A guide to employment settlement agreements

A guide to settlement agreements

Settlement agreements are one of the most common pieces of work seen by employment lawyers; both drafting them and advising on their contents for employees who have been offered one.

Here, Chris Dobbs, solicitor in our specialist Employment & HR Team, answers some of the most common questions about settlement agreements, whether you are offering them as an employer or have been offered on as an employee.

We offer a free initial chat with one of our bright lawyers to all new clients, so if you'd like to speak with someone about any of the issues contained in this article, don't hesitate to get in touch.

The Basics

Settlement agreements can be complex, and this article covers a lot of ground, so you can either grab a coffee and settler in for a big read, or use the handy links below to skip to the bits that are most relevant to you.

1. What is an employment settlement agreement?
2. Legal Advice for settlement agreements
3. Signing a settlement agreement
4. What goes in a settlement agreement?
5. Are settlement agreements confidential?
6. Are confidentiality clauses legal?
7. Settlement agreements and tax
8. Settlement agreements - Jargon busting

What Is An Employment Settlement Agreement?

Settlement Agreements are legally binding contracts which are signed between an employee and employer. They settle claims which an employee may have arising from their employment such as pay claims or discrimination, or claims following termination of employment such as unfair dismissal.

Usually but not always, settlement agreements will involve a payment by the employer in exchange for the employee agreeing not to bring proceed with any legal claims they may have.

Compromise agreements is just an older name for what was basically the same thing until 2012. There were some slight differences in the regulations which mean that some (increasingly rare) claims still have to be dealt with under the old compromise regime.

When Can Settlement Agreements Be Used?

An employer can offer a settlement agreement in a variety of situations, but they are most commonly used in:

Redundancies 

If an employer wants to offer an enhanced redundancy sum and avoid the process of selection, a settlement agreement may be appropriate to ensure the employee does not pursue an unfair dismissal claim

Related Article: How to avoid making redundancies

Disciplinary Matter 

An employer may decide that a disciplinary process is too time-consuming and that a simple cost analysis means it is more expedient to offer the employee a settlement to leave without the need for the procedure to be followed. The employer can also avoid concern about claims which might arise as part of a disciplinary procedure such as unfair dismissal or discrimination

Grievances 

In very much the same way as for a disciplinary but with the reverse logic. Employers may want to avoid the implications of a grievance process by offering a settlement agreement and a quieter exit for the individual concerned.

Related: How to handle Workplace Grievances in 2023

How long do settlement agreements take?

There is no set time limit, but employees must be given ‘reasonable time’ to consider the agreement before signing. Acas recommends a minimum of 10 days for this.

In general, using a settlement agreement will be much faster than allowing the matter to go to an employment tribunal. Once a claim is entered with the tribunal, it typically takes around 6 months for a hearing. If you are seeking a swift resolution, a settlement agreement is therefore normally the best option.

Legal Advice for Settlement Agreements

The regulations which govern settlement agreements require the employee to take independent legal advice on its ‘terms and effects’ and, in particular, on its effect on the employee’s ability to pursue their claims to the tribunal.

Are settlement agreements binding?

In order to be legally binding, the employee must have taken this independent legal advice; and most settlement agreements will have a certificate which must be signed by the person giving the advice as proof that it has been taken.

Due to it being a legal requirement for employees to take the advice, employers will often make a contribution towards the employee’s legal costs in taking the advice.

Who can advise on settlement agreements?

Usually this will be a qualified lawyer although it is also sometimes possible for this advice to be given by a trade union representative or suitably qualified advice workers who are authorised to advise on such agreements.

We would always suggest that the advice obtained should be from a solicitor. Additionally to the advice required by law, a solicitor will also be able to discuss the circumstances surrounding the agreement with an employee and give some initial advice as to whether there may be further or more valuable claims which could also be settled. A result of this might be that the employee instructs the solicitor to try and negotiate a larger settlement figure.

Signing a settlement agreement

Who signs settlement agreements?

The agreement is designed to settle all and any claims an employee has against the employer. A truly independent advisor will only allow an employee to sign it once they are satisfied that the individual is happy with the amount offered and understands that they are agreeing not to pursue any additional claims further.

