Settlement Agreements: A Fact Sheet for Employers
What are settlement agreements?
Settlement agreements are voluntary, legally binding, confidential contracts that set out the terms and conditions agreed by you and your employee when they waive their rights to make a claim against you at an employment tribunal or court over something that is covered in the agreement, usually in return for a severance payment.
The document is lengthy, and provides protection for your business in relation to a range of workplace scenarios; from preventing your employee from making disparaging remarks about you or your business, to confirming their post-termination covenants.
Settlement agreements can also be used to reach a final conclusion to a workplace dispute without resulting in the end of the employment relationship. For example, resolving a dispute over holiday pay.
In addition to being between you and your employee, settlement agreements can also be agreed between you and a non-employee – for example, an unsuccessful job applicant who feels they were discriminated against at a job interview.
Why would someone use a settlement agreement?
Settlement agreements are normally used to bring an employment relationship to an end in a mutually agreed way. They are often used in situations where an employer and employee feel that their employment relationship is no longer working and a ‘clean break’ is the best way forward. In these situations, both parties can agree the basis for bringing the employment to an end.
Can only employers offer a settlement agreement?
In some situations, an employee may suggest using a Settlement Agreement to end a scenario and achieve a clean break. This is usually when there has been a breakdown of trust and confidence in your relationship, perhaps following a grievance or a disagreement regarding a workplace disciplinary event. You are under no obligation to accept their proposal, but should consider whether this would be beneficial for your business.
When would someone offer a settlement agreement?
Settlement agreements can be offered at any stage of an employment relationship. There is no legal requirement to go through a disciplinary process, or even start one, before offering a settlement agreement.
You should however, carefully consider when and how to offer a settlement agreement as not all disputes lend themselves to resolution through a settlement. Good management, communication and constructive conversations can be a better option for resolving an issue with an employee.
Where you have not previously mentioned a problem, disciplinary issue or a grievance, offering a settlement agreement could be a shock to an employee. You could then face resistance to reaching a suitable agreement and cause future resentment if a conclusion is not reached.
What are the advantages of a settlement agreement?
A settlement agreement can avoid the costs, time and stress involved in a tribunal claim whilst securing a swift and dignified end to an employment relationship that is not working.
What are the disadvantages of a settlement agreement?
There is a risk that if your employee does not agree to the settlement you will have to rebuild the employment relationship, and relations with the wider workforce can also be damaged if the settlement agreement is not used appropriately. Additionally, there is the cost of paying the agreed financial sum.
What should be covered within a settlement agreement?
Each settlement agreement is unique to the circumstances between you and the individual employee, but the document should give the full breakdown of the proposed financial payment being made to your employee, including whether any payments will be made free of tax, and often also include a reference.
Can your employee reject the settlement agreement?
If your employee either does not wish to terminate their contract via a settlement, or they do not feel the payment is sufficient, they are able to reject the offer.
Can your employee refer to your Settlement Agreement terms if they reject it?
The rules surrounding the admissibility of settlement negotiations in legal proceedings are very technical. It is important that both parties feel free and able to openly discuss the details surrounding the contract termination in order to reach an agreement, and they must therefore not feel incumbered by the fear that anything discussed could be used against them as evidence if a related claim is then brought to an employment tribunal or court.
Claims relating to any automatic unfair dismissal or of discrimination, harassment or victimisation are not covered by the confidentiality clause. If there is a possibility for your employee to make such a claim, then the details of any “off the record” conversations you may have had with your employee, and any relating documents, could be shown to an Employment Tribunal. For example, if you offered a settlement agreement to an employee who has been unhappy to return to the office after Covid and has reported health and safety concerns, then all of your discussions regarding the settlement would be admissible at Tribunal if they brought an unfair dismissal claim.
Have you offered a fair amount of money?
A fair settlement will depend on the circumstances leading up to your decision to wish to terminate the employment contract, the terms in your employee’s contract and any potential claims that your employee may have against you. You might also keep in mind your employee’s length of employment, the time it will take to resolve the problem if a settlement is not reached, and the costs and time needed to recruit to fill the role. Your solicitor will advise you as to a fair settlement.
