The Settlement Privilege and the Threat of Legal Action

The first part of this article considers the issue of when a threat to litigate encased by a settlement demand raises the specter of extortion, and the extent to which a potentially extortionate settlement communication should be outside the scope of the privilege. The second part examines case law assessing potentially extortionate settlement communications and concludes by suggesting that it may be worthwhile to consider whether an exception for extortionate demands should be made explicit as a means to discourage this manner of criminal activity as well as meritless suits.

Relevant Statutes and Ethical Rules

As noted previously, both federal and state laws criminalize extortion. The Hobbs Act forbids effecting commerce by extortion, which in turn is defined as “the obtaining of property from another, with his consent, induced by wrongful use of actual or threatened force, violence, or fear, or under color of official right.” 18 U.S.C. ' 1951. Blackmail, a subset of extortion, is covered by 18 U.S.C. ' 873, which provides that “whoever, under a threat of informing, or as a consideration for not informing, against any violation of any law of the United States, demands or receives any money or other valuable thing, shall be fined under this title or imprisoned not more than one year, or both.”

The New York Penal Code proscribes larceny by extortion. This is defined as any act inducing another to deliver property by instilling a fear that, should the property not be surrendered, the actor will take some action to harm the victim, including but not limited to: 1) accusing the victim of a crime; or 2) exposing a secret that will harm the victim's reputation, career, and/or personal relationships, or otherwise subject the victim to hatred, contempt or ridicule. See N.Y. Penal Code ' 155.05(2)(e).

For lawyers, the foregoing is enhanced by relevant ethical canons and rules of professional responsibility. For example, Rule 3.1 of the New York Rules of Professional Conduct prohibits an attorney from bringing a claim that is unwarranted by existing law, or that serves merely to harass or maliciously injure another. Similarly, Rule 3.4(e) prohibits a lawyer from “present[ing], participat[ing] in presenting, or threaten[ing] to present criminal charges solely to obtain an advantage in a civil matter.”

These statutes make clear that, of course, threatening litigation in order to persuade an adversary to settle a legitimate claim, and warning of the consequences of failing to settle amicably, fall far short of accomplishing an extortion of any sort. But more challenging are the myriad matters that lie beyond this overly simple absolute. For example, what of the threat to an adversary to file a litigation of no genuine legal value that has been cleverly designed as a shakedown for a considerable sum on pain of filing a meritless but nonetheless commercially crippling or defamatory litigation? The prospect of simply moving for legal sanctions ' following consequential commercial harm already done ' hardly seems satisfactory to the company that is now out of business. Yet this is largely what the law demands.

The Settlement Privilege

Rule 408 of the Federal Rules of Evidence provides, in pertinent part, that “conduct or a statement made during compromise negotiations” is not admissible “to prove or disprove the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction.” Nonetheless, such evidence may be admitted “for another purpose, such as proving a witness's bias or prejudice, negating a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.” Section 4547 of the New York Civil Practice Law and Rules similarly bars admission of settlement discussions to prove “liability for or invalidity of the claim or the amount of damages.”

The rationale for these rules is: 1) that settlement discussions are irrelevant, since they “may be motivated by a desire for peace rather than from any concession of weakness of position”; and 2) to promote “the public policy favoring the compromise and settlement of disputes.” FED. R. EVID. 408, Notes of Advisory Committee on Proposed Rules.

The settlement privilege “encourages settlement by protecting parties to a settlement agreement or negotiation from having their good-faith efforts to settle a dispute used against them in subsequent litigation.” Am. Soc'y of Composers, Authors & Publishers v. Showtime/The Movie Channel, Inc., 912 F.2d 563, 580 (2d Cir. 1990).

Yet the doctrine, when applied broadly or without a “crime-fraud” exception, can accomplish the unintended result of protecting conduct that may be criminal. Two cases illustrate the conundrum.

