This article was originally published in the IADC Newsletter, September 2006, No. 2. © Copyright 2006 by IADC. All rights reserved. Republished by Butler with permission from IADC.
Until a few years ago, the term “Most Favored Nation” was a phrase restricted primarily to the world of international trade. However, with the upsurge in both class action and mass tort lawsuits, Most Favored Nation clauses (MFN), are increasingly used as a tool to encourage settlement.
If you are unfamiliar with the concept, MFN clauses are primarily used in large tort case settlements. Essentially, it is a stipulation incorporated into a settlement agreement between a Defendant and a single Plaintiff or small group of Plaintiffs. The clause requires that if the Defendant settles for more money with another party in the future, the Defendant will pay the difference of the two settlements to the first settling Plaintiff(s) pursuant to the MFN clause. For example, a Defendant settles with a single Plaintiff in a mass tort case or class action for $1,000. Thereafter, Defendant later settles with other Plaintiffs for $1,500. If the first Plaintiff had negotiated a MFN clause to the settlement agreement, the Defendant would then owe that Plaintiff an additional $500.
This scenario would seem to beg the question “why would any Defendant use such a clause?” Primarily, the reason appears to be an effort to weed out weaker cases in litigation, capping costs, and then allowing the Defendant to proceed to trial with more serious Plaintiffs if he so chooses. Strategically, the Defendant could argue that small amounts paid to prior Plaintiffs act as a “ceiling” or lower the “market rate” for future settlements. Even if the Defendant is forced to later pay a small percentage to other Plaintiffs under the MFN clause, he could potentially save himself money in the long run by encouraging settlements early at a low dollar figure..
From the Plaintiff’s perspective, it would appear to be a tantalizing choice. Settle today for a sum certain with the guarantee that if other Plaintiffs do better than you do, you will later be paid an equal amount of money. On the other hand, of course, it could be that the Defendant chooses to go to trial against other Plaintiffs in which case the amount of the judgment would not effect an earlier Plaintiff’s settlement under the concept of Most Favored Nation. Additionally, if the Plaintiff actually has a strong case, an MFN clause is unlikely to do him any good since other settlements will presumably be at or below the same amount. At its very heart, one who is the beneficiary of an MFN clause is essentially making a “hedge bet” against future risk.
It should be noted that MFN clauses are by no means a one-way street. These clauses are available to Defendants as well and have been used in several large cases. Recently in an antitrust class action case against several large vitamin manufactures, the defendants used a “Reverse Most Favored Nations Clause.” In Re: Vitamin Antitrust Litigation, 398 F. Supp. 2d 209 (U.S. Dist. Ct. D.C. 2005). The court explained…
“The Reverse MFN provided that the Big 6 defendants could settle with opt-outs at a certain level without paying the class an additional sum certain. In this way, the parties could reach an earlier settlement without Plaintiffs worrying that later settlements would cause embarrassment because of higher settlement amounts reached with individuals, as opposed to class, Plaintiffs. The reverse MFN was important because the success of settlement depended on class members believing it was a good settlement, staying in the class, and getting recovery sooner rather than later.” Id. at 216.
Thus, not all MRNs are designed to primarily benefit just Plaintiffs. Newberg on Class Actions notes that a reverse MFN is one “which would require Plaintiffs who negotiate a settlement with one of several defendants to offer to reduce the first defendant’s obligations if they should accept smaller settlement terms from other settling defendants.” Newberg on Class Actions § 12.2 (West 2006).
Undoubtedly, most Most Favored Nation clauses are not right for every situation. Wording must be precise. The practitioner must also carefully calculate the returns of such a practice, especially where there are numerous parties involved. The clause may actually be more practical for cases involving fewer Plaintiffs (or Defendants), which may allow counsel to eliminate one or two troublesome other parties and focus on one major adversary. The “carrot” of a Most Favored Nation clause may induce a peripheral party to settle when they would not previously have done so. As always, the facts of each case will determine the propriety of employing this or any other strategic method of settlement.