Proceeds and Taxes

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The draft model treats taxes owed by the Plaintiff as a result of receiving the Proceeds differently depending on whether the Proceeds result from a judgment or a settlement. If the Proceeds result from settlement, a Litigation Proceed Right is worth 1% of the pre-tax proceeds. If the Proceeds result from judgment, a Litigation Proceed Right is worth 1% of the after-tax proceeds.

Our thinking is this: if the claim is settled, the Plaintiff has the ability to influence the structure of the settlement to minimize taxes. If the claim is reduced to judgment, the Plaintiff has no influence on the tax bill. Thus, to put the tax burden on the Plaintiff in the case of settlement incentivizes the Plaintiff to structure the settlement to minimize tax, but  putting the burden on the Plaintiff in the judgment result is simply punitive. Note, this binary allocation is purely to illustrate the issue; parties could agree that the Plaintiff and Funder would share the tax burden in myriad ways. Moreover, it could be possible for the Plaintiff to enter an agreement with the Defendant that the payments made to satisfy a judgment would be done in a manner that minimized taxes. In such a case the rationale underlying our tax allocation breaks down.

Nonetheless, as a starting proposition we effectuate this differential tax treatment by revising our definition of Proceeds as follows (new language underlined):

Proceeds: (i) Any and all value received to satisfy the Award, if the Award results from settlement or other agreement negotiated by the parties, and (ii) any and all value received to satisfy the Award, less any state, federal or international taxes owed on such value, if the Award is a judgment, order, or other determination by an independent party such as a court or arbitrator.

 

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