Settlement Agreements Guide
- What is a Settlement Agreement?
- When would a Settlement Agreement be used?
- What are the incentives for each party?
- What are the alternatives to using a Settlement Agreement?
- Are Settlement Agreement payments tax-free?
- What if the employee works between the date of agreement and the termination date?
- Does the employee waive all of their rights to bring a claim?
- What does the employee warrant?
- What does the employer warrant?
- What if either party breaches the Settlement Agreement?
- What else should be included in the Settlement Agreement?
- Our Team
What is a Settlement Agreement?
An agreement that is aimed at settling all present and future claims between an employer and employee. If agreed and signed by both parties the effect of the settlement agreement is to draw a line under the employment relationship. Neither party can force the other to accept a settlement agreement. The terms in the settlement agreement are normally reached after negotiation.
The settlement agreement should set out all terms between the parties for example: termination date; payments owed; immediate and on-going obligations of each party; warranties; indemnities; reference.
One of the conditions for a settlement agreement to be valid is that the employee has received independent legal advice on the terms and effect of the agreement from a legal adviser. The fees associated with this advice are frequently covered by the employer. Regardless of who is paying the legal costs, the adviser must act in the individual’s best interests!
When would a Settlement Agreement be used?
Usually settlement agreements are suggested either when a claim has already been filed by an employee or when one is contemplated by the employee and/or anticipated by the employer. However, in some industries (such as investment banking) it is becoming increasingly common for settlement agreements to be offered to all exiting employees because it provides certainty to the employer.
Most often a settlement agreement will be suggested by the employer. This will be in the context of a “Without Prejudice” conversation or correspondence.
What are the incentives for each party?
The incentives for an employer to enter in to a settlement agreement may be to: settle an existing claim; gain certainty about existing and/or future claims; limit the time, legal fees and business costs associated with litigation; include terms that protect the company (such as a clause ensuring no derogatory comments are made about the company); have clarity on the sums that are owed and when they are payable; return of company property; re-assertion of post-termination restrictions and/or adding new ones (in return for consideration); and/or confidentiality on the fact and terms of the agreement.
Some likely incentives for an employee are that: they should be offered more than they are entitled to under their contract and under statute; their reference may be agreed; an announcement about their departure may be agreed; and/or they can be protected by other terms (such as that the company must not make derogatory comments about them and the agreement must be kept confidential). If the employee has already filed a claim against their employer or former employer then agreeing a settlement agreement with terms that are acceptable to them would mean less time, energy and legal fees need to be invested.
What are the alternatives to using a Settlement Agreement?
If the employee has not filed a claim against the employer and a settlement agreement is not agreed then the employer may be content to run the risk of having a claim filed against them. (The level of risk of which will depend on all the circumstances.)
If the employee or worker has already filed a claim against the employer then the options are to take the claim through the tribunal process to hearing and (potentially if the employee is successful) remedy; to mediate; or to agree a COT3 (generally a less detailed settlement agreement arranged through the conciliation service ACAS).
Are Settlement Agreement payments tax-free?
- Notice pay, any sums paid pursuant to a contract (such as payment for accrued holiday, or a contractual bonus) and anything deemed to be ‘salary’ will be taxable. This is because those sums are classed as ‘earnings’. Since 6 April 2018, employers have been required to subject to tax and class 1 National Insurance Contributions an amount equivalent to the employee’s basic pay for any periods of unserved notice. Therefore notice pay is taxable whether notice is worked, paid for ‘garden leave’, paid in lieu of notice (regardless of whether the employment contract has a Payment in Lieu of Notice clause or not) or a combination of the foregoing.
- If a sum within the settlement agreement is genuinely “ex-gratia” or compensation for loss of employment (and is demonstrably not Post-Employment Notice Pay) then up to £30,000 of it can be paid ‘tax-free’ (or rather, taxable at 0%). Statutory redundancy payments and enhanced or contractual redundancy payments come under the £30,000 tax-free exemption. Over £30,000, sums of these types will be taxable at the individual’s normal rate.
