Defendants may also require that counsel be able to sign and be bound to sign the confidentiality agreement. Counsel must remember that the parties sign the transaction agreement and are bound by its terms – the case belongs to the client and not to the lawyer. A confidentiality clause can create a taxable event if it is not carefully crafted. The U.S. Tax Court has clarified that a confidentiality clause must be supported by sufficient and clearly worded consideration, or that the Internal Revenue Service (IRS) may award a “fair or equitable amount” as an amount within the scope of the consideration and that, in all cases, any consideration for confidentiality must be taxed on the recipient. See z.B. Amos/Commissioner, T.C. Memo. Docket No. 13391-01, 2003-329, December 1, 2003 (tinyurl.com/9d25phz).
In that case, the tax court issued a memorandum decision that probably made Dennis Rodman smile. At a National Basketball Association game in 1997, Rodman assaulted a television cameraman, Eugene Amos, while chasing a loose ball on the field. In the ensuing anger, Rodman Amos kicked. Amos filed a complaint, and the case was settled for $200,000. In the transaction agreement, the amount of the transaction was recited and a confidentiality and non-disappearance clause was added, without specifying the amount of payment of the clause. The agreement also included a $200,000 compensation clause for Amos breaching confidentiality. Given that this was the full amount paid, it was clear that confidentiality was essential to Rodman. Although the payment of a claim under the Internal Income Code is not taxable, the money paid to settle most claims is taxable. The IRS attempted to make the entire payment taxable and ultimately the Tax Court ruled that $80,000 was due to the confidentiality clause. As the confidentiality clause is itself a compensation for non-personal violations, a certain amount would be taxable.
The transaction contract remained silent on the amount, so the analysis focused on the intent of the party who made the payment. In the absence of “sufficient and clearly articulated consideration” in the agreement, the tax court is free to allocate a “fair or equitable amount.” A confidentiality clause is intended to prohibit parties to a transaction from disclosing the terms of the transaction and sometimes more. Confidentiality is a problem. This article discusses perceived and real problems related to the use of confidentiality clauses in settlement agreements and advises on how to deal with and avoid them. Non-confidential transaction agreements can also complicate future negotiations. A party may attempt to use the basic information of the settlement agreement during negotiations, although the information contained in the agreement does not give a complete picture of the case.