Sanders v. Madison Square Garden

In Sanders v. Madison Square Garden, L.P., 525 F. Supp. 2d 364 (S.D.N.Y. 2007), the Southern District of New York addressed the application of the settlement privilege in the context of potentially extortionate settlement discussions. There, the plaintiff commenced a lawsuit against her former employer, alleging that: 1) she was discriminated against on the basis of gender by virtue of sexual harassment by the defendant; and 2) she was fired in retaliation for her sexual harassment claim. To prove the retaliation claim, the plaintiff had to establish, among other things, that she was acting in good faith when she made her sexual harassment claim. The defendants sought to present evidence that the plaintiff offered a large sum of money to settle the sexual harassment claim, suggesting that she did not believe she had a good-faith claim, but rather sought to extort money from the defendants. The court granted the plaintiff's motion in limine to exclude this evidence, stating that this was simply an effort to use compromise discourse to disprove the validity of her claim. The court explained its ruling as follows:

[A]ccording to defendants, [evidence of plaintiff's large settlement demand] shows that her underlying sexual harassment claim was made in bad faith, that is, that it was not merely invalid, but was known to be such by plaintiff when she made it. Thus, even if the offer is limited to its alleged relevance to the retaliation claim, it is offered precisely for the forbidden purpose of showing that the underlying claim that was the subject of the settlement discussions was frivolous.

Here, then, the court clearly determined that the value of preserving the confidentiality of settlement talks outweighed the principal point that the plaintiff was seeking to leverage a potentially meritless claim by threat of a lawsuit ' a different conclusion than that recently reached by the District of Massachusetts.

Ray v. Ropes & Gray LLP

The District of Massachusetts took a different approach to that of the Sanders court in Ray v. Ropes & Gray LLP, 961 F. Supp. 2d 344 (D. Mass. 2013). In Ray, the defendant law firm terminated the plaintiff's employment in December 2008 and offered him six months of severance pay. In May 2009, the plaintiff threatened to file a racial discrimination complaint with the United States Equal Employment Opportunity Commission (EEOC) unless the firm extended his severance period indefinitely or paid him $8.5 million. This settlement demand then increased to $40 million over the course of the parties' discussions. Indeed, the plaintiff further threatened the firm's partners with criminal prosecution, bar discipline and public embarrassment if his demands were not met.

The parties were unable to settle, and the plaintiff commenced a lawsuit. He alleged, among other things, that the firm retaliated against him by refusing to provide letters of recommendation after he filed a complaint with the EEOC. To prove his retaliation claim, he had to establish, among other things, that he was acting in good faith when he filed his complaint with the EEOC.

At trial, the court allowed the firm to offer evidence of the plaintiff's exorbitant settlement demands and threats to the firm's partners to show that the plaintiff did not believe he had a good-faith claim, but rather sought to extort money from the firm. The court acknowledged that Rule 408 “bars the use of an offer of compromise as an admission of liability.” Nonetheless, the court sought to avoid this bar by explaining that the firm “characterize[d] the 'offer,' coupled as it was with the threat to file a discrimination complaint, as an attempt at extortion (relevant to the issue of bias).” In other words, after acknowledging that Rule 408 bars the use of settlement demands to prove liability, the court referenced the “bias” exception in an attempt to justify its decision to admit such evidence. After just two and a half hours of deliberations, the jury returned a verdict in favor of the defendants.

By our analysis, the conclusion to admit the evidence at issue is sound ' though it seems that the notion of “bias” is artifice. Every alleged settlement demand could be said to reveal a “bias.” Instead, it would appear that the District of Massachusetts sought to impose upon the plaintiff accountability for his unreasonable and, at a minimum, criminally suspect demand for $40 million in favor of his claim in order to avoid the threat of public humiliation or worse to the lawyers at Ropes & Gray LLP.

Conclusion

Aggressive advocacy can often cross the line from legitimate negotiation tactics to extortion. It is laudable to encourage good-faith efforts to settle legitimate claims; however, this policy cannot and should not be used to undermine a defendant's ability to present civilly evidence demonstrating a criminally extortionate demand. The Ray court's characterization of allegations of extortion as sounding in “bias” is less intellectually honest than simply conceding that this conflict of policy exists.

