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Employment Settlement Agreements: A brief guide

What’s the appeal, why are they useful and what are the risks?

What is a Settlement Agreement?
A Settlement Agreement (previously known as a Compromise Agreement) is a legally binding contract made between an employer and an employee. They are commonly used by employers on termination of employment as an effective way of ensuring that they are not sued by the employee and have to bear the associated expense, bad publicity and management time associated with a court or tribunal claim.

How do they work?
In essence the employee receives a sum of money in return for signing away their legal rights to sue their employer (commonly known as “paying off” the employee). In addition the employee is usually required to keep the settlement confidential and not to make any derogatory comments about their employer, its directors, agents or employees. Although such confidentiality clauses are extremely common, they have received a lot of press attention lately in the light of the #metoo scandal where they have become commonly referred to as Non-Disclosure Agreements or NDAs.

In order for the Settlement Agreement to be legally binding, it must meet certain statutory requirements and the employee must receive their own legal advice in relation to its terms and effect. It is standard practice for the employer to pay a contribution towards the cost of the employee obtaining this advice.

When are settlement agreements used?
Settlement Agreements are commonly used where an employer wishes to terminate employment in circumstances that could give rise to a claim (e.g. for a long-serving employee who is performing poorly, but has not undergone any formal performance management process, or where an employee is on long-term sick leave and it is not clear when, and in what capacity, they will be able to return to work). Another common example of their use is where an employer is proposing to make an enhanced redundancy payment and wants the certainty of knowing that in doing so, they are not going to get stung for a further payment down the line.

Why not ask the employee to sign a simple waiver and save some money?
Whilst a waiver may have some deterrent effect to an employee ignorant of the law, it will only take one call to an employment advisor, or even a simple Google search, for them to realise that such a waiver has no legal effect whatsoever. This is an extremely risky strategy and not advisable where an employer is handing over an enhanced termination payment.

How much do I offer?
This is completely up to you. Factors that often influence how much employers offer include the following:

  • The amount that would have to be paid to the employee in any event on fair termination of their employment (such as wages, notice pay, redundancy pay and holiday pay);
  • The strength and value of any potential claim they might have in a court or tribunal;
  • Personal knowledge of the employees character – what you think they will accept and the likelihood that they will pursue a claim; and
  • How much you are prepared to pay rather than take your chances defending a court or tribunal claim.
    There are also non-financial incentives that could be offered such as an agreed reference, payment in lieu of working notice, writing off training costs and outplacement support.
    If you require assistance, we are on hand to advise you in relation to an appropriate settlement amount taking into account the circumstances in which the Settlement Agreement is offered.

How is the payment taxed?
Taxation of termination payments has recently become more complex.

In summary:

  • Any contractual payments such as holiday pay, notice pay, wages and bonus payments should be subject to tax and NICs in the usual way.
  • If the employee has worked their full contractual notice period, it is likely that any redundancy payment or remaining goodwill termination payment may be paid free of tax up to £30,000.
  • If the employee has not worked their full notice period, the remainder of the termination award must be split into what is known as “post-employment notice pay” (PENP), which is subject to tax and NICs, and the remainder, the balance of which may be paid tax-free up to £30,000.
    HMRC has set out detailed guidance on the calculation of PENP in accordance with a defined formula. It is extremely important that this is followed sought and termination payments are subject to the correct tax treatment. Failure to do so can amount to a criminal offence therefore advice should be sought where there is any concern.

How do I go about proposing a settlement?
You can make your proposal verbally or in writing (a combination of both is usually best so that you can ensure that the employee understands what is happening and there is no confusion about the process) at any time. We can advise you through this process and assist with the drafting of appropriate correspondence to send to the employee.

What happens if the offer is not accepted? Can the offer be used against the company in court or at a tribunal?
If the offer is not accepted, employment continues until terminated by either party in circumstances that may, or may not, give rise to a claim.

The law does afford some protection to employers in allowing certain settlement negotiations to take place without the fear of the offer being wafted before a judge in any subsequent legal proceedings. It is good practice for all settlement discussions and correspondence to be clearly expressed as “without prejudice” to any claim. This means that if negotiations break down, it should in effect be as though the discussions never happened. However, this will not be sufficient in all circumstances, in particular where there is no existing dispute between you and your employee.
Where there is no dispute, section 111A of the Employment Rights Act 1996 provides additional protection for employers by permitting what is known as a “protected conversation” to take place with an employee in relation to the termination of their employment that cannot be referred to in an employment tribunal. However, it is not possible to have protected conversations in respect of all kinds of claims. For example, discrimination, harassment and whistleblowing claims are not covered by section 111A. It may well be that the “without prejudice” rule could apply in the circumstances or there may be some risk if you decide to go ahead with negotiations. You should always seek advice where you are concerned.

Can I rely on a standard-form Settlement Agreement document? Reliance on standard documents is risky.
Any Settlement Agreement should be customised to the particular employee. It is becoming increasingly important to ensure that the drafting of the settlement agreement fits with the particular circumstances of termination.

In the light of the #metoo movement, the use of confidentiality clauses should be carefully considered in respect of certain kinds of claims. Further, it is extremely important that the law in relation to the tax treatment of PENP is complied with and the correct taxation rules are applied to the termination payment.

Get in touch
If you would like more information on exit negotiations, settlement agreements or employment law generally, please contact Melanie Rowe on 01872 227006 or by email