A settlement agreement (previously known as a compromise agreement) is a legally binding contract between an employee and their employer. It is usually used to terminate the employment relationship on mutually agreed terms. Settlement agreements can often be used to bring about a conclusion to a workplace dispute.
The employer will usually provide a severance payment in return for the employee’s agreement to waive their right to bring almost all types of legal claim under the agreement. It is often a lengthy contract; however, it will be legally binding once it has been signed. Therefore, both parties will be held to obligations that will constitute a breach of contract if not adhered to.
We have set out some information below regarding settlement agreements and have answered some FAQs.
Why would you want use a settlement agreement?
Sometimes the employment relationship between an employer and an employee inevitably breaks down; this could be due to several reasons. The most common scenarios are due to an employee’s conduct, performance, capability, or an employee’s role being at risk of redundancy.
In many situations, the only alternative available to the employer is to follow a lengthy and often costly process to “fairly” terminate the employment relationship. When this transpires, a settlement agreement can be an appealing alternative option to employers to help bring about a swift and amicable end to an employment relationship. It can be attractive to employees, too, where an enhanced termination payment is on offer.
Both parties can benefit from entering into a settlement agreement. From the employee’s perspective, they will have the security of a legally binding contract setting out the severance payment they will receive. Often, an agreed reference and internal announcement will be appended to the agreement. From the employer’s perspective, it will speed up the termination process, and they will have protection against a vast range of legal claims. The agreement will offer certainty and clarity for both parties regarding the severance terms.
It is a legal requirement for an employee to take legal advice on the terms of the settlement agreement before signing it.
Can I request a settlement agreement from my employer?
As an employee, you can request a settlement agreement from your employer, although this is less common. If you are experiencing issues at work that have made you consider claiming against your employer (for example, discrimination or constructive unfair dismissal), you may wish to ask for a severance package to bring matters to a conclusion. There is, of course, no obligation on your employer to grant such a request.
What is the best approach to offering a settlement agreement?
We would always advise employers to seek employment law legal advice before offering an employee a settlement agreement. The correct or most appropriate approach will depend on the circumstances in which you want to offer your employee a settlement agreement.
The most common approach is to offer the settlement agreement during a “protected conversation” under section 111A of the Employment Rights Act 1996. Or, where the circumstances do not allow for a protected conversation to occur (for example, where there is an ongoing dispute between the parties), then a “without prejudice” conversation may be more appropriate.
In these types of conversations, provided that they are properly held, the issues discussed and the offers made cannot be used as admissible evidence in Employment Tribunal proceedings should the discussions not result in a settlement. This is why settlement agreements and negotiations are always marked “without prejudice” while the terms are discussed.
There are circumstances where this protection will not apply, for example, where the employer has engaged in improper conduct during the settlement negotiations, such as bullying or seeking to coerce the employee into accepting the offer.
Further, the protection provided by section 111A only covers situations where there is a risk of an unfair dismissal claim. In reality most Employment Tribunal claims involve additional complaints such as discrimination; it is in these matters where many employers may inadvertently lose the protection and elements of the settlement discussions may then become admissible evidence in subsequent Employment Tribunal proceedings.
It is for this reason that seeking legal advice and guidance in this area is essential.
How long should an employee be given to consider the offer?
Under no circumstances should an employee be coerced or placed under undue pressure into accepting a settlement agreement offered by their employer; it is an entirely free decision.
The ACAS Code of Practice on Settlement Agreements, whilst not legally binding, recommends that an employee is given ten calendar days to consider the offer. We would generally recommend that this is the minimum timeframe given. However, if you want to reduce the consideration period, we would recommend that you take legal advice on this.
Employees may wish to seek legal advice on the offer before they take advice on the terms of the agreement itself, the latter being a legal requirement.
Employers shouldn’t be surprised if the employee seeks to negotiate the initial severance payment. They may instruct a lawyer to negotiate for them, or they may do so on their behalf.
What terms are usually included in a settlement agreement?
Settlement agreements may be drafted in different ways. However, the broad contents of them tend to be fairly standard. A standard agreement would typically include:
- A termination date;
- A provision for salary and contractual benefits to be paid as normal up to the termination date;
- The amount of notice, or payment in lieu of notice, the employee is entitled to;
- A termination payment (sometimes referred to as an ex-gratia or severance payment);
- Accrued but untaken holiday pay, which is due to be repaid;
- Entitlements to contractual benefits such as bonus or commission on the termination date;
- A timeframe for payment of the sums due under the agreement;
- What will happen to the employee’s pension on termination;
- An obligation for the employee to return company property on or before the termination date;
- Confidentiality provisions;
- Post-termination restrictions (e.g. non-competition clauses);
- A tax indemnity clause, which will also set out the tax position of the termination payment;
- A waiver of claims included those claims which are excluded;
- A reference (although this is not mandatory);
- A contribution towards the employee seeking legal advice on the agreement;
- Consequences for breaching the agreement;
How much should an employee be offered?
There is no “rule” as to how much an employee should be offered. In most cases, it will depend on the circumstances of the proposed termination and the potential risk, or alternative cost, to the employer, should the employee reject the offer and either come back to work or issue a claim in the Employment Tribunal.
We would advise seeking legal advice regarding an appropriate level of the offer in each case.
Will any payments made under the settlement agreement be tax-free?
Any notice pay, holiday pay or other contractual payments such as bonus or commission will be taxable as earnings.
However, as the law currently stands, an employee is entitled to receive up to £30,000 tax-free for payments compensating for the loss of employment. This should be clearly set out within the settlement agreement.
Does an employee waive all claims under a settlement agreement?
There are certain claims that a settlement agreement specifically carves out in the agreement itself as not being waived. These include the following:
- A claim by the employee to enforce the settlement agreement if the employer breaches the agreement;
- A claim by the employee in respect of personal injury of which they were not aware and could not reasonably be expected to be aware of at the date of the settlement agreement (other than claims under discrimination legislation); and
- A claim by the employee in relation to accrued entitlements under the pension scheme.
There are further exceptions relating to the TUPE Regulations 2006 and in relation to failure to inform and consult in collective redundancy situations. We would advise you to take specific legal advice on this element of settlement agreements.
What happens if an employee refuses to sign a settlement agreement?
It will depend on the circumstances that have led to the settlement agreement being offered in the first place.
From the employer’s perspective, the alternative option may be to bring the employee back to work and commence a formal process (for example, a disciplinary or capability process). This may still result in dismissal at the conclusion of the process.
From the employee’s perspective, they may decide against signing the settlement agreement if they are not satisfied with the offer that has been made. Instead, they may proceed to issue a claim against their employer in the Employment Tribunal. The timeframes for bringing Employment Tribunal claims are strict, and so we would advise acting quickly.
How is a settlement agreement enforced if one party breaches it?
A settlement agreement can be enforced in:
- The civil courts for a breach of contract; or
- The Employment Tribunal as a contractual claim, providing the settlement agreement was made before the termination of employment.
If an employee has signed a settlement agreement, can they “go public” with their story?
It will depend on the circumstances of the matter; an employee cannot be prevented from reporting a crime to the police or “blowing the whistle” even if they have signed a settlement agreement.
However, settlement agreements will contain a confidentiality clause that provides that neither party can disclose the terms or existence of the settlement agreement or the circumstances that led to the termination of their employment.
Therefore, in the vast majority of circumstances, the employee will be in breach of the agreement if they discuss any matter pertaining to it with a third party (aside from those expressly excluded within the agreement). If an employee breaches the agreement in this way, they may be liable to repay their ex-gratia sum and potentially be liable for substantial damages and legal costs.