Settlement Agreements
What is a Settlement Agreement?
Settlement agreements, formerly known as compromise agreements, are often used as an alternative to the employer going through a lengthy disciplinary, performance management or redundancy procedure. Settlement agreements may also be used by employers as a means of settling serious employee grievances, such as claims of constructive dismissal or unlawful discrimination.
Essentially, a settlement agreement is a formal, legally binding agreement made between an employer and employee (or ex-employee) where the employee agrees not to pursue particular claims in relation to their employment or its termination e.g., unfair dismissal or discrimination claims. In return, the employee generally receives a financial settlement and, usually, an agreed form of reference. A settlement agreement must be entered into voluntarily. In most cases, settlement agreements are used because the employer wishes bring an employee’s employment to an end quickly and with the minimum of trouble, while avoiding the expense and uncertain outcome of an employment tribunal.
Employers should seek professional advice before starting conversations with an employee about a settlement agreement.
ACAS has issued a Code of Practice about the use of settlement agreements, which can be found here:
https://www.acas.org.uk/acas-code-of-practice-settlement-agreements.
What has to be included in a Settlement Agreement?
A number of important conditions have to be fulfilled, for the agreement to be legally binding:
- The agreement must be in writing.
- The agreement must relate to a particular complaint or proceedings.
- The employee must have received advice from a relevant independent adviser on the terms and effect of the proposed agreement and its effect on the employee’s ability to pursue that complaint or proceedings before an employment tribunal or other court.
- The independent adviser must have a current contract of insurance or professional indemnity insurance covering the risk of a claim by the employee in respect of loss arising from that advice.
- The agreement must identify the adviser.
- The agreement must state that the statutory provisions which set out the above conditions regulating the validity of the settlement agreement have been satisfied.
For the purposes of advising on a settlement agreement, an independent adviser can be:
- a qualified lawyer
- a certified and authorised officer, official, employee or member of an independent trade union who has been certified in writing by the trade union as competent to give advice and is authorised to do so on behalf of the trade union or
- a certified and authorised advice centre worker if they have the same certification required for a trade union.
The agreement is contractually binding once it has been signed by both parties so, if one party breaches the agreement, the other is no longer bound by its terms. For example, if the employer does not pay what has been agreed in the settlement agreement, the employee can take his or her claims to the employment tribunal or court.
Pre-termination Conversations
Since 2013, pre-termination negotiations (known as 'protected conversations') between an employer and employee with a view to ending the employment under a settlement agreement have not been admissible as evidence in most unfair dismissal claims. The idea is to extend the traditional "without prejudice" rule to circumstances where no dispute exists between employer and employee. However, the confidentiality of pre-termination negotiations applies only to unfair dismissal claims.
Pre-termination discussions are not protected if the employee has been dismissed for an automatically unfair reason, for example taking maternity leave. In addition, where something ‘improper’ is said or done, the content of the discussions is protected only to the extent that the tribunal considers just. Improper conduct would include bullying or harassment. Further advice on pre-termination (protected) conversations can be found in the ACAS Code of Practice on Settlement Agreements and employers should proceed with caution in using such conversations to end employment disputes.
Employers should be aware that an employee can rely on what was said during pre-termination negotiations as evidence in other types of claims, for example a discrimination or whistle-blowing claim. Employers should, therefore, continue to use "without prejudice" discussions in negotiating with an employee to settle an employment dispute wherever possible. For the “without prejudice” rule to apply, the employee must have genuinely agreed to the meeting being held on a without prejudice basis, there must be a pre-existing dispute between the parties and the discussion must be a genuine attempt to settle the dispute.
The Negotiation Process
Usually, the employer (or its solicitors) will produce the draft settlement agreement. The employer will then request that the employee take independent legal advice on it. Employees should be given a reasonable amount of time to consider the proposed conditions of the settlement agreement; the ACAS Code of Practice on Settlement Agreements specifies a minimum of 10 calendar days. Employers should note that settlement agreements are voluntary and parties do not have to agree to them or enter into discussion about them.
There will generally be a period of negotiation between the parties until they manage to agree on the terms of the settlement agreement or they both conclude no agreement can be reached. If a settlement agreement is not reached, resolution may be pursued through a performance management, disciplinary or grievance process, whichever is the most appropriate. If both parties agree on the settlement agreement, two copies are produced for signature. Once the copies have been signed by both parties, the agreement becomes legally binding. Each party will keep one of the copies.
In order to protect themselves, employers should state that, until a settlement agreement is signed by all parties, no part of it is binding.
The Taxation of Termination Payments
Not all payments made on termination of employment under a settlement agreement are tax-free.
Outstanding wages, bonuses, commission and holiday pay are fully taxable, as are payments made under the employee's contract of employment. Ex gratia (non-contractual) sums paid as compensation for loss of employment under the terms of the settlement agreement are taxable, but subject to the £30,000 tax-free exemption. This includes statutory and contractual redundancy payments, provided that they are made on account of genuine redundancy.
Following a change to the law in 2018, all notice payments or sums attributable to the notional notice period are taxable in full as earnings. This means, therefore, that all notice pay is subject to tax and national insurance.