Previously known as a compromise agreement, a settlement agreement is a legally binding contract between an employee and their employer and is usually used to terminate the employment relationship on mutually agreed terms.
As the name implies, settlement agreements can often be used to bring about a conclusion to (ie. to settle) a workplace dispute. In this instance, an 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.
Much certainty
As to why an employer would want to bring an end to an employee's employment using a settlement agreement, Sophie Wahba, a solicitor at Wright Hassall, provides further insights. According to Wahba, ‘they are used when the employment relationship between an employer and an employee inevitably breaks down; this could be due to several reasons and the most common scenarios are due to an employee's conduct, performance, capability, or an employee's role being at risk of redundancy’.
She says that, in many situations, the only alternative to a settlement agreement available to the employer is to follow a lengthy, and often costly, process to ‘fairly’ terminate the employment relationship. In this light she says that ‘a settlement agreement can be an appealing alternative option to employers to help bring about a swift and amicable end to an employment relationship’. She adds that it can be attractive to employees, too, where an enhanced termination payment is on offer.
Additionally, 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 that sets out the severance payment they will receive. An agreed reference and internal announcement will often be appended to the agreement. However, from the employer's perspective, it will speed up the termination process, and they will have protection against a vast range of legal claims.
In other words, Wahba notes, ‘the agreement will offer certainty and clarity for both parties regarding the severance terms. This is why it is a legal requirement for an employee to take legal advice on the terms of the settlement agreement before signing it’.
The best approach
It is notable that employees can request a settlement agreement from their employer. Although Wahba says that this is less common, she says that they tend to be asked for when an employee ‘is experiencing issues at work that has made them consider claiming against their employer—for example, with regard to discrimination or constructive unfair dismissal’. Simply put, they may wish to ask for a severance package to bring matters to a conclusion. That said, there is no obligation on the employer to grant such a request.
From an employer's perspective, Wahba thinks the matter less straightforward and would also advise that employers seek legal advice before offering an employee a settlement agreement as ‘the correct or most appropriate approach will depend on the circumstances in which you want to offer your employee a settlement agreement’.
She says that the most common approach is to offer a settlement agreement during a ‘protected conversation’ under section 111A of the Employment Rights Act 1996. However, where circumstances do not allow for a protected conversation to occur, say where there is an ongoing dispute between the parties, then she recommends that a ‘without prejudice’ conversation may be more appropriate.
As she details, ‘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’.
It should be pointed out that there are circumstances where this protection will not apply. An example of this is 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.
Furthermore, Wahba points out that 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 and 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’.
Time to consider
Referring to the risk of improper conduct, when it comes to giving an employee time to consider the offer, Wahba says that under no circumstances should an employee be coerced or placed under undue pressure into accepting a settlement agreement—it is meant to be an entirely free decision.
She refers to the Advisory, Conciliation and Arbitration Service Code of Practice on Settlement Agreements, which ‘while not legally binding, recommends that an employee is given 10 calendar days to consider the offer’. She thinks this is the minimum time frame.
Additionally, 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. Naturally, employers should not be surprised if the employee seeks to negotiate the initial severance payment, and they may instruct a lawyer to negotiate for them or do so on their behalf.
Terms to include
As with any document, settlement agreements may be drafted in different ways. However, the broad contents of them tend to be standard and would typically include:
- A termination date
- 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
- Accrued but untaken holiday pay
- Entitlements to contractual benefits such as bonus or commission on the termination date
- A time frame for payment of the sums due under the agreement
- What will happen to the employee's pension upon termination
- An obligation for the employee to return company property on or before the termination date
- Confidentiality provisions
- Post-termination restrictions
- A tax indemnity clause, which will also set out the tax position of the termination payment
- A waiver of claims, including those claims that are excluded
- A reference (although this is not mandatory)
- A contribution towards the costs incurred by the employee seeking legal advice on the agreement
- Consequences for breaching the agreement.
» Should a breach of a settlement agreement occur, once concluded, Wahba says that it can be enforced in the civil courts, or the Employment Tribunal as a contractual claim, providing the settlement agreement was made before the termination of employment «
Offers to employees
As to what to offer an employee, there is no rule on this. However, as Wahba says, ‘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’.
At this point, it should be said that any notice pay, holiday pay or other contractual payments, such as a bonus or commission, will be taxable as earnings. However, Wahba advises that ‘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’.
She adds that there are certain claims that a settlement agreement specifically carves out in the agreement itself as not being waived. These include claims by the employee to enforce the settlement agreement if the employer breaches the agreement; claims by the employee in respect of personal injury of which they were not aware of and could not reasonably be expected to be aware of at the date of the settlement agreement (other than claims under discrimination legislation); and claims by the employee in relation to accrued entitlements under the pension scheme.
Wahba adds that there are further exceptions relating to the Transfer of Undertakings (Protection of Employment) Regulations 2006 and in relation to failure to inform and consult in collective redundancy situations.
An employee refuses to sign
A natural question to ask is what happens if an employee refuses to sign. In answer, Wahba says that this depends on the circumstances that have led to the settlement agreement being offered in the first place.
However, she explains that, ‘from the employer's perspective, the alternative option may be to bring the employee back to work and commence a formal disciplinary or capability process. This may still result in dismissal at the conclusion of the process’.
Yet, from the employee's perspective, Wahba says that ‘they may decide against signing 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 time frames for bringing Employment Tribunal claims are very strict, though.
Dealing with breaches
Should a breach of a settlement agreement occur, once concluded, Wahba says that it can be enforced in the civil courts, or the Employment Tribunal as a contractual claim, providing the settlement agreement was made before the termination of employment.
Once signed, can an employee ‘go public’ with their story? Again, Wahba's view is that this ‘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, she warns that 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’.
Wahba continues: ‘In the vast majority of circumstances, an employee will be in breach of the agreement if they discuss any matter relating to it with a third party (aside from those expressly excluded within the agreement)’.
So, 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.
Summary
Settlement agreements have a role to play in the workplace. However, all need to recognise that they are legally binding contracts and so all need to follow good advice before getting involved with them.