How a QSF helps your employment clients and your law firm survive in times of pandemics and disasters

Courts are closed because of the pandemic, and defense attorneys are refusing to produce witnesses for remote depositions. The free webinars are educational, and you are working remotely to do what you can to move your employment cases along, but you are concerned that your firm’s contingency fee income will be negatively impacted for months to come. You could take out a loan or tap into a line of credit, but more debt is not the best solution to anyone’s financial concerns. Your law firm will likely survive this crisis, and it appears that courts will reopen in a few weeks, but how do you prepare your law firm’s financial condition for the next shutdown due to pandemic, earthquake, war or other disaster? The answer is to use a Qualified Settlement Fund (“QSF”) and a Structured Settlement the next time you settle a big case.

What is a QSF?

A QSF is a trust established when a case settles to allocate the settlement funds to a plaintiff and plaintiff’s counsel. The purpose of the QSF is to accept, hold and distribute funds paid by defendants in consideration of the release of claims against defendants. One option that both the plaintiff and plaintiff attorney have is to receive all, or a portion, of their recovery spread out over several years for protection during tough times, secured by a structured settlement. As an example, in a 2018 FEHA-based case that resulted in a $1.5M fee, instead of receiving the fee as a lump sum and paying state and federal taxes of at least 40%, we placed the entire settlement into a QSF and then allocated $1.5M to a Structured Settlement that pays roughly $300,000 for five years. Depending on the firm’s fees for each year, fewer taxes may be owed. At a minimum, tax liability is deferred and may even be reduced depending on the situation. Interest rates on short-term Structured Settlements generally are low, so the payments do not “grow” substantially, but can earn interest comparable to a certificate of deposit or money market fund depending on the duration of the payment schedule. The main benefit during a pandemic is the peace of mind knowing that fees will be received even when the firm’s current case inventory may not produce fee income due to a government shutdown. If the firm is having a great year and generating substantial fee income such that the $300,000 is not needed at the time it is received, the funds may be contributed to a cash balance plan, 401(k) plan, or other retirement vehicle up to certain limits and defer (or eliminate) tax exposure until retirement years. But if the firm is struggling because of a pandemic, disability or other disaster, it is comforting to know that $300,000 is coming in the door. In short, a Structured Settlement will conserve your fees, i.e., your cash, for a rainy day.

Why use a QSF and Structured Settlement instead of other settlement vehicles? 

You have likely used Structured Settlements without a QSF, but they require the defendant’s cooperation, which often can be difficult on a contentious case. A QSF can be established with little or no cooperation from the employer defendant compared to a Structured Settlement by itself. A QSF is also preferable because there are tax benefits to both sides when using one. For you and your plaintiff client, even assuming the settlement is taxable, QSF claimants are not taxed on funds in the QSF until those funds are distributed. If the plaintiff or plaintiff attorney allocates a portion to a Structured Settlement, then they are only taxed on the remaining funds distributed from the QSF. The defendant employer benefits from using a QSF by receiving an immediate tax deduction upon funding the settlement. The defendant is not taxed or impacted when distributions are paid out of the QSF and is completely removed from the administration.

How does a QSF work? 

A QSF allows the defendant to be released and then receives and holds the settlement dollars until the plaintiff and attorney have decided how they would like to disburse the funds. Because the QSF holds the funds and avoids constructive receipt, you are able to purchase a Structured Settlement with a portion of your big fee and not be fully taxed on your entire fee in the year you are paid out of the settlement. Therefore, instead of being taxed on $1.5M when you are paid from the settlement, you can spread out your fees over five years, receiving roughly $300,000 per year and being taxed on that payment in the year it is received. You can spread your fees over fewer years or more years. We have been involved in settlements where lawyers spread their fees over two years and some cases where lawyers allocated their fees over seven or more years. A Structured Settlement is great for planning for long-term expenses such as college tuition, retirement or alimony. You get to decide when you want to receive your fees after discussing your options with a Structured Settlement consultant at the time the QSF is established.

When should a QSF be considered? 

There are few “rules” governing the type of cases where a QSF may be used, but a QSF should be considered as an option in a seven-figure case with multiple claimants. A QSF typically requires multiple claimants, so if you have a two-plaintiff case of harassment, discrimination or retaliation that is expected to settle, say, for $2M, speak to a consultant and defense counsel about a QSF. Retain a consultant with expertise in QSFs and Structured Settlements to calculate the options for your client and your firm when negotiating gross settlement amounts. Once you have communicated with a consultant about the options available, discuss the idea with your client(s) and co-counsel, if any. By the way, QSFs are a great tool for resolving claims among clients or co-counsel regarding allocation of settlement proceeds.

From a bargaining standpoint, the mere mention of a QSF during your initial settlement talks with defendant’s counsel or with a mediator should help you “own the anchor” in your negotiations. Studies have shown that anchoring directly affects the settlement value of personal injury claims and the same reasoning should apply in employment cases. By raising the proposal of using a QSF when discussing how to document the settlement, you are signaling that the settlement will be in the seven figures. Presumably, you already will have signaled that your client is looking for a seven-figure settlement in your pre-litigation demand, pleadings and discovery responses, but the QSF proposal sends the signal that you are serious about a settlement in the seven figures. Raising the QSF idea places a duty on defendant’s counsel to communicate with the defendant’s decision makers and insurer, if there is insurance, about your proposal. Remind the defendant’s counsel about the QSF tax advantages for the defendant and let them know that the defendant is dismissed and out of the picture once the QSF is funded.

What does it take to establish a QSF? 

It sounds complicated, but the process of establishing a QSF is very simple. First, the settlement agreement or memorandum of understanding should include language reserving the right to fund a qualified settlement fund. Second, the consultant will take care of the legal forms to create the QSF as a separate, legal entity, a trust, under the law of any state, usually by retaining a trust attorney that specializes in QSFs. The legal documents are not filed in the case being settled and you are not the attorney of record in the QSF proceeding. The QSF forms consist of a Fund Agreement, which is written like a settlement agreement and roughly 10 pages, a brief petition or motion to establish the trust that is filed with a court, and an order for the court to sign to establish the QSF. The petition and proposed order may be filed ex parte and are unopposed. We have worked with QSF attorneys in Texas and on the East Coast who obtain the Order for us. The parties will need to agree on naming the QSF. Some employers are fine with the QSF identifying the employer in the documents, such that the name is the [insert name of Defendant Employer] Section 468B Qualified Settlement Fund. Other employers may not want there to be any public filing to reflect a settlement so you could name it after the plaintiff, your name, or something that is acceptable to both sides. The entire process of establishing the QSF is similar to documenting a settlement. In other words, it should not take longer than a few weeks. Again, the process is quite simple and handled by a consultant.

What happens after the QSF is established? 

With an Order approving/establishing the QSF, the consultant works with both sides to have the settlement funds wired to an administrator, and from there the monies are wired to your client, your law firm, and to fund a Structured Settlement on the terms that you selected. In the example described above, the law firm receives a check for roughly $300,000 every year, on December 15, which is the perfect time for year-end bonuses, making charitable contributions, funding a retirement plan or, if you are in the middle of a pandemic or other disaster, paying bills and surviving. Knowing that the funds are preserved and coming to your law firm at the end of each year allows you to successfully operate your firm and perhaps be more aggressive in your negotiations and settlement v. trial decisions in your current cases—ultimately helping your other clients and your firm.

            We are not tax attorneys and are not giving tax advice in this article, or at all. We simply recommend that you consider a QSF as an option when settling your next big case. A QSF is a unique tool that is available to your client and your firm to provide resources for a rainy day. We wish you the best of luck in your settlement negotiations.