Your solicitor will be able to calculate what payments your employee might receive if they were to pursue their claim at Tribunal, as well as advise you on the statutory cap on unfair dismissals, and compare this to the amount you are offering in the settlement agreement.
If leading up to presenting the settlement agreement you have carried out a fair and full disciplinary or grievance procedure, you will be in a stronger position to negotiate with your employee should they reject your offer.
If your employee rejects your offer on the basis that the amount being suggested is not sufficient, your solicitor can advise you as to what amounts are reasonable, and negotiate on your behalf.
It is highly advisable to seek specialist employment legal advice prior to going down the route of a settlement agreement.
What are the usual payments?
Compensation for loss of office
A compensatory payment of up to £30,000 can be paid free of tax if it is an ex-gratia payment rather than a contractual payment.
If you are paying your employee in lieu of notice, this will be covered within the Settlement Agreement. This is known as PILON. As of April 2018, all PILONs are subject to income tax and National Insurance contributions in full. Your solicitor should check your employee’s contract before drafting the settlement agreement to make sure that the sums you present to your employee are correct as the sums offered need to accord with tax law.
Bonus and commission
Any bonus or commission payments due should be set out in the agreement. Your solicitor should check your employee’s contract to make sure that all contractual bonuses and commissions are paid in full. However, if the contract refers to discretionary bonuses your solicitor will advise you if you are legally obliged to pay these and whether they need to be pro-rated to reflect the termination date.
There is likely to be a contractual obligation to continue to make pension contributions for the length of your employee’s notice period, even if this is to be paid in lieu. You may be able to reach an agreement with your employee in relation to a lump sum of money being paid directly into their pension as part of the overall settlement. Subject to the terms of the pension scheme, your employee could benefit from this as an additional tax-free payment.
Medical and life insurance
Some schemes will require this benefit to terminate on the last day of employment, others may allow your employee to remain within the company scheme until its renewal. It is a good idea to advise your employee to approach the insurer direct to find out whether enhanced terms will be provided if the individual stays in the scheme once their contract has terminated, if there is no break.
There is not usually an obligation to provide any reference to an employee except in specific job sectors, however, any reference provided must ‘in substance be true, accurate and fair’. You will need to agree on the format and content for the reference, whether it be a full and comprehensive reference, or a short statement confirming that the individual was employed, the dates of the employment and the employee’s job title. Your solicitor will be able to guide you on this, especially where there have been performance issues prior to termination. It is important to keep in mind your responsibility towards the employee and the recipient of the reference and the potential liability for any misleading information provided. Once the format and terms of the reference have been agreed, you must ensure that if asked in the future, any oral reference you give regarding that employee remains consistent with what has been agreed in the written reference.
You should use the settlement agreement to ensure that enforceable post-termination restrictive covenants within your employee’s contract are included and reaffirmed, protecting your business. When a Settlement Agreement is given because you have seriously breached a contract, your employee’s solicitor may advise that the restrictive covenants have ‘fallen away’. Reintroducing the covenants into the Settlement Agreement will ensure that you have protection, particularly where a small additional amount of consideration (money) is provided for your employee in reaffirming their post-termination covenants.
Confidentiality is a very important part of the settlement agreement for you as the employer. There may be a need for you to adjust the scope of the agreement to allow your employee to discuss the circumstances of their departure with future employers, their spouse or immediate family. Confidentiality clauses should prevent your employee from making derogatory comments against you in the press or on social media. Occasionally your employee will request a mutual obligation for you to also keep confidentiality, which may be in the interests of both parties where there has been a particularly difficult termination. You will need to be careful not to promise this where you have little control over third parties or employees.
How much will it cost?
For advice on a well-drafted and mutually beneficial Settlement Agreement, dependent on the requirements of the business and the complexity of the payments in relation to tax rules, my fees are usually between £1,000 to £1,500 (plus VAT). In addition, you will usually be expected to pay a contribution towards your employee’s legal fees which usually ranges from £350 plus VAT to £500 plus VAT.