Settling a commercial dispute: offers, without prejudice talks, releases and deeds

Most commercial disputes never reach a judgment. They end in a phone call, a meeting, a mediation or an exchange of letters, followed by a document in which the parties agree to stop fighting. That document often matters more than any argument that came before it. A well-drafted settlement closes a dispute cleanly and lets both businesses move on. A poorly drafted one can leave the most important claims unresolved, release rights a party never meant to give up, or create a new dispute about what was settled.

Settlement is also a process with its own rules. What you say during negotiations may or may not be usable later. An offer made the right way can shift legal costs if the other side unreasonably rejects it. Agreeing to accept less than you are owed may not bind you unless the arrangement is properly structured. And a “handshake” settlement at a mediation can be binding immediately, or not binding at all, depending on the words used.

This article explains, in general terms, how commercial settlements work in Australia: why parties settle, how to protect settlement discussions, how offers can carry costs consequences, the difference between an agreement and a deed, what a settlement document should contain and how to avoid the common traps. It is general information, not legal advice. Settlement terms have legal, tax and commercial consequences, so take advice on any significant settlement before signing.

Why most disputes settle

Litigation is slow, expensive and uncertain. Even a party with a strong case faces legal costs it may not fully recover, months or years of management attention, the risk of an unexpected result and, often, damage to a relationship that still has value. Settlement exchanges those risks for certainty.

A useful way to approach any settlement decision is to compare the offer on the table with a realistic estimate of the alternative. That estimate should consider:

• the likely outcome if the dispute were decided, expressed as a range rather than a single figure;
• the probability of each outcome, honestly assessed;
• legal and expert costs to reach a decision, and the portion likely to be recovered;
• the time value of money and the cost of waiting;
• management time and disruption;
• the other party’s ability to pay any judgment; and
• relationship, reputational and confidentiality considerations.

Every decision to sue or settle comes down to this comparison, made carefully. A settlement that looks low against the claimed amount can be excellent against the realistic alternative. The thinking clearly about a contract problem article offers a structured way to separate facts, obligations and options before making it.

Figure 1The offer against your realistic alternative

• The realistic alternative
  • Outcomea range, not one figure
  • Probabilityhonestly assessed
  • Coststo reach a decision, less what is recovered
  • Timethe cost of waiting
  • Management timeand disruption
  • Collectabilitycan they pay a judgment?
  • Relationshipreputation and confidentiality

Protecting settlement discussions: without prejudice

Parties are understandably reluctant to make concessions if those concessions could later be used against them in court. The law addresses this through the without prejudice principle. In general terms, communications made in a genuine attempt to settle a dispute are protected from being used as evidence of an admission in later proceedings about that dispute. In jurisdictions that have adopted the uniform evidence legislation, including federal courts, a statutory version of this protection applies, and the common law principle continues to operate as well.

Some practical points:

• The label is not decisive. Writing “without prejudice” on a letter helps show intention, but it does not protect a communication that is not a genuine attempt to settle. Conversely, genuine settlement discussions may be protected even without the label.
• There must be a dispute. Ordinary commercial correspondence before any dispute exists is not usually protected.
• There are exceptions. Protected communications can generally be used to prove that a settlement was reached and what its terms were, and in some other limited circumstances.
• Keep the streams separate. It is good practice to keep without prejudice correspondence separate from open correspondence about the dispute, so that it is clear which communications are protected.

Being careful here supports better negotiation. A business can explore options and float compromises without worrying that every concession will become an admission.

Offers that carry costs consequences

In Australian litigation, the general rule is that the losing party pays a portion of the winning party’s legal costs. That rule creates a powerful settlement tool. Court rules in each jurisdiction provide for formal offers of compromise, and courts also recognise informal offers, often called Calderbank offers, made “without prejudice save as to costs”.

The idea is straightforward. If a party makes a reasonable offer that the other party rejects, and the other party then does worse at trial than the offer, the court may order costs consequences against the party that rejected it, such as paying a greater share of the other side’s costs from the date of the offer. The precise rules, time limits and consequences differ between courts and between formal and informal offers.

For a business, the lessons are:

• A well-timed, reasonable offer applies pressure. It tells the other side that continuing carries a real cost.
• Offers should be clear and capable of acceptance. Vague offers carry less weight.
• Reasons help. Explaining why the offer is reasonable makes it harder for the other party to justify rejecting it.
• Rejecting an offer is a decision with a price. When you receive one, assess it against your realistic alternative, not against your best case.