One potential solution is for the legislature to create a “crime-fraud” exception to the settlement privilege that is analogous to the “crime-fraud” exception to the attorney-client privilege. The latter is a relatively elaborate standard applied when one looks to pierce the otherwise sacrosanct attorney-client privilege. See United States v. Jacobs, 117 F.3d 82, 87 (2d Cir. 1997) (“A party wishing to invoke the crime-fraud exception must demonstrate that there is a factual basis for a showing of probable cause to believe that a fraud or crime has been committed and that the communications in question were in furtherance of the fraud or crime.”). Certainly, it is worth considering whether an analogous standard should exist to protect against the instance of settlement overtures tinged by extortion.

Arguably, a “crime-fraud” exception would not undermine the policies underlying the settlement privilege. To the contrary, it will promote ' rather than interfere with ' good-faith efforts to settle legitimate claims. It will also have a restraining influence on those who might otherwise be inclined to make extortionate-type demands while hiding behind the mask of faux negotiation.

Stanley S. Arkin and Lisa C. Solbakken are partners of Arkin Solbakken LLP. The authors thank Deana Davidian, an associate at the fiem, for her contributions to this article.

Is there a time when extortionate threats of meritless litigation become a criminal act that should be exempt from the settlement privilege?

Some time ago, one of these authors observed that nearly all manner of communication is apt to contain the seedlings of a threat at one time or another. See Stanley S. Arkin, “Blackmail and the Practice of Law,” N.Y.L.J. (Feb. 7, 1995). Whether this be a communication between a parent and child (“Eat your vegetables or else!”) or a TV commercial, the practice in our discourse of imposing a consequence to coerce a concession, achieve an economic or political end, or resolve a dispute is so commonplace that it may proceed without care or notice, much less analysis. Of course, the laws and regulations designed to punish extortion and blackmail are notable exceptions to this. Our society rejects these efforts to exploit others by virtue of fear-invoking threats that are designed to achieve wrongful objectives.

Uniformly excluded from these laws and regulations, however, are threats levied within the context of settlement negotiations. This is accomplished by application of the so-called “settlement privilege,” crafted as it is with the intention of encouraging informal dispute resolution by deeming inadmissible communications made during the course of settlement talks. Statutes ordaining the settlement privilege typically espouse a standard close to (or mirroring) the proscription set for by Rule 408 of the Federal Rules of Evidence ' which by its terms excludes from evidence “conduct or a statement made during compromise negotiations” offered “to prove or disprove the validity or amount of a disputed claim.”

The first part of this article considers the issue of when a threat to litigate encased by a settlement demand raises the specter of extortion, and the extent to which a potentially extortionate settlement communication should be outside the scope of the privilege. The second part examines case law assessing potentially extortionate settlement communications and concludes by suggesting that it may be worthwhile to consider whether an exception for extortionate demands should be made explicit as a means to discourage this manner of criminal activity as well as meritless suits.

Relevant Statutes and Ethical Rules

As noted previously, both federal and state laws criminalize extortion. The Hobbs Act forbids effecting commerce by extortion, which in turn is defined as “the obtaining of property from another, with his consent, induced by wrongful use of actual or threatened force, violence, or fear, or under color of official right.” 18 U.S.C. ' 1951. Blackmail, a subset of extortion, is covered by 18 U.S.C. ' 873, which provides that “whoever, under a threat of informing, or as a consideration for not informing, against any violation of any law of the United States, demands or receives any money or other valuable thing, shall be fined under this title or imprisoned not more than one year, or both.”

The New York Penal Code proscribes larceny by extortion. This is defined as any act inducing another to deliver property by instilling a fear that, should the property not be surrendered, the actor will take some action to harm the victim, including but not limited to: 1) accusing the victim of a crime; or 2) exposing a secret that will harm the victim's reputation, career, and/or personal relationships, or otherwise subject the victim to hatred, contempt or ridicule. See N.Y. Penal Code ' 155.05(2)(e).

For lawyers, the foregoing is enhanced by relevant ethical canons and rules of professional responsibility. For example, Rule 3.1 of the New York Rules of Professional Conduct prohibits an attorney from bringing a claim that is unwarranted by existing law, or that serves merely to harass or maliciously injure another. Similarly, Rule 3.4(e) prohibits a lawyer from “present[ing], participat[ing] in presenting, or threaten[ing] to present criminal charges solely to obtain an advantage in a civil matter.”

These statutes make clear that, of course, threatening litigation in order to persuade an adversary to settle a legitimate claim, and warning of the consequences of failing to settle amicably, fall far short of accomplishing an extortion of any sort. But more challenging are the myriad matters that lie beyond this overly simple absolute. For example, what of the threat to an adversary to file a litigation of no genuine legal value that has been cleverly designed as a shakedown for a considerable sum on pain of filing a meritless but nonetheless commercially crippling or defamatory litigation? The prospect of simply moving for legal sanctions ' following consequential commercial harm already done ' hardly seems satisfactory to the company that is now out of business. Yet this is largely what the law demands.

The Settlement Privilege

Rule 408 of the Federal Rules of Evidence provides, in pertinent part, that “conduct or a statement made during compromise negotiations” is not admissible “to prove or disprove the validity or amount of a disputed claim or to impeach by a prior inconsistent statement or a contradiction.” Nonetheless, such evidence may be admitted “for another purpose, such as proving a witness's bias or prejudice, negating a contention of undue delay, or proving an effort to obstruct a criminal investigation or prosecution.” Section 4547 of the New York Civil Practice Law and Rules similarly bars admission of settlement discussions to prove “liability for or invalidity of the claim or the amount of damages.”

The rationale for these rules is: 1) that settlement discussions are irrelevant, since they “may be motivated by a desire for peace rather than from any concession of weakness of position”; and 2) to promote “the public policy favoring the compromise and settlement of disputes.” FED. R. EVID. 408, Notes of Advisory Committee on Proposed Rules.

The settlement privilege “encourages settlement by protecting parties to a settlement agreement or negotiation from having their good-faith efforts to settle a dispute used against them in subsequent litigation.” Am. Soc'y of Composers, Authors & Publishers v. Showtime/The Movie Channel, Inc., 912 F.2d 563, 580 (2d Cir. 1990).

Yet the doctrine, when applied broadly or without a “crime-fraud” exception, can accomplish the unintended result of protecting conduct that may be criminal. Two cases illustrate the conundrum.

Sanders v. Madison Square Garden

In Sanders v. Madison Square Garden, L.P. , 525 F. Supp. 2d 364 (S.D.N.Y. 2007), the Southern District of New York addressed the application of the settlement privilege in the context of potentially extortionate settlement discussions. There, the plaintiff commenced a lawsuit against her former employer, alleging that: 1) she was discriminated against on the basis of gender by virtue of sexual harassment by the defendant; and 2) she was fired in retaliation for her sexual harassment claim. To prove the retaliation claim, the plaintiff had to establish, among other things, that she was acting in good faith when she made her sexual harassment claim. The defendants sought to present evidence that the plaintiff offered a large sum of money to settle the sexual harassment claim, suggesting that she did not believe she had a good-faith claim, but rather sought to extort money from the defendants. The court granted the plaintiff's motion in limine to exclude this evidence, stating that this was simply an effort to use compromise discourse to disprove the validity of her claim. The court explained its ruling as follows:

[A]ccording to defendants, [evidence of plaintiff's large settlement demand] shows that her underlying sexual harassment claim was made in bad faith, that is, that it was not merely invalid, but was known to be such by plaintiff when she made it. Thus, even if the offer is limited to its alleged relevance to the retaliation claim, it is offered precisely for the forbidden purpose of showing that the underlying claim that was the subject of the settlement discussions was frivolous.

Here, then, the court clearly determined that the value of preserving the confidentiality of settlement talks outweighed the principal point that the plaintiff was seeking to leverage a potentially meritless claim by threat of a lawsuit ' a different conclusion than that recently reached by the District of Massachusetts.

Ray v. Ropes & Gray LLP

The District of Massachusetts took a different approach to that of the Sanders court in Ray v. Ropes & Gray LLP , 961 F. Supp. 2d 344 (D. Mass. 2013). In Ray, the defendant law firm terminated the plaintiff's employment in December 2008 and offered him six months of severance pay. In May 2009, the plaintiff threatened to file a racial discrimination complaint with the United States Equal Employment Opportunity Commission (EEOC) unless the firm extended his severance period indefinitely or paid him $8.5 million. This settlement demand then increased to $40 million over the course of the parties' discussions. Indeed, the plaintiff further threatened the firm's partners with criminal prosecution, bar discipline and public embarrassment if his demands were not met.

The parties were unable to settle, and the plaintiff commenced a lawsuit. He alleged, among other things, that the firm retaliated against him by refusing to provide letters of recommendation after he filed a complaint with the EEOC. To prove his retaliation claim, he had to establish, among other things, that he was acting in good faith when he filed his complaint with the EEOC.

At trial, the court allowed the firm to offer evidence of the plaintiff's exorbitant settlement demands and threats to the firm's partners to show that the plaintiff did not believe he had a good-faith claim, but rather sought to extort money from the firm. The court acknowledged that Rule 408 “bars the use of an offer of compromise as an admission of liability.” Nonetheless, the court sought to avoid this bar by explaining that the firm “characterize[d] the 'offer,' coupled as it was with the threat to file a discrimination complaint, as an attempt at extortion (relevant to the issue of bias).” In other words, after acknowledging that Rule 408 bars the use of settlement demands to prove liability, the court referenced the “bias” exception in an attempt to justify its decision to admit such evidence. After just two and a half hours of deliberations, the jury returned a verdict in favor of the defendants.

By our analysis, the conclusion to admit the evidence at issue is sound ' though it seems that the notion of “bias” is artifice. Every alleged settlement demand could be said to reveal a “bias.” Instead, it would appear that the District of Massachusetts sought to impose upon the plaintiff accountability for his unreasonable and, at a minimum, criminally suspect demand for $40 million in favor of his claim in order to avoid the threat of public humiliation or worse to the lawyers at Ropes & Gray LLP.

Conclusion

Aggressive advocacy can often cross the line from legitimate negotiation tactics to extortion. It is laudable to encourage good-faith efforts to settle legitimate claims; however, this policy cannot and should not be used to undermine a defendant's ability to present civilly evidence demonstrating a criminally extortionate demand. The Ray court's characterization of allegations of extortion as sounding in “bias” is less intellectually honest than simply conceding that this conflict of policy exists.

One potential solution is for the legislature to create a “crime-fraud” exception to the settlement privilege that is analogous to the “crime-fraud” exception to the attorney-client privilege. The latter is a relatively elaborate standard applied when one looks to pierce the otherwise sacrosanct attorney-client privilege. See United States v. Jacobs , 117 F.3d 82, 87 (2d Cir. 1997) (“A party wishing to invoke the crime-fraud exception must demonstrate that there is a factual basis for a showing of probable cause to believe that a fraud or crime has been committed and that the communications in question were in furtherance of the fraud or crime.”). Certainly, it is worth considering whether an analogous standard should exist to protect against the instance of settlement overtures tinged by extortion.

Arguably, a “crime-fraud” exception would not undermine the policies underlying the settlement privilege. To the contrary, it will promote ' rather than interfere with ' good-faith efforts to settle legitimate claims. It will also have a restraining influence on those who might otherwise be inclined to make extortionate-type demands while hiding behind the mask of faux negotiation.

Stanley S. Arkin and Lisa C. Solbakken are partners of Arkin Solbakken LLP. The authors thank Deana Davidian, an associate at the fiem, for her contributions to this article.