- Payments that relate to restrictive covenants are taxable. If a sum is not attributed to “new” restrictive covenants then this should be agreed so that the entire compensation package does not become taxable.
- Payment of the employee’s legal fees within the settlement agreement is tax-free (to the extent that they relate to advice on the settlement agreement). This is an advantage for the employee who would otherwise be paying their legal costs out of taxed income. (N.B. The VAT on the legal costs will not be recoverable by the employer.)
- If an employee has more than two years’ service then payment for outplacement assistance is tax-free.
- More often than not a settlement agreement will include a tax indemnity outlining that tax will be paid by the employee if the payment is assumed to be tax-free but becomes taxable. However, the settlement agreement should outline that the employee is not responsible for any penalty charges issued by HMRC if they were caused by the employer.
What if the employee works between the date of agreement and the termination date?
- In the vast majority of cases, a settlement agreement will provide for termination of employment on or around the date the settlement agreement is signed.
- However, if the employee continues working for some time after signing a settlement agreement the employer may wish to provide for a second or ‘confirmatory’ settlement agreement to be signed after the termination date.
- Alternatively, the employer may put the employee on garden leave for the duration of the period to termination.
Does the employee waive all of their rights to bring a claim?
- If the settlement agreement is drafted correctly then the effect should be that all existing and future claims by the employee against the employer are waived.
- Under law, an employee’s right to bring certain specified claims cannot be waived including: personal injury claims (unless the injury is known about at the time the agreement is signed and a claim is waived), a claim for accrued pension entitlements and a claim to enforce the terms of the settlement agreement itself.
What does the employee warrant?
The following are common warranties for employees to give in the settlement agreement:
- That they have not committed a fundamental breach of contract.
- That they have not (at the date of the agreement) received another offer of employment.
- That they have returned all company property.
- That they no longer have any confidential information belonging to the company.
- That they have raised any potential claims against the company with their independent legal adviser.
- That they will keep the terms of the agreement and the circumstances leading up to the termination of their employment confidential.
- That they will not make derogatory statements about the company or group companies and its/their officers and employees.
What does the employer warrant?
The following are common warranties for an employer to give in the settlement agreement:
- That they will keep the terms of the agreement and the circumstances leading up to the termination of the employee’s employment confidential.
- That they will not make derogatory statements about the employee.
What if either party breaches the Settlement Agreement?
If the employee breaches
Depending on the drafting, the employee may have to repay all of the sums in the agreement, part of them or none of them. For example, the agreement may provide for repayment only in the event that the employee breaches a ‘material’ term. Employees may only have to repay the ex gratia payment(s).
If the employer breaches
If negotiations are not successful following a breach by the employer, then the employee will have to bring a breach of contract claim against the employer. Or (if the time limits allow) they could seek to file a claim against the employer at the Employment Tribunal and/or reinstate a claim settled under the (breached) settlement agreement.
What else should be included in the Settlement Agreement?
- If you want to be able to enforce the agreement in England & Wales then it should be stated that the law of England & Wales governs the contract and that the courts of England & Wales will have exclusive jurisdiction.
- It is extremely helpful to have a clause stating that the agreement can be signed in ‘counterparts’ (i.e. that each person can sign a different copy of the settlement agreement).
- You may wish to have an ‘entire agreement’ clause stating that all previous agreements are superseded by this settlement agreement. However, check with your legal adviser whether this could have any adverse consequences.
- If a Reference has been agreed then an example should be included as a Schedule to the agreement.
- The employee’s legal adviser’s certificate must be included as a Schedule to the agreement. The employee must have received independent advice in order for the agreement to be valid!
Our Senior Executive Unit has a wealth of experience and expertise in dealing with settlement agreements. Furthermore, as we regularly advise our corporate clients on settlement agreements, we are expertly equipped to anticipate the actions of employers. This is a valuable asset when negotiating terms.
This publication is intended for general summary guidance. It is not and should not be considered legal advice. Specific advice should be sought for specific cases; we cannot be held responsible for any action (or decision not to take action) made in reliance upon the content of this publication.