The #MeToo movement involves a hashtag that has been utilized widely on social media in an attempt to demonstrate the widespread prevalence of sexual harassment and assault. In the past year, the #MeToo movement has had a profound impact on many aspects of U.S. society. Without question, it has raised the national consciousness concerning sexual violence and harassment in the workplace. But, of special interest to lawyers, it has also called into question the processes and practices that many believe have allowed serious allegations to go unreported and unaddressed. One of them is the established practice of using nondisclosure provisions in settlement agreements, provisions that promote settlement but effectively shield allegations of wrongdoing from further scrutiny. In response to the movement's claim that such provisions provide cover to serial abusers, federal and state lawmakers have passed or proposed laws aimed at prohibiting or discouraging their use.

In particular, the federal Tax Cuts and Jobs Acts (TCJA) added a new section to the Internal Revenue Code (the “Code”) in an obvious effort to discourage the use of nondisclosure agreements (“NDAs”). Very recently, the state of Washington passed a law limiting the use of NDAs. In addition, there are bills pending in California, Pennsylvania, New York and New Jersey that would impact the settlement of sexual harassment claims. This article will review the proposed bill in New Jersey, summarize the federal law and Washington's new law, and offer suggestions for practitioners.

Proposed Law in NJ Would Impact Settlement of Many Employment-Related Claims

If a bill pending in the New Jersey Legislature becomes law, it will declare that any provision in any employment contract that waives a substantive or procedural right or remedy relating to a claim of discrimination, retaliation or harassment, is unenforceable and against public policy. Furthermore, the bill provides that any provision in an employment contract or settlement agreement that would prevent the disclosure of discrimination, retaliation or harassment will also be deemed unenforceable and against public policy, and that no person can take any retaliatory action against a person on the grounds that the person refused to enter into such an agreement. The bill also states that “[e]very settlement agreement resolving a discrimination, retaliation or harassment claim by an employee against an employer shall include a bold, prominently placed notice that although the parties may have agreed to keep the settlement and underlying facts confidential, such a provision … is unenforceable against the employer if the employee publicly reveals sufficient details of the claim so that the employer is reasonably identified.” Finally, the bill provides for an employee's attorney fees and costs if an employer seeks to enforce a provision deemed unenforceable and against public policy.

The New Jersey Senate passed the bill on June 7. As of August 1, the bill is on its second reading in the Assembly. Governor Murphy has not yet indicated whether he will sign it if it clears the Assembly.

If this bill becomes law, it will have a significant impact on the way that most employment-related claims are settled in New Jersey. For employers, a NDA is typically an essential term of an agreement to settle a discrimination, harassment or retaliation claim. If the law makes such provisions unenforceable, employers will not receive as much of a benefit from settling them. Accordingly, employers may lower the amount that they are willing to pay or insist on trials. As a result, all attorneys who handle employment-related claims in New Jersey should keep a close eye on this bill.

New Federal Law Impacts Settlements of Sexual Harassment Claims

The TCJA contains a provision concerning the settlement of sexual harassment and sexual abuse claims by adding a new section to the Code, Section 162(q) which states: “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.”

In general, Section 162 allows deductions for ordinary and necessary expenses incurred in connection with a trade or business, including the costs associated with the settlement of employment-related lawsuits. The TCJA modified Section 162 to eliminate that deduction if the settlement or payment is “related to sexual harassment or sexual abuse if such settlement or payment is subject to a [NDA].” Stated differently, if a sexual harassment or sexual abuse claim is settled with a NDA, then the settlement payments and attorney fees associated with that settlement are not deductible. Section 162(q) applies to all settlement amounts paid after Dec. 22, 2017. Thus, the provision applies to settlements negotiated prior to Dec. 22, 2017, that provide for the payments after Dec. 22, 2017. This could lead parties who negotiated settlements prior to Dec. 22, 2017, to incur significant tax liabilities that they did not anticipate when they entered into the agreement.

Section 162(q) raises several unanswered questions. First, the TCJA does not define what it means to be “related to sexual harassment or sexual abuse” and that phrase is not defined anywhere else in the Code. Many employment-related lawsuits contain multiple claims, and it is unclear whether the new provision would apply only to the settlement of a specific claim for sexual harassment or abuse; whether it would apply to the whole settlement in any case where sexual harassment claims have been asserted; or to any settlement that requires an employee to release his/her claims for sexual harassment or abuse. If the new provision applies to all agreements where the employee releases any sexual harassment or abuse claims, then it would apply to the general release provisions in most separation agreements and the settlement agreements for nearly every employment-related lawsuit—even if that employee never made any allegations of sexual harassment or abuse.

Furthermore, it is unclear whether the elimination of the deduction applies to individuals as well as employers. Although it appears that the intent of the provision is to discourage employers from insisting on NDAs, its broad language may bar individuals from deducting the fees they paid to their attorneys. Furthermore, while Section 162 only allows deductions for expenses incurred in connection with a trade or business, 162(q) states that “No deduction shall be allowed under this chapter,” which appears to broaden the scope to any deductions available under Chapter 1 of the Code, including 26 U.S.C. §62(a)(20) which provides a deduction for attorney fees paid by, or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination.

Although the IRS has not yet offered any guidance on Section 162(q), it appears unlikely that Congress intended Section 162(q) to eliminate the deduction for attorney fees for employees who are victims of sexual harassment or abuse. Many commentators expect that the IRS will correct this apparent oversight.

As for the issue of how Section 162(q) applies to the settlement of multiple claims, employers have several options. First, employers could decide to forgo the deduction in cases where the value of the nondisclosure provision outweighs the economic benefit of the deduction. This may be appropriate in cases where the allegations are particularly egregious and/or involve a high-level executive. Second, employers could attempt to allocate certain settlement payments for certain claims, and take the deduction for payments related to any claims other than claims for sexual harassment or abuse. When it is warranted by the facts of a particular case, the parties could agree that no part of the settlement is allocated toward the settlement of sexual harassment claims. Third, employers could settle sexual harassment or abuse cases without requiring a NDA. This may be appropriate in cases where the employer anticipates that public disclosure of details relating to the claim would not have a significant impact upon the company.

For general releases in separation agreements, and settlement of lawsuits where the employee did not allege sexual harassment or assault, employers could require employees to make a representation in the agreement that the employee has not asserted such claims and is not aware of any facts that would give rise to such claims.

Washington Bans Employers from Requiring Employees to Sign NDAs

On June 7, a new law concerning NDAs took effect in the Washington State. The law provides that an employer cannot require an employee, as a condition of his or her employment, to sign a NDA, waiver, or any other document that would prevent that employee from disclosing sexual harassment or sexual assault in the workplace. Any such agreement signed by an employee as a condition of employment for the purpose of preventing disclosure or discussion of sexual harassment or assault in the workplace is unenforceable.

The law does not prohibit an individual and a company from entering into a settlement agreement of a sexual harassment claim that contains a NDA. Accordingly, the new law only prohibits employers from requiring employees to sign prospective NDAs. Once an employee or a former employee has raised such a claim, then the parties are permitted to enter into a settlement agreement that contains a NDA. As a practical matter, it does not appear that this law will have much impact on work-related sexual harassment claims. But, it may lead some employees in Washington who were deterred from filing such a claim due to a prospective NDA to come forward with their claims.

James W. Boyan III is a partner at Pashman Stein Walder Hayden in Hackensack where he practices employment law and litigation. Yelena Yukhvid is an associate with the firm.