Frequently Asked Questions
Frequently asked questions about settlement agreements
A settlement agreement is a special type of legal agreement between employer and employee, which sets out the terms of a ‘deal’ they have made to settle a dispute between them. Usually, the employer pays the employee an agreed sum of money that they would not otherwise be entitled to and the employee agrees to waive his / her right to bring any claim in relation to their employment or the termination of their employment. The payment from the employer is treated as compensation for the employee’s potential claims. For example, an employee who has been given notice of dismissal for redundancy may dispute the selection criteria used to select them, but is willing to settle their potential claim instead of bringing an employment tribunal claim for unfair dismissal.
An employee cannot waive statutory claims (for example, claims for unfair dismissal, discrimination or a statutory redundancy payment) unless they sign a settlement agreement. Any attempt to do so using a document or agreement other than a settlement agreement will be legally unenforceable.
Do I have to enter into a settlement agreement to terminate my employment?
No, but it is increasingly likely that an employer will insist on it before they pay out any settlement monies to you. This is because they will not want to risk you bringing a claim as well. A settlement agreement is the only way they can achieve certainty that you have given up the right to claim.
Are there any requirements to be met when entering into a settlement agreement?
In order to be valid and enforceable, a settlement agreement must comply with a number of legal requirements. They are:
- The employee must receive independent legal advice on the terms and effect of the settlement agreement. This requirement recognises that the employee must be absolutely certain before agreeing to waive their rights. Advice can be given by:
- a qualified lawyer (or certified legal executive);
- a certified and authorised officer, official, employee or member of a trade union; or
- a certified and authorised worker at an advice centre who is not paid for providing advice to the employee.
- The legal adviser must be clearly identified in the agreement;
- The agreement must be in writing;
- The agreement must specify the claims to be waived; and
- The agreement must state that the above requirements have been satisfied.
Who pays for the cost of my legal advice?
Although there are no set rules for this, in practice most employers will contribute towards the employee’s legal fees. We would normally expect to see a contribution of at least £300 plus VAT. Any fