Settlement Agreement Factsheet
If you have been offered a settlement agreement by your employer and need to take legal advice, this fact sheet sets out information you should be aware of when considering the proposal made.
What is a Settlement Agreement?
A settlement agreement (formerly known as a compromise agreement) is an agreement between an employer and an employee which settles claims that the employee may have against their employer, normally arising from the termination of their employment.
The primary purpose of a settlement agreement is to set out the terms of settlement between the parties, and then to prevent the employee from bringing legal action against the employer in respect of their employment and/or its termination. Normally, the settlement agreement will provide a financial incentive/compensation to the employee to enter into the agreement, such as a termination or severance payment.
The main benefit of entering into a settlement agreement is the certainty it provides to both parties, effectively drawing a line under the employment relationship.
A settlement agreement will only become binding if you and your employer sign it, after you have received independent legal advice on it, usually by a qualified solicitor.
Settlement agreements can be used in many circumstances, including cases of redundancy, misconduct, performance management, sickness absence, TUPE (transfer of a business) and discrimination or grievance resolutions.
Due to the cost to both parties of Employment Tribunal proceedings, and the uncertainty of outcomes, settlement agreements have become commonplace and are a route to agreeing a fast, certain and amicable method of settling claims.
What is a ‘Protected Conversation’?
A protected conversation is the common term used by employers and solicitors to describe a conversation which takes place pre-termination to seek to agree the termination of the employment under a settlement agreement.
Such conversations are ‘protected’ from being disclosed in unfair dismissal claims provided that certain rules prescribed by ACAS are followed. The rules include that the employer must not act improperly, which includes that they must give the employee adequate time to consider the offer made (normally a minimum of ten days), and must not place undue pressure on the employee to sign the settlement agreement, for example by stating that they will be dismissed if they do not sign it.
Ordinarily, during the protected conversation, the employer will make an offer to terminate the employment under the terms of a settlement agreement and provide a copy of the draft settlement agreement.
Why Do I Need Legal Advice?
The legal provisions which cover the validity of settlement agreements state that to be binding the employee must have taken independent legal advice. This is to protect the employee, as without legal advice on what can be a legally complex document, the employee might give up a very valuable claim, or could be agreeing to terms which are very detrimental to them.
Normally, the legal adviser will be a solicitor. The solicitor will be required to provide a declaration to state that they have given advice to the employee. All such advisers must have professional indemnity insurance to provide the advice, which Smith Partnership have in place.
The good news is that the employer will usually agree to pay for the employee’s legal advice when entering into a settlement agreement. Our solicitors will always attempt to ensure that we work within the legal fee contribution made by the employer, except where protracted negotiations are necessary in which case we will always seek to get the employer to increase their legal fee contribution.
What Will the Main Terms of a Settlement Agreement Normally Cover?
The terms of a settlement agreement will normally include:
The date on which your employment will terminate and the reason for the termination.
Whether you will work your notice period, be placed on ‘gardening leave’ or be paid in lieu of notice.
The continuation of benefits where applicable, including company car entitlement, private medical or healthcare cover and pension contributions.
The position with payment or taking of accrued holiday entitlement.
Payment of any pro-rata or accrued bonus entitlement.
The compensation payment or termination payment that will be made to you if you sign the settlement agreement.
The tax treatment of the payments made to you, which may include up to £30,000 being paid without deductions for tax and National Insurance (see below – ‘Will I pay tax on the payments?’)
An indemnity from you to meet the liability for any future taxation claims by HMRC.
A waiver or settlement of claims through which you agree not to pursue certain listed claims to an Employment Tribunal or other court.
An agreement for you to keep both your employer’s information confidential, as well as the terms of the settlement agreement confidential.
An agreement for you to not make any derogatory or disparaging comments about the employer and its employees.
An agreed job reference that will be sent to your future prospective employers.
The details of any continuing obligations upon you after the employment ends, including any post-employment restrictive covenants preventing you from competing with the employer, or poaching their customers or employees.
The details for return of any company property, such as keys, mobile phones, computer equipment and company vehicles.
A contribution towards your legal fees for taking advice on the agreement.
Any offer of outplacement services made by the employer.
An agreed internal/external announcement explaining the termination of your employment.
We will advise you on whether your settlement agreement covers the areas we would expect it to and whether it is fair, balanced and reasonable. We can negotiate the terms of the settlement agreement directly with your employer or their advisers, including the value of any payments offered to you.
Will I Pay Tax on the Payments?
Payments under the settlement agreement which are contractual will normally be subject to deductions for tax and National Insurance. This will include all payments for salary, notice, bonus payments including retention or loyalty bonuses and accrued holiday payments. Further, if a payment is for a future undertaking, such as agreeing not to compete with the employer after the employment ends, this payment will be subject to tax and National Insurance.
The tax rules for notice pay are complex. In summary, HMRC will claim tax and National Insurance on most payments of notice and if the employee has neither worked their notice nor have they received a separate notice payment (known as a “payment in lieu of notice” or “PILON”) then HMRC will claim for tax and National Insurance against the payment received under a settlement agreement for the period of notice that the employer would have had to have given to terminate the employment lawfully. This is known as “Post-Employment Notice Pay”. We can assess for you the likely tax treatment for your payments.
With the exception of the contractual payments referred to above, generally payments on termination which are genuinely non-contractual or ‘ex gratia’ can be paid by your employer tax free up to a maximum total of £30,000. Any such payments over £30,000 will be subject to tax on the amount by which it exceeds £30,000. The £30,000 tax free rule includes an entitlement to pay statutory redundancy pay and contractual redundancy pay tax free.
The tax treatment of your settlement agreement is important as the agreement will include an indemnity in favour of the employer stating that you will repay to the employer any tax or National Insurance, and normally any additional payments such as penalties and interest, if HMRC challenge the tax treatment applied.
What if I am not Happy with the Settlement Agreement Offer?
As well as advising you on the terms and merits of the settlement agreement offer made to you, we can discuss your other options which may include:
- Negotiating the terms of the settlement agreement
- Rejecting the offer and remaining in the employment of the employer
- Claims in the Employment Tribunal
Smith Partnership provides advice on settlement agreements in each of our branch offices in Derby, Leicester, Burton upon Trent, Stoke-on-Trent and Swadlincote, or by email or telephone. It is not essential to meet you, and therefore we provide settlement agreement advice to clients across the UK.
We will discuss the process with you and make arrangements for a consultation meeting to advise you on the settlement agreement offered to you. We will normally ask to see a copy of the settlement agreement and your contract of employment in advance.
We can normally provide settlement agreement advice very quickly as we understand that there are often tight timeframes to respond to employers. We will often be able to see clients with settlement agreements within one working day of their initial contact.