A covenant not to sue in California is a contract in which someone with a potential legal claim promises not to file a lawsuit over it, usually in exchange for money or another benefit. The underlying claim technically survives; what’s given up is the right to enforce it in court against the party who signed the covenant. That difference from a full release is small on paper and large in practice, especially when more than one defendant is on the hook for the same injury.
How It Differs From a Release of Claims
A release extinguishes the obligation itself. Under Civil Code Section 1541, an obligation is destroyed when the person owed it gives the other party a release supported by new consideration.1California Legislative Information. California Code CIV 1541 – Release Once signed, the claim is gone. If the releasing party later sues on the same claim, the defendant flashes the release and the court dismisses the case.
A covenant not to sue works differently. The claim survives; only the right to enforce it is contractually surrendered. If the covenantor breaks the promise and files suit anyway, the covenantee cannot get an automatic dismissal on the strength of the agreement. The remedy is a separate breach-of-contract action against the person who broke the promise, which is slower and messier than a release defense. That’s why many defendants push for a full release when they can get one.
The practical appeal of the covenant is flexibility. In a personal injury case with three defendants, you might settle with one through a covenant not to sue while keeping your claims alive against the other two. A full release in the same scenario could inadvertently benefit the non-settling defendants. The covenant lets you take money off the table from one party without handing a windfall to the rest.
Unknown Claims and Section 1542
California Civil Code Section 1542 provides that a general release does not cover claims the releasing party did not know about at the time of signing, if those unknown claims would have materially changed the settlement terms.2California Legislative Information. California Code CIV 1542 – Extinction of Obligations That protection is waivable, and nearly every California settlement with a release contains an express Section 1542 waiver. Without one, unknown claims stay available for a later lawsuit.
A covenant not to sue sidesteps this issue somewhat because the underlying claim isn’t being extinguished. But if the covenant is drafted broadly to cover “any and all claims arising from” a transaction, both sides should still address Section 1542 to head off a later fight about whether unknown claims fall within the covenant’s scope.
What Makes a Covenant Not to Sue Valid
A covenant not to sue is a contract, held to the same formation requirements as any other. Civil Code Section 1550 lists four essentials: parties who are legally capable of contracting, their consent, a lawful purpose, and sufficient consideration.3California Legislative Information. California Code CIV 1550 – Essential Elements of Contract
Consideration trips people up more than any other element. Each side has to give up something of value. The claimant gives up the right to sue; the other party typically pays money. If the claimant gets nothing in return, the agreement is an unenforceable gift of a legal right. Courts also recognize that compromising a genuinely disputed claim is itself valid consideration, so even a modest payment can suffice when the underlying dispute was real.
Mutual consent means both parties actually agreed to the same terms. If one side was pressured, misled, or lacked capacity to understand the agreement, the covenant is voidable. Lawful purpose means the deal cannot be designed to accomplish something illegal or violate public policy, such as concealing evidence of a crime.
Scope, Breach, and Enforcement
Enforceability lives or dies on how precisely the covenant defines what is covered. The agreement should identify the specific claims, the parties, and the transactions or events at issue. Vague language like “all disputes between the parties” invites litigation about whether a particular claim falls within the covenant’s scope, and California courts tend to interpret ambiguities against the party trying to enforce the restriction.
If the covenantor breaks the promise and files suit anyway, the covenantee’s path forward is a breach-of-contract claim, either as a cross-complaint in the same action or as a separate lawsuit. Recoverable damages include the attorney fees and litigation costs the covenantee incurred defending against the improper suit.
Liquidated Damages for Breach
Some covenants include a liquidated damages clause fixing a predetermined amount the covenantor must pay for breaking the promise. California law generally enforces these provisions in commercial agreements unless the amount was unreasonable when the contract was made.4California Legislative Information. California Code CIV 1671 – Liquidated Damages The standard is tougher in consumer contracts: the liquidated amount is void unless the parties agreed that actual damages would be impractical or extremely difficult to calculate. A well-drafted clause can spare the covenantee from having to prove actual losses, but a figure designed to punish rather than compensate will be struck down.
