Settlement Agreements – Advice for Employers

Overview

A Settlement Agreement is a legally binding contract that is used to settle employment disputes. They can also be called Termination Agreements or Compromise Agreements. In return for receiving a sum of money and/or benefits the employee or ex employee agrees not to pursue claims against the employer. A Settlement Agreement is designed to allow a clean break of the employment relationship.

In order to be legally binding a Settlement Agreement must be in writing and the employee must obtain independent legal advice on the terms of the agreement. The employer will usually offer to make a contribution towards the cost of that advice.

We are experienced in advising on the amounts to be offered to the employee and drafting Settlement Agreements for employers and would be pleased to provide an estimate of our fee for these services.

Frequently asked Questions

Q: In what circumstances should an employer consider offering a Settlement Agreement?

It may be appropriate to offer a Settlement Agreement where the normal employer/employee relationship has broken down, where a redundancy situation has arisen or where, following discussion, there is a mutual agreement to end the employment contract. A Settlement Agreement may be a viable alternative to entering into a performance/capability review or a full redundancy process.

It is sensible to take legal advice before offering a Settlement Agreement as the discussions and documentation surrounding the offer of a Settlement Agreement may have to be disclosed to the Employment Tribunal in any subsequent proceedings brought by the employee.

Q: Can an employee refuse a Settlement Agreement?

An employee can refuse to terminate their employment on the terms offered. Normally this will be on the basis that they do not want to accept the reason given for termination or because they believe that the amounts offered are insufficient.

Q: What payments should be offered?

We will advise you on what is a fair amount taking into account the value of any potential claim the employee may have against you and the payments due in accordance with the employment contract. If the sums offered are insufficient the independent solicitor advising the employee may seek to negotiate an increase.

The Settlement Agreement should provide a breakdown of the various sums offered. These will normally consist of:

• Notice payment: if you do not require the employee to work their notice period the employer can make a payment in lieu of notice. This should be paid net of tax where the contract of employment contains a payment in lieu of notice (PILON) clause.
• Bonus and Commission payments: all contractual bonuses and commission should be paid in accordance with the terms set out in the employment contract. Discretionary bonuses may also need to be paid and we will provide advice on this.
• Pension: the employer may have a contractual obligation to continue to pay pension contributions, particularly during the notice period, if notice is to be paid in lieu.
• Medical and Life Insurance: some schemes require cover to stop on the date of termination of employment others allow cover to continue up to the date that the employer has paid the relevant premium.
• Compensation for loss of office: a payment of up to £30,000 can be made to the employee tax free provided it is an ex gratia payment and not as a result of a contract term

Q: Settlement Agreements- are there any formalities?

Yes, the agreement will only be binding if:

• The agreement is in writing.
• The employee has received independent legal advice from a relevant adviser (usually a solicitor) on the terms and effect of the proposed agreement. The adviser must be identified in the agreement.
• The agreement states that the conditions regulating Settlement Agreements have been satisfied.
• The agreement must specify what claims or potential claims are covered by it.

Q: What terms are usually contained in a Settlement Agreement?

The typical terms include:

• That the employer will pay the salary and accrued benefits, including untaken holiday, up to the date of termination of employment.
• Payment in lieu of employee’s notice period if the employee is not required to work their notice. Advice will be required on whether this payment should be subject to tax.
• Payment of compensation for loss of employment. This can be paid tax free up to a maximum of £30,000.00.
• The employer may require the employee to provide an indemnity in respect of any tax liabilities for payments made under the agreement.
• The employee may be asked to enter into restrictive covenants relating to contacting clients, suppliers or employees of the employer and against disclosure of confidential information belonging to the employer. In some circumstances it may be appropriate to offer an additional sum to the employee in the Settlement Agreement to ensure that the covenants can be enforced against them.
• The employee may be asked to warrant (confirm) that they do not have an existing job offer and that they have not committed any act of gross misconduct.
• The employer will often agree to provide a reference for the employee, the terms of which are usually agreed in advance. There is no duty to provide a reference except in certain employment sectors. However if a reference is given if must be true, accurate and fair. When providing a reference a duty if care is owed to the ex employee and to future employers.

Q: What if the employee believes they have a claim against the employer?

If the employee believes they may have a claim against the employer, for example for unfair dismissal or discrimination the potential value of the claim needs to be assessed and advice provided on whether the sum offered in the Compromise Agreement is a fair settlement sum. If necessary we can negotiate with the employer to increase the amount offered. We may have to charge you for the time spent in doing this.

Q: What are the tax consequences of a Settlement Agreement?

Under an exemption granted by HMRC payments of up to £30,000.00 (in total) to the employee under a Settlement Agreement can be paid free of tax. However how the payments made under a Settlement Agreement are treated for tax purposes varies according to the type of payment:

• Salary and benefits to the date of termination including payment in lieu of holiday are subject to tax and national insurance deductions in the normal way and should be paid net of these.
• Payments in lieu of Notice are taxable where provision is made for them in the employees contract or employee handbook.
• Payment for loss of office or employment can be paid gross and will count towards the £30,000 exemption.
• Statutory and contractual redundancy payments can be paid gross and will count towards the £30,000 exemption.

If the Settlement Agreement includes compensation that exceeds the £30,000 exemption the employer must deduct tax at the OT tax code rate which may mean making deductions at different rates from 20% to 50% depending on the extent to which the payment exceeds £30,000.

Q: Is the employer required to pay the employees legal costs for the independent legal advice on the Settlement Agreement?

There is no legal obligation on the employer to pay for the employee’s legal costs but it is usual to make a contribution towards the costs. This contribution varies according to the sums involved, the complexity of the situation and even the geographical location of the employee. We can advise you on what level of contribution to offer.

For a copy of our presentation on settlement agreements and protected conversations, please click here.