Can Settlement Agreements Be Signed Electronically?

Especially since the start of lockdown, an increasing number of settlement agreements have been completed remotely. The documents are circulated electronically, the advice is given remotely by phone or video and the agreement can be completed using electronic signatures.

What Goes In A Settlement Agreement?

The following are just some of the most common terms or provisions which might appear in a Settlement Agreement:

Termination

More often than not a settlement agreement is part of an employee leaving the business and so the agreement usually confirms a leaving date and reason.

Settlement Figure

The agreement is a contract in which the employee agrees not to pursue their potential legal claims arising from their employment. In order to be binding, and indeed of any benefit to the employee, there is almost always some kind of payment to them. This can be as simple as a redundancy payment or may be significantly more if the claims settled are serious.

The ‘Specified Claims’

Strictly speaking, settlement agreements are supposed to settle a specific complaint which an employee has or may have. Some agreements will set out the specific dispute in question but many will list anywhere between 20 and 40 ‘specified claims’ which tend to cover the most common employment law disputes.

The Tax Indemnity

Often the parties to the agreement will confirm that they understand the first £30,000 of a compensatory sum can usually be paid without tax deduction of tax. However, HMRC are the only people who can decide that and while it is very unlikely that this will change soon, an employer will not want to be left paying an employee’s tax for them if the situation changed.

Obligations on the Employee

These are usually things which the employer wants to make sure happens to ensure a smooth exit such as the return of company property, or a period of garden leave.There may also be a reminder of contractual post-termination restrictions and the employee’s duty to keep business information confidential.

Legal Advice

The employee will usually be asked to confirm that they have taken independent legal advice on the terms and effect of the agreement and confirm that they have told their legal advisor all the relevant facts leading to the dispute. In many cases, the advisor is expected to sign a certificate proving they have given the necessary advice.

Confidentiality

Settlement Agreements are confidential and the employee will be asked to promise not to discuss its contents or the circumstances leading to it with anyone other than a select group of individuals. This is subject to a few restrictions, however, which are often also included in the agreement.

Are Settlement Agreements Confidential?

By default, no they are not; but the agreement itself will almost always make sure that both parties agree it will be kept confidential.

The various regulations which govern settlement agreements do not make them confidential documents. In fact, the whole purpose of them is to settle a dispute and, if a claim is alter raised, serve as evidence that the complaint has already been resolved; it would be incredibly unhelpful to an employer if they could never reveal a settlement agreement to anyone else including their legal advisors, accountants or shareholders, for example.

However, many settlement agreements will contain a provision that the terms of it, the fact of its existence, and the discussions leading to it will all be kept confidential by both the employee and employer.

There may be some authorised disclosures to legal advisors, the employee’s immediate family or relevant members of the employer organisation for example, but beyond that it is usually a requirement that the parties do not discuss the contents.

Settlement agreements and gagging clauses

There was a lot of talk in recent years about so-called ‘gagging’ clauses, especially in public sector settlement agreements which concerned wrongdoing in organisations such as the NHS. These clauses claimed to prevent employees who left under such agreements from making ‘protected disclosures’ about wrongdoing (more commonly known as whistleblowing).

Settlement agreements and whistleblowing

That said, there is some value in preventing an employee from discussing, for example, an allegation of discrimination if half the purpose of the settlement agreement is to protect the reputation of the business from having the allegation proven true in open court.

Are confidentiality clauses legal?

Confidentiality clauses are basically legal however it is important to note that an employer cannot prevent an employee, even by this kind of clause, from making certain kinds of disclosure such as reporting a regulatory breach or a criminal offence committed by the employer.

Are settlement agreements public record?

Settlement agreements do not appear on any kind of public record in the UK and most are only ever disclosed to HMRC or, where a dispute arises later, as part of court proceedings concerning their own enforcement.

Settlement Agreements and Tax

The tax rules surrounding settlement payments can be complicated and while your lawyer will be able to advise in general terms, and also on options about how payments can be made in the most tax efficient way, we would strongly recommend that clients seek tax advice before offering or accepting substantial settlement figures.

