions. But aside from peripheral alterations, these agreements have, by and large, retained their same basic form and content.

Among the most important terms of your company’s “form” severance and settlement agreements is the confidentiality clause. This provision protects your business from the public disclosure of potentially damaging allegations of workplace wrongdoing. This is particularly important when the asserted allegations exaggerate or skew the facts or are flat out spurious. Or when the alleged misconduct was perpetrated by a rogue manager, unbeknownst to management. Regardless of the reason, the confidentiality clause is of paramount importance. In fact, outside of the employee’s release of claims, your company – like so many others – considers this clause to be the seminal term of the agreement. Without it, your company might be far more hesitant, if not outright unwilling, to enter into potentially costly severance and settlement arrangements with current and former employees.

Two recently enacted laws – one at the federal level and one spurred by New York legislators – threaten to topple the long-standing use of confidentiality clauses in severance and settlement agreements, at least in cases involving sexual harassment. Below, we discuss each of these laws, as well as how you and your company can navigate the proverbial minefield of recent nondisclosure-related legislation.

Internal Revenue Code Section 162(q)

Last December, President Donald Trump signed into law a tax bill overhauling various facets of the Internal Revenue Code (IRC). Among other things – many other things – the president’s tax bill created IRC Section 162(q). Section 162(q) was adopted in response to the momentum generated by the #MeToo movement and the groundswell of opposition to nondisclosure agreements purporting to “buy the silence” of alleged sexual harassment victims. In fact, Section 162(q) is colloquially referred to as the “Harvey Weinstein” provision of the tax bill.

Although the plain language of Section 162(q) is rather simple, its implications are anything but. Specifically, the newest addition to the tax code provides that

No deduction shall be allowed under this chapter for – (1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney’s fees related to such a settlement or payment.

Section 162(q) presents employers with a dilemma. On the one hand, employers can still include standard confidentiality clauses in severance and settlement agreements resolving claims of sexual harassment. The inclusion of such a clause, however, renders the employer unable to take the cost of the settlement as an ordinary business expense deduction on its tax return. This deduction often incentivizes employers to settle, particularly when management views the accusations as unfounded.

On the other hand, Section 162(q) permits employers to forego the confidentiality clause altogether and, thereby, retain the tax deduction. In this scenario, though, the settling employee remains free to broadcast their underlying allegations of harassment – regardless of the merit or veracity – to the consuming public. This effectively negates one of the primary benefits of privately resolving claims of alleged workplace malfeasance.

Does Section 162(q) also harm settling employees?

Interestingly, some practitioners have suggested that the plain language of Section 162(q) will have the consequence – presumably unintended – of also disadvantaging employees who raise, and subsequently settle, sexual harassment claims. Supporters of this theory point to prong (2) of Section 162(q) – namely, the prohibition on deducting attorney’s fees related to sexual harassment settlement payments. In particular, they note that prong (2), together with the preamble language of Section 162(q) (“No deduction shall be allowed under this chapter for…”), does not specify precisely whose attorney’s fees – that is, the defendant, the plaintiff or both – are exempted from deduction.

Consequently, in these practitioners’ estimation, the attorney’s fees component of Section 162(q) applies not only to settling defendants but, rather, to all settling parties, including the alleged victim. This interpretation would mean that an employee who resolves a claim of workplace sexual harassment would be unable to avail themself of the above-the-line tax deduction established by Congress in 2004 for legal fees in employment cases, thereby saddling the employee with a potentially unexpected tax burden. Under these circumstances, Section 162(q) would render settlement a potentially less attractive proposition for employees.

Until the Internal Revenue Service issues guidance or Congress passes clarifying legislation, Section 162(q) poses perplexing questions for both sides of a sexual harassment dispute when settlement is contemplated.

2018-19 New York State Budget Bill

Earlier this year, New York Governor Andrew Cuomo signed into law the State’s Budget Bill for fiscal year 2018-19. Employers may recall that the Budget Bill has, in the past, been the governor’s preferred mechanism for enacting sweeping employment law reforms. For example, the 2016-17 Budget Bill included provisions that will ultimately increase the statewide minimum wage to $15/hour by 2021. The 2016-17 Budget Bill also laid the groundwork for the State’s paid family leave law, which took effect on January 1 of this year. In this year’s Budget Bill, the governor pivoted his attention to the recent upsurge of high-profile sexual harassment claims.

Among its most salient provisions, the 2018-19 Budget Bill bars employers from including in any agreement that resolves a sexual harassment claim, a “term or condition that would prevent the disclosure of the underlying facts and circumstances to the claim or action” – namely, a confidentiality clause – unless the inclusion of such a clause is the employee’s preference. If the employee prefers the inclusion of a confidentiality clause, the Bill then attaches a required 21-day period for them to consider the clause. After 21 days, if inclusion of the clause remains the employee’s preference, then such preference is to be memorialized in an agreement. Thereafter, the employee has a subsequent 7-day period during which to revoke the agreement. These respective 21- and 7-day periods are similar to the requirements levied by the Older Workers Benefit Protection Act for waivers of federal age discrimination claims.

Like IRC Section 162(q), this part of the Budget Bill, which took effect July 11, 2018, appears to apply to both judicial and extrajudicial agreements resolving sexual harassment allegations/claims.

What does my company do now?

Both Section 162(q) and New York’s new nondisclosure law place employers – at least those alleged to have committed or condoned sexual harassment – in a precarious position. Businesses of all shapes and sizes should immediately review their “form” severance and settlement agreements to determine whether, to what extent and under what circumstances adjustments are warranted.

 For instance, employers faced with a predicament under Section 162(q) – that is, whether to include a confidentiality clause and potentially relinquish an important tax deduction, or forfeit the clause and claim the deduction but risk public disclosure of the underlying allegations – should consider alternative solutions when settling sexual harassment claims. Perhaps that means having the employee represent in the agreement itself that they are withdrawing their allegations or claims of sexual harassment. Or that part or all of the severance or settlement payment is unrelated to sexual harassment. In the context of litigation, perhaps it means having the employee file an amended complaint dismissing all claims of sexual harassment before the settlement is consummated. Or, further still, perhaps it means allocating discrete portions of the severance or settlement payment to a particular claim or quantum of damages (for example, Portion A is for lost wages, Portion B is for attorney’s fees related to lost wages, Portion C is for sexual harassment and Portion D is attorney’s fees related to sexual harassment).

The onus should not be on the defense alone, however, to formulate such solutions. As noted above, Section 162(q) could have a potentially adverse tax impact not just on defendants, but also on plaintiffs. Attorneys on both sides of the aisle, therefore, should collaborate to address the potential repercussions of Section 162(q) when crafting severance or settlements agreements.

And for employers in New York State – who have an added layer of difficulty to tackle in the context of confidentiality clauses – it is imperative to make clear from the outset of any severance or settlement negotiation that confidentiality will be a required term of resolution. The resultant agreement should memorialize, in writing, that the employee preferred the inclusion of the confidentiality clause, and that they were afforded the requite 21-day consideration and 7-day revocation periods.

Given these broad new requirements in the area of sexual harassment law, coupled with the myriad of questions that remain unanswered by the plain language of Section 162(q) and the New York bill, it is more crucial than ever that employers stay in regular contact with their experienced employment law counsel. For more information on developments in this area, please contact Mark Goldstein at mgoldstein@reedsmith.com or Kelley Miller at kmiller@reedsmith.com.