Good Faith Settlements in Multi-Party Cases
When a covenant not to sue resolves part of a lawsuit against multiple defendants, the non-settling defendants will almost certainly challenge whether the settlement was made in good faith. Code of Civil Procedure Section 877 treats releases and covenants not to sue identically on this point: given in good faith to one of several defendants who share liability, either agreement does not discharge the remaining defendants unless it says so, and the total claim against the non-settling defendants is reduced by either the amount stated in the agreement or the amount actually paid, whichever is greater.5California Legislative Information. California Code CCP 877 – Release of One or More Joint Tortfeasors or Co-Obligors The settling defendant also gets full protection from contribution claims by the others.
Code of Civil Procedure Section 877.6 gives any party the right to a court hearing on that good-faith question.6California Legislative Information. California Code CCP 877.6 – Determination of Good Faith of Settlement The settling party can file a notice of settlement along with an application for a good faith determination, describing who is settling, the terms, and the amount. Non-settling parties then have 25 days if the notice was mailed, or 20 days if personally served, to file a motion contesting the settlement’s good faith. If no one objects in that window, the court approves it.
The stakes are real. A good-faith finding wipes out the non-settling defendants’ rights to seek contribution or indemnity from the settling defendant. The party arguing the settlement was not in good faith carries the burden of proof, and a party unhappy with the ruling can challenge it through a writ of mandate filed within 20 days.
Extra Rules for Employment Settlements
Covenants not to sue used to end an employment dispute carry additional layers of regulation that don’t apply to ordinary commercial disputes. California and federal law both restrict what employers can include, and violating those restrictions can void the covenant.
No-Rehire Provisions
Under Code of Civil Procedure Section 1002.5, any provision in a settlement agreement that prevents an employee from seeking future employment with the settling employer is void and against public policy. This applies to settlement agreements entered on or after January 1, 2020. The ban has a narrow exception where the employer made a good faith determination that the employee engaged in sexual harassment or sexual assault, and it does not force an employer to rehire anyone if there is a legitimate, non-discriminatory reason for the refusal.
Age Discrimination Waivers
If the covenant waives age discrimination claims, the Older Workers Benefit Protection Act imposes strict procedural requirements. The agreement must be written in plain language, specifically reference rights under the Age Discrimination in Employment Act, and offer consideration beyond anything the employee was already entitled to receive.7Office of the Law Revision Counsel. 29 USC 626 – Recordkeeping, Investigation, and Enforcement The employee must receive at least 21 days to consider the agreement, or 45 days if it’s part of a group layoff, plus a 7-day window to revoke after signing. The agreement must also advise the employee in writing to consult an attorney. Skip any of these steps and the waiver is invalid.
Whistleblower and Organizing Protections
A covenant not to sue cannot prevent someone from reporting potential securities violations to the SEC. Rule 21F-17(a) prohibits any person from impeding direct communication with the SEC about possible violations, including by enforcing or threatening to enforce a confidentiality agreement.8Securities and Exchange Commission. Whistleblower Protections A clause that nominally allows SEC reporting while requiring the employee to notify the company first may still violate the rule.
On the labor side, the NLRB’s 2023 decision in McLaren Macomb held that severance agreements with broad non-disparagement and confidentiality clauses violate the National Labor Relations Act because they tend to discourage workers from discussing wages, cooperating with the NLRB, or engaging in other protected organizing activity. The current NLRB general counsel rescinded the aggressive enforcement memo that followed that decision, but McLaren Macomb remains live precedent, and administrative law judges continue to apply it.
Tax Treatment of What You Receive
Money received through a covenant not to sue is taxed the same way as any other settlement payment. What matters is what the payment is compensating you for.
Damages received on account of personal physical injuries or physical sickness are excluded from gross income under 26 U.S.C. ยง 104(a)(2).9Office of the Law Revision Counsel. 26 USC 104 – Compensation for Injuries or Sickness The exclusion covers both economic losses like medical bills and lost wages and non-economic losses like pain and suffering, as long as they stem from a physical injury. Emotional distress alone does not qualify as a physical injury, so payments for standalone emotional distress claims are taxable. One exception: if part of the settlement reimburses medical expenses you paid for treating emotional distress and you never deducted those expenses on a prior return, that portion is not taxable.
Punitive damages are always taxable, with a narrow exception for punitive damages awarded in wrongful death actions where state law limits the available remedy to punitive damages. When structuring a settlement through a covenant not to sue, the allocation of the payment between compensatory and punitive components should be spelled out in the agreement itself. A lump sum with no allocation invites the IRS to treat the entire amount as taxable income.