A hot topic that has been the subject of recent legal, political, and media comment is the use of non-disclosure agreements (NDAs) in sexual harassment settlement agreements to silence the employee who made the complaint. These types of NDAs prohibit the employee from speaking about the allegations for a period of time, sometimes indefinitely. Employers commonly use these agreements to settle employment discrimination and harassment claims in order to avoid publicity, including situations in which the allegations are believed to have no validity. If an employee breaches the NDA, he or she may be liable for monetary penalties or be required to return the settlement payments if a court enforces the agreement. NDAs, however, have come under increasing attack on both the federal and state level.
Several states have created barriers to the use of NDAs and other states have considered legislation to limit their use. For example, California, Illinois, New Jersey, New York, Tennessee, Vermont, and Washington have all adopted different approaches to curtail the use of such NDAs. These range from voiding contracts that prevent a party from testifying in legal proceedings (California) to completely making these NDAs unenforceable (New Jersey).
One not-so-obvious issue with determining whether to include an NDA in a settlement agreement involves federal tax law. Back in December 2017, just two months after the #MeToo movement ignited following reports of the Harvey Weinstein allegations, Congress amended Section 162(q) of the Tax Code to prohibit business expense deductions for:
- settlement payments relating to sexual harassment or sexual abuse if the settlement or payment is subject to a nondisclosure agreement; or
- attorney’s fees related to such settlement or overpayment.
Prior to this amendment, Companies were generally permitted to deduct such settlement payments and legal fees, even if an NDA was part of the settlement. Today, if a settlement payment in a sexual harassment case does not include an NDA it is still deductible. Companies are left to balance the need for an NDA versus the benefits of a tax deduction.
This dilemma has produced mixed reactions from critics about the so-called “Weinstein Tax” described above. For instance, NDAs can add value to settlement payments because employers value confidentiality. Also, because settlements with NDAs are no longer tax deductible, employers may offer less money to settle a case to offset the loss of the deduction. Will victims be hesitant to enter into an NDA because of decreased settlement payments? Will employers become more motivated to fight allegations than settle? Will plaintiffs be tempted to avoid sexual harassment claims in favor of different claims so that they may settle with an NDA and perhaps add some dollars to the settlement? Or could the decline of these NDAs combat the sexist work atmosphere that NDAs have been argued to foster by reducing a company’s ability to avoid related publicity?
Employers considering using an NDA as part of a settlement of a sexual harassment claim need to look at both federal tax law and state statutes before considering whether an NDA is right for them. If you want more information about how these laws may impact you, please contact a member of the McGrath North Labor and Employment Group.