Are settlement agreements tax free?

The taxable status of almost all sums is governed by the Income Tax (Earnings and Pensions) Act 2003 which is often referenced in the agreement itself. This Act sets out how income tax is paid on what types of payments in every day life and applies equally to payments made under a settlement agreement. The general position is as follows:

• Anything which amounts to employment income is likely to be subject to tax. That includes ongoing earnings, notice pay, a payment in lieu of notice, accrued holiday pay and any payment in lieu of other taxable benefits.
   
• Statutory redundancy payments can be made free of tax.
   
• Compensatory payments up to £30,000 can usually be paid free of tax. The parties will rely on sections of the Act but it is important to remember that neither the employer nor the employee’s lawyer can guarantee that HMRC will not decide tax is payable on any given sum or part of it. Any redundancy payment counts towards this amount and compensatory payments including sums for ‘loss of employment’ and discrimination ‘injury to feelings’ payments.
   
• Payments in excess of £30,000 are subject to tax and employer’s national insurance contributions on the sum which exceeds this limit.

Are all settlement agreements taxable?

The best advice, especially in larger settlements, is to take the relevant tax advice or at least contact HMRC to confirm the position. The taxable status of various components has changed over time. For example, payments in lieu of notice used to be considered non-taxable and so it is very important to understand what elements of the settlement are and are not taxable.

Settlement Agreements - Jargon Busting

Employment disputes which are resolved by settlement agreement often conclude very quickly and yet the agreements contain a huge amount of legal jargon. Employees and employers alike may find themselves swimming in this language without being engaged in the process for long enough to really come to terms with what it all means.

Glossary of Terms 

ACAS

The Advisory, Conciliation and Arbitration Service is an independent body established to help encourage strong workplace relations between employees and employers. They play a role in employment disputes and can help to negotiate settlement terms. They also provide guidance and support to both employees and employers.

Remember, we offer a free initial chat with one of our bright lawyers to all new clients, so if you'd like to speak with someone about any of the issues contained in this article, don't hesitate to get in touch.

Breach of Contact 

A breach of contract in employment law terms is when one party or the other does something which is not allowed or doesn’t do something which is required of them under the contract of employment. Terms of employment contracts can be express (i.e. stated in writing or otherwise) or they can be implied either by previous behaviour or by law. The wronged party is able to sue for breach of contract and this can be as simple as not being paid the correct wages.

Contract 

A binding and legal agreement between two parties. English contract law is a huge area which developed over hundreds of years into the system we have today. Contracts do not have to be written down, they can be verbal as long as they meet all the other requirements.

COT 3 Agreement 

This is a form of agreement which is arranged by someone from ACAS to settle an employment dispute. They are more common after a claim has been issued to the Employment Tribunal and are often significantly shorter than a settlement agreement.

Compensatory Payment 

This term, or sometimes a variation of it, refers to an amount of money which someone is paid to make up for damage suffered or some kind of loss. In employment cases this is usually past or future loss of earnings. Separately, there may be contractual payments which are simply sums the employee was due anyway such as accrued wages or holiday. Compensatory payments can also be made for the loss or breach of a legal right.

Derogatory Comments

Increasingly in settlement agreements there will be a clause about derogatory comments, sometimes called “non-disparagement clauses”. All this means is that the parties are agreeing not to say anything about the other after the matter has concluded which is negative, offensive or potentially damaging to their reputation. This is especially important in the era of social media.

Early Conciliation

Back to ACAS. Before issuing a claim to the Employment Tribunal, a potential claimant has to notify ACAS who will then see if they can assist in resolving the dispute without resorting to going to Tribunal. If the parties cannot agree, ACAS will issue an ‘Early Conciliation Certificate’ to show that they have tried. The time the parties spend in this period can be important as it affects the time limits to issue an employment tribunal claim.

Employment Tribunal

An important one: this is the type of court where most employment disputes are heard in the UK. Cases are decided by an employment judge, usually alone, or by a panel of three people in discrimination cases. In discrimination cases the Judge is assisted by two lay (not legally-qualified) members; one will be from an employer background and the other from an employee background.

