SETTLEMENT AGREEMENTS Quick Guide
What are they? A settlement agreement is a means through which employers and employees may resolve their employment disputes. It is a legally binding agreement where the employee agrees to waive their employment rights and settle any potential court or tribunal claims, normally in return for financial compensation. An employee may also be asked to sign a settlement agreement if they are receiving an ex-gratia payment such as an enhanced redundancy payment. Settlement agreements were previously called compromise agreements. The name changed in 2013 because it was believed that this language provided a more accurate description of what was happening between the parties and it was hoped it would encourage greater workplace dispute resolution. Settlement agreements may also sometimes be referred to as a severance agreement or termination agreement.
Requirements of a Settlement Agreement In order to be legally binding, a settlement agreement must fulfil the following conditions:
It must be in writing. It must relate to a particular complaint or proceedings. This means that the agreement must narrate the specific claims being waived. Having only a general clause that seeks to exclude liability for all and any claims could render the agreement unenforceable. The employee must have received independent legal advice from an independent legal adviser as to the terms and effect of the proposed agreement. Usually, this will be from a solicitor. The adviser must be identified in the Agreement. The Agreement must state that all of the above conditions have been satisfied.
Once these conditions have been met and the agreement is signed by the parties, it will have the effect of discharging the employee’s statutory rights referred to in the agreement.
Claims being settled Proceedings which may be settled include unfair dismissal claims, discrimination claims, claims for breach of contract, unlawful deduction of wages and equal pay claims. The employee in return for signing away their rights will usually receive compensation normally within a specified period of between 7 to 21 days. Although a settlement agreement normally requires the employee to waive all of their employment related rights against the employer, there are usually two exceptions to this general principle. It is common for settlement agreements to exclude a waiver of personal injury and/or accrued pension rights claims which enable the employee to be able to make such a claim despite signing the agreement.
Without Prejudice and Subject to Contract The offer from the employer to the employee will usually be described as ‘without prejudice’ so as to prevent the terms of the offer being referred to in subsequent court or tribunal proceedings in the event that the employee chooses not to accept the agreement. Employers may also enter into a “protected conversation” with an employee with a view to agreeing their exit. There doesn’t have to be a pre-existing dispute for such a conversation to take place. The issues discussed are not usually admissible in an employment tribunal hearing, although there are some exceptions where this will not apply (e.g. for discrimination cases). Subject to contract means that the settlement agreement will not be binding until it is signed.
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Terms of a Settlement Agreement Financial Payments: The settlement agreement will set out the terms under which the employee will be agreeing to give up their employment rights. It should make clear what payments the employee will receive. Depending on the circumstances, it may include some or all of the following:
Contractual payments such as salary and benefits up until the termination of employment. A payment in lieu of notice. Accrued holiday pay. A compensation payment, this could include a payment for loss of office or employment or if applicable, a statutory redundancy payment. Arrangements regarding bonus payments, share schemes or long-term incentive plans. A contribution towards legal fees.
Non-financial terms: Settlement agreements often also contain clauses covering future behaviours (on both sides), including:
Confidentiality - this will usually prevent the employee from disclosing the terms of their agreement, the circumstances of their departure as well as confidential information obtained during their employment. Sometimes an additional sum may be provided as consideration for agreeing to such a clause. The provision of an agreed reference to future potential employers. This will usually be annexed to the settlement agreement. Many employers now have a practice of only providing a brief factual reference confirming dates of employment etc. Any announcement that will be made to colleagues or third parties about the departure. Protection of reputation in the form of a clause prohibiting the making of derogatory comments. Returning company property. Provision of outplacement counselling (i.e. assistance in finding alternative employment). Treatment of outstanding company expenses. Restrictive covenants - an employee may be prohibited for a certain period of time from joining a competitor or setting up in competition with their previous employer. An employee may also be precluded for a certain period of time from soliciting clients, dealing with clients and poaching staff. Care should be taken to ensure that post termination restrictions are not too onerous, or they could end up being unenforceable. Occasionally settlement agreements will include an additional sum for an employee who agrees to be bound by these. Garden leave - an employer may wish the employee to stay away for the remainder of their employment. They will be paid for this period but will not be allowed to enter the workplace, access any work databases or contact any suppliers, clients or customers.
Legal Fees There is no set rule as to who should pay for the legal advice the employee receives before signing a settlement agreement. However, it is standard practice for the employer to contribute towards the employee's legal fees in recognition that they have to take this advice. It is up to the employer how much they contribute with standard offers varying from £250 to £500 plus VAT. This may not cover all of an employee's legal fees, particularly if they want to negotiate what is being offered. The legal fee contribution can sometimes be negotiated upwards.
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Tax The first £30,000 of an ex-gratia payment compensating the employee for loss of employment will usually be tax free. Statutory and contractual redundancy payments would also fall within this exemption. If a settlement agreement offers compensation which exceeds £30,000, the excess will be subject to income tax and employer's Class 1A National Insurance Contributions ("NIC"). Any contractual payments such as salary and benefits or any bonus entitlement payable up to and including the termination date will be subject to tax and NIC. Payments relating to any notice period (whether worked or not) including payments in lieu of notice ("PILON") (including non-contractual PILONs) should also be taxed in the usual way. Payments for accrued holiday pay will be treated the same as salary and are taxable. If any payment has been made for complying with restrictive covenants or confidentiality clauses, this would also be taxable. HMRC treats payments made directly to pension schemes separately from the £30,000 exemption and so pension contributions are not subject to tax. In light of the fact that some elements of the compensation can be paid tax free, a tax indemnity is virtually always given by the employee. This makes them ultimately responsible for the payment of any tax and national insurance should HMRC determine that tax should have been deducted.
Period for Accepting the Settlement Agreement Employers will usually give an employee a deadline by which they should return the signed settlement agreement. This should be a reasonable period of time to consider the proposed settlement agreement. How long is reasonable will depend on the circumstances, but as a general rule the ACAS Code of Practice on Settlement Agreements states that employees should be given a minimum of 10 days to consider the formal written terms of the agreement and to take legal advice.
Breach of Agreement If either party breaches the terms of the settlement agreement, they will have the same remedies available to them as they would have for any breach of contract and will be able to sue for damages if they suffer loss as a result of the other party’s breach. Agreements are also likely to provide that if an employee breaches any of its terms, they will have to repay some or all of the payments made by the employer and indemnify them for future costs and proceedings. The repayment should not include sums to which the employee was already entitled such as contractual notice pay.
Conclusion It is important that employers take legal advice prior to issuing a settlement agreement to ensure that it is suitably tailored to their particular circumstances and identifies all of the potential claims the circumstances could give rise to.
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Next Steps We hope this assists you in understanding settlement agreements. We are of course happy to discuss any aspect of this note further.
Lindsey Cartwright Partner E: lindsey.cartwright@morton-fraser.com T: 0141 274 1141
Innes Clark Partner E: innes.clark@morton-fraser.com T: 0131 247 1007
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