These mechanisms belong mostly to litigation. If proceedings have started or are likely, get advice on how to make or respond to an offer in the form your court recognises.

Agreeing to accept less: the consideration problem

A settlement is a contract, and like other contracts it usually needs consideration: each side must give something. That creates a well-known trap.

The traditional rule is that a creditor’s promise to accept part payment of an undisputed debt in full satisfaction does not, by itself, bind the creditor, because the debtor gives nothing new in exchange for the release of the balance. The creditor could, in principle, later sue for the rest. Courts may soften this in some circumstances, for example through estoppel, but relying on that is risky.

The rule usually does not cause trouble in genuine disputes. Where the amount owed is genuinely disputed, each party gives up its position on the disputed claim, and that compromise is itself consideration. The problem arises in “settlements” of debts that are not really disputed, such as a customer who simply cannot pay in full and offers less.

There are two common ways to make such an arrangement binding:

• Add something. The debtor gives something extra, such as earlier payment, security, a guarantee or a different form of payment, in exchange for the release.
• Use a deed. A deed does not need consideration to be binding, which is one reason settlements are usually documented as deeds.

The concept of accord and satisfaction describes this process: the accord is the agreement to accept something different in discharge of the obligation, and the satisfaction is the performance of that agreement. Until the satisfaction occurs, for example until the agreed payment is made, the original obligation may not be discharged, depending on how the settlement is structured.

Agreement or deed

Settlements are commonly documented as a deed of settlement and release. A deed differs from an ordinary agreement in several ways relevant to settlement:

Companies typically execute deeds in accordance with the Corporations Act 2001 or their constitution, and individuals must meet the requirements of their state, which may include witnessing. Electronic execution of deeds is now possible in many circumstances, but the rules differ between jurisdictions and have changed in recent years, so check the current position before signing remotely.

What a settlement deed should contain

A settlement deed does not need to be long, but it does need to be precise. Typical elements include:

• Parties. Include every entity that has or could bring claims, and consider related companies, directors who gave guarantees and insurers.
• Background. Short recitals describing the dispute help define what is being settled.
• Settlement payment. Amount, due date, payment method and whether it includes or excludes GST, interest and costs.
• Conditions. Whether the release takes effect on signing or only on payment.
• Release. Exactly which claims are released, by whom, and whether the release covers known claims only or unknown claims too.
• Carve-outs. Rights that survive, such as ongoing warranties, defect obligations, confidentiality obligations or claims about unrelated work.
• Covenant not to sue. An agreement not to bring proceedings on the released claims.
• Discontinuance. If proceedings are on foot, how and when they will be discontinued and what happens to costs.
• No admission. A statement that neither party admits liability.
• Confidentiality and non-disparagement. If wanted, with sensible exceptions for advisers, insurers, regulators and legal requirements.
• Default. What happens if a payment is missed, for example the right to enter a consent judgment for a stated amount.
• Warranties of authority. Each signatory has authority and has not assigned the claims.

The release deserves the most attention

The release clause is where most settlement disputes arise. A release that is too narrow may leave related claims open. One that is too broad may give away rights the party did not intend to release, such as warranties for work that has not yet failed. Courts interpret releases in the context of the dispute being settled, but drafting clearly is far better than relying on interpretation.

A useful discipline is to write two lists before drafting: everything the release must cover, and everything it must not. Then check the clause against both.

Figure 2Two lists before drafting the release

The release must cover

• The claims in dispute
• Every party that could bring them
• Known claims, and unknown ones if intended

The release must not cover

• Ongoing warranties and defect obligations
• Confidentiality obligations
• Claims about unrelated matters

Settling at mediation

Many disputes settle at mediation, where a neutral mediator helps the parties negotiate. Mediation settlements are often reached late in the day, when everyone is tired and keen to finish. The common practice is to sign short heads of agreement before leaving.

Whether those heads are binding depends on their wording. Some state that the parties are bound immediately and will later sign a formal deed recording the same terms. Others state that nothing is binding until a formal deed is signed. Either can be appropriate, but ambiguity is dangerous. If the heads are meant to bind, make sure they contain all essential terms. If they are not, say so clearly. The resolving disagreements without stopping work article explains how to choose and prepare for processes such as mediation and expert determination.

Tax and accounting

Settlement payments can have tax consequences. GST may or may not apply depending on what the payment is for, and income tax treatment depends on the nature of the claim. The Australian Taxation Office has published guidance on GST and compensation and settlement payments. Agree in the deed whether the amount is inclusive or exclusive of GST, and get tax advice on significant settlements before signing.