Ex-gratia Sum/Payment

Money which is paid ex-gratia is paid as a goodwill gesture rather than because there is a legal obligation to do so. The literal translation is “by favour” so this could an employer offering a sum of money because they feel morally obliged to do so rather than because the law says they must.

Indemnity(ies)

These are promises to compensate the other party for any loss they might suffer or to do deal with any liability they might incur. The most common example in settlement agreements is an additional tax indemnity. If HMRC decide that more tax is due on a compensatory sum they will take it against the employer under PAYE. The employee agrees to indemnify the employer for this sum as, of course, income tax and national insurance are both personal taxes. Indemnities can be used in many other situations.

ITEPA

This is the excitingly named Income Tax (Earnings and Pensions) Act 2003 which was drafted to make income tax clearer. It applies to settlement agreements because parts of the Act refer to payments which may not be taxable and it is from here that most ex-gratia payments under £30,000 are paid tax-free.

PILON

A payment in lieu of notice. Most employees are entitled to a notice period during which they are supposed to continue working. In some cases, an employer may wish them to leave immediately in which case they will make a payment equivalent to what the employee would have earnt during the notice period.

Post-termination Restrictions

Sometimes referred to as ‘restrictive covenants’ these are terms contained either in an employment contract or the settlement agreement itself which deal with things an employee is not allowed to do after the employment ends. They commonly prevent an employer from working in competition, poaching clients or other employees or dealing with previous suppliers within a specified distance for a certain time. These kind of restrictions are unenforceable by default but can be justified if they are only as restrictive as necessary to meet the employer’s legitimate business needs.

Protected Conversations

These are discussions which can be had between an employee and employer concerning a settlement. They cannot be referred to in most employment tribunal claims later providing they are conducted fairly and the parties are not already in legal dispute. These conversations can be useful to test the waters about leaving by agreement.

Protected Disclosure

These are statements made by an individual to their employer or another person or organisation about a breach of law which is a matter of public interest. It is often known as ‘whistleblowing’ and the person doing it a ‘whistle blower’. The law about making protected disclosures can be very complicated and dismissing an individual for making a genuine protected disclosure is very likely to be unfair.

Relevant Independent Adviser

Includes us. This is a person who meets the definition set out in the legislation which allows for settlement agreements and includes solicitors and barristers who can advise on the terms and effects of settlement agreement.

Redundancy

Occurs when a job is lost because either the workplace closes or there is a reduced need by an employer for people doing a particular type of work. It is one of the potentially fair reasons for dismissing an employee but there are strict rules about selecting people for redundancy, especially in larger business where there might be multiple redundancies at once. Employees with at least 2 years’ service are usually entitled to a redundancy payment.

Statutory Claims

These are claims which an employee may have because the rights are created by an act of Parliament (statute) rather than their common law rights which come from case law. Examples of statutory rights include protection from unfair dismissal (Employment Rights Act) and the right to not be discriminated against (Equality Act).

Solicitors

Legal professionals who are qualified to give advice and represent clients. They are regulated by the Solicitors Regulation Authority and must hold a current, valid practicing certificate in order to act for you. All solicitors are lawyer but not all lawyers are solicitors.

Subject to Contract

A term which appears usually on the front of most settlement agreements and indeed many other documents. It means much the same thing as it does in relation to a house sale and purchase; the document is not yet binding as it has not yet been signed and agreed.

Waiver of Claims

The most common basic purpose of a settlement agreement. It simply means an agreement not to pursue legal claims someone may have.

Warranties

A type of contractual term which are legal promises given by the employee as part of a settlement agreement.

Without Prejudice

A term used to describe correspondence which takes place ‘off the record’ to try and settle a dispute. It cannot be shown to a court or tribunal in most circumstances.

Specialist Employment Solicitors in Bournemouth, Poole, Christchurch and The New Forest

Our specialist employment law & HR team have advised many businesses and employees on settlement agreements. 

We offer a free initial chat with one of our bright, friendly lawyers to all new clients. Call us on 01202 499255 or visit the contact us page to get in touch.

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