First Circuit Finds Triable Issues of Fact in Dispute Over Terms of Executive's Release Agreement

Practical Law Legal Update w-029-7705 (Approx. 6 pages)

First Circuit Finds Triable Issues of Fact in Dispute Over Terms of Executive's Release Agreement

by Practical Law Employee Benefits & Executive Compensation

Background

Starting in January 2016, Zhang served as the Chief Strategy Officer, Vice President, and President of North American and Enterprise Sales for Dahua, a US subsidiary of a Chinese company.

Original Terms of Employment

Under the original terms of Zhang's 2015 employment agreement:

Zhang would be paid $510,000 per year, receive 100,000 shares of Dahua stock on his January 1, 2016 start date, and serve a three-year term.
If Dahua terminated Zhang for cause, Zhang would be entitled to payment of his salary through the end of his three-year term.
There was no non-compete clause, confidentiality provision, non-disparagement clause, or release of claims.

August 2017 Negotiations

In August 2017, Dahua's senior leaders decided to terminate Zhang for what they considered to be poor performance in his role. A lawyer in Dahua's internal legal department and Dahua's outside counsel, who was based in Virginia, were tasked with drafting a separation agreement for Zhang.

During the same month, the founder and chairman of Dahua, Liquan Fu, traveled from China to Boston to inform Zhang of his termination and negotiate the terms of Zhang's separation agreement. They agreed that Zhang would:

Leave his current role but stay on as a corporate advisor for two years.
Be paid $240,000 a year in his new role.

However, they did not discuss specific dollar amounts to compensate Zhang for the time remaining on his employment agreement, or the 100,000 shares of company stock that Zhang owned.

The two lawyers working on Zhang's separation package included the terms agreed to by Zhang and Fu, and produced multiple versions of a separation agreement and a consulting agreement. The First Circuit wrote in its decision that there were at least five different versions of the separation agreement in the record and that:

The terms varied considerably from version to version.
The two lawyers working on the agreements did not consistently coordinate their work. For example, certain terms that inside counsel asked outside counsel to include in the separation agreement do not appear in any separation agreement in the record.

It is unclear which version of the separation agreement was ultimately given to Zhang.

Zhang refused to sign the separation and consulting agreements that were presented to him, one reason being that the separation agreement offered to pay him $680,000 total severance (the amount he was already entitled to under his employment agreement) and added further restrictions, including a 16-month non-compete.

After Zhang rejected the initial package, Fu agreed to keep Zhang on as an employee of Dahua as a senior corporate advisor for two years. The lawyers therefore prepared a release agreement for Zhang to replace the original severance agreement.

August 2017 Release Agreement

The draft release agreement differed from the draft separation agreement in several ways. Significantly, whereas the separation agreement had provided for severance equal to continued payments of base salary for 16 months (totaling $680,000), the release agreement provided for 16 monthly severance payments of $680,000 each.

Dahua's attorneys claim that they made several mistakes when preparing the August 2017 release agreement:

First, focusing on the different wording in the release agreement as compared to the prior separation agreement, one of the lawyers said that when she typed $680,000 into a blank space in the agreement, she believed that she was indicating the total severance amount, rather than the amount of each of the 16 monthly installment payments.
Second, one of the lawyers who drafted the release agreement said that she forgot to change the choice-of-law provision in the agreement template she was provided. The release agreement therefore indicated that it would be governed by Virginia law, rather than Massachusetts law as was intended.

Zhang read the release agreement before signing it, but he did not discuss the new terms of the agreement with anyone, nor did anyone from Dahua explain those changes to him. Fu signed the agreement but did not read it before signing and did not have it translated from English to Chinese.

After signing the release agreement, Zhang received $62,500 per month for four months (according to Dahua, this represented $20,000 for his senior consultant role and $42,500 as severance), instead of the $700,000 per month ($20,000 plus $680,000) he claims that he believed he was entitled to. Zhang claimed he did not raise the discrepancy with Dahua at that time because the company had a history of paying him late. Zhang also received a payment to cover the appreciation in the value of the Dahua shares he received under his 2015 employment agreement.

When Dahua sought to end its consulting relationship with Zhang in January 2018, it sent Zhang a draft separation agreement, which provided for a lump sum payment of $910,000. Zhang refused to sign the separation agreement, claiming that the company owed him over $11 million under the August 2017 release agreement.

The District Court

In May 2018, Dahua filed a complaint against Zhang, asking the court:

For a declaratory judgment that the August 2017 release agreement was unenforceable.
To reform the August 2017 release agreement because the parties had made a mutual mistake.
For damages against Zhang for breaching the August 2017 release agreement's implied covenant of good faith and fair dealing.

Zhang filed a counterclaim, arguing that Dahua breached the August 2017 release agreement. He made a motion for summary judgment in May 2019, and the following month Dahua made its own summary judgment motion.

In January 2020, the US District Court for the District of Massachusetts:

Granted Dahua's motion for summary judgment and denied Zhang's motion.
Applying Massachusetts law, held that:
- a unilateral, if not mutual, mistake permeated the August 2017 release agreement; and
- Zhang breached the release agreement's implied covenant of good faith and fair dealing.
Reformed the release agreement to provide for a $680,000 total severance payment, to be paid in 16 monthly installments of $42,500 each.
Denied Dahua's request for attorney's fees.

(433 F.Supp.3d 41 (D. Mass. 2020).)

The Appeal

Zhang appealed the district court's grant of summary judgment in favor of Dahua and the district court's denial of his own summary judgment motion, arguing, among other things, that the district court:

Erred in applying Massachusetts law instead of Virginia law to the August 2017 release agreement.
Did not view the evidence in the light most favorable to him, and that genuine disputes of fact exist that preclude summary judgment in favor of Dahua.

On appeal, the First Circuit held that:

Massachusetts law governs the release agreement, as neither party had a substantial relationship to Virginia.
The district court:
- erred in granting summary judgment to Dahua because there exist triable issues of material fact that bear on the viability of Dahua's contract defenses, such as whether either party made a mistake, and whether Zhang knew or should have known of any mistake Dahua might have made; and
- did not err in denying summary judgment to Zhang because of disputed facts that, if resolved in Dahua's favor, could allow one of Dahua's mistake defenses to succeed.

Practical Implications

While the ultimate resolution of this case is currently unknown, it should nonetheless serve as a stark reminder to anyone involved in negotiating, drafting, or executing employment, consulting, or severance and release agreements to:

Be meticulous when working with multiple versions of agreements, and proofread every version carefully to ensure that it accurately reflects intended terms.
For in-house attorneys working with outside counsel, ensure that outside counsel's drafts properly reflect the instructions provided.
Start from a generic template rather than a version with governing law or other provisions already filled in.
Translate agreements as needed to ensure that all parties involved know what they are agreeing to or signing.

For more on negotiating and drafting executive agreements, including common pitfalls, see:

First Circuit Finds Triable Issues of Fact in Dispute Over Terms of Executive's Release Agreement | Practical Law