A worked example

This is an illustrative example. The businesses, figures and events are hypothetical.

A small steel fabricator claims $65,000 from a builder for unpaid progress claims and variations on a warehouse project. The builder says $20,000 of the claim is for variations it never approved and that it is entitled to deduct $15,000 for delays, so it offers $30,000. Proceedings have not started. Both sides want to avoid legal costs that could easily exceed $30,000 each.

The fabricator assesses its realistic alternative. It is confident about the $45,000 in progress claims, less confident about the variations and thinks the delay deduction is weak but not impossible. Allowing for unrecovered costs and eight to twelve months of delay, it estimates its realistic net outcome from litigation at between $35,000 and $50,000. In a without prejudice letter, it offers to settle for $48,000, explaining its reasoning on each component. After discussion, the parties agree on $45,000.

Figure 3The steel fabricator's $65,000 claim

Builder's first offer$30,000

Realistic net outcome from litigation$35,000 to $50,000after unrecovered costs and delay

Fabricator's offer$48,000

Agreed settlement$45,000

Amount claimed$65,000

$0$35,000$70,000

The settlement deed provides for $25,000 within seven days and $20,000 within thirty days, inclusive of GST. The release takes effect only when both payments are made, and the fabricator can enter consent judgment for the unpaid balance plus $5,000 if a payment is missed. Importantly, the release carves out the fabricator’s ongoing warranty obligations for the steelwork, which the builder needs, and the builder’s obligation to return the fabricator’s bank guarantee, which the fabricator needs. Both carve-outs were identified using the “must cover” and “must not cover” lists.

Figure 4How the settlement deed was structured

1. Day 7$25,000 dueinclusive of GST
2. Day 30$20,000 duethe release takes effect only when both are paid
3. If a payment is missedConsent judgmentfor the unpaid balance plus $5,000
4. Carved outWarranty and bank guaranteeeach side kept what it needed

How this applies to a small Australian business

• Value the alternative honestly. Compare offers with a realistic range of outcomes, net of costs and time, not with the claimed amount.
• Separate open and without prejudice correspondence. Make concessions in genuine settlement communications, clearly identified.
• Use offers strategically. A reasonable, reasoned offer made at the right time puts pressure on the other side to engage.
• Document the settlement as a deed. Especially where one side is giving up more than it receives, or where a debt is being compromised.
• Draft the release with care. List what must be released and what must survive before you draft.
• Protect against default. Payment instalments, conditions on the release and a consent judgment mechanism reduce the risk of settling and then not being paid.
• Check the authority. Make sure the people signing can bind their organisations.

Common mistakes

• Comparing the offer with the best case. Settlement decisions should be made against the realistic alternative.
• Assuming “without prejudice” protects everything. It protects genuine settlement attempts, not ordinary correspondence.
• Accepting part payment of an undisputed debt without a deed or extra consideration. The release may not bind as intended.
• Releasing too much. Broad releases can extinguish warranties and claims the party meant to keep.
• Releasing before being paid. Releases should usually take effect on payment, not on signing.
• Ambiguous heads of agreement. Unclear mediation documents create a second dispute about whether there was a settlement.
• Ignoring GST. An unclear GST position can cost one party a tenth of the settlement.

Questions to ask

• What is our realistic range of outcomes if this dispute is decided, and what will it cost to get there?
• Which communications are without prejudice, and are we keeping them separate?
• Would a formal or informal offer now put useful pressure on the other side?
• Is the debt genuinely disputed, or do we need a deed or extra consideration to make a compromise binding?
• What must the release cover, and what must it not cover?
• When does the release take effect, and what happens if a payment is missed?
• Is the settlement amount inclusive or exclusive of GST, and what are the tax consequences?
• Are the signatories authorised, and are all relevant parties included?

Bringing it together

Settlement is how most commercial disputes end, and the quality of the settlement process decides whether the end is clean. Genuine settlement discussions are generally protected from being used as admissions, which allows parties to negotiate openly. Reasonable offers, properly made, can shift costs onto a party that unreasonably refuses them. Compromising an undisputed debt usually needs a deed or something extra in return. And the settlement deed itself, especially the release, deserves careful drafting so that it resolves exactly what the parties intend and nothing more.

The commercial discipline matters as much as the legal one: value the alternative honestly, protect the money with conditions and default mechanisms, and keep alive the rights the business still needs.

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Source: KEVOS editorial notes. Examples and figures in this article are illustrations. This article provides general information and does not constitute legal or tax advice.