Guest Article

By John G. Loughnane, Partner
Nutter McClennen & Fish LLP

The Massachusetts Appeals Court recently issued an opinion in ZVI Construction Co. v. Levy, et al., 90 Mass. App. Ct. 412 (2016), refusing to override the terms of a written confidentiality agreement entered into between parties to a mediation.  The opinion is noteworthy because it refuses  to recognize a fraud exception to the confidentiality of mediation.  In addition, the opinion emphasizes the need for careful strategy when dealing with distressed situations – including agreements arising out of the mediation of disputes with distressed companies.

The decision stemmed from claims  originally made by a construction  company against a financially distressed chain of pizza restaurants known as The Upper Crust.   Those claims were resolved as part of a mediated settlement agreement.   Pursuant to  the agreement,  the chain agreed to pay  to the construction company  within thirty days certain funds due to the chain from a third party.   Within a month of the mediation’s conclusion, however, The Upper Crust chain commenced a chapter 11 proceeding.  Although The Upper Crust received the expected funds from the third party, it did not pay the funds over to the construction company but rather used the funds to cover other expenses including legal fees and payroll.

Thereafter, the  construction company filed suit against counsel for The Upper Crust and others alleging misrepresentation and other wrongdoing in connection with the mediated settlement.  The trial court dismissed all claims and the construction company appealed.   The Massachusetts Appeals Court affirmed the ruling of the lower court.

The construction company’s claims were based on allegations that at the mediation, counsel for The Upper Crust represented that “he would pay the funds” to the construction company once his client received payment  from the third party.   Counsel denied the allegation.   The opinion notes that the mediated settlement agreement “did not contain an escrow provision or otherwise call for or obligate [counsel to The Upper Crust] to act as escrow agents.   [Counsel] were never specifically asked, nor did they expressly agree, to act as an escrow agent for [the construction company’s] benefit.   [Counsel] were not parties to or signatories to the … settlement.”

The opinion notes that the funds paid by the third party were  deposited into the  Interest on Lawyers Trust Account  (IOLTA) maintained by counsel to The Upper Crust.   Massachusetts law is clear that the principal amount of funds held in a lawyer’s IOLTA account belongs to the relevant client and can only be transferred elsewhere as instructed by the client.   For that reason, the Appeals Court held that the construction company’s claims of conversion by the law firm in honoring its clients’ payment instructions could not be considered conversion.

More importantly, the Court refused to allow the construction company to introduce communications allegedly made during mediation in support of its claims against counsel for The Upper Crust.   The Court noted that plain language of Section 23C of  Chapter 233 of the Massachusetts General Laws which provides in pertinent part:  “Any communication made in the course of and relating to the subject matter of any mediation and which is made in the presence of such mediator by any participant, mediator or other person shall be a confidential communication and not subject to disclosure in any judicial or administrative proceeding; provided, however, that the provisions of this section shall not apply to the mediation of labor disputes.”

Further, the Court noted that the parties to the mediation had also executed a confidentiality agreement which provided: “The parties further agree that the mediation, including all communications, documents and other materials, used during said mediation, including all communications between and among the parties and their counsel, shall be confidential and shall not be used for any purpose other than for said mediation.”   The Court declined to ignore  this plain language and ruled that the trial court properly blocked the introduction of allegedly fraudulent statements made at the mediation session.  In addition, the Court went on to cast skepticism of the significance of any such statement in light of the sophistication of the parties, their representation by counsel, and the terms of the mediated agreement ultimately reached.

In sum, the opinion is of interest  in two respects.  First, the decision  upholds the bedrock principle of confidentiality that is fundamental to the success of any mediation process.   The promise of confidentiality is found not only in Massachusetts state law  (and other states such as those enacting the Uniform Mediation Act)  but also in the  written agreements of  parties at the outset of mediation.  Secondly, the opinion emphasizes the need for careful strategy and attention to detail in reaching any agreement – especially an agreement involving a distressed party.   Many parties, of course, were affected by the chapter 11 filing of The Upper Crust.   The construction company thought it had reached a mediated solution which would allow it to be paid.  Unfortunately the documentation executed was not sufficient to transform that belief into reality.   When it comes to mediating with a distressed party, it is important not just to reach a general agreement on the underlying dispute but  to include provisions resolving  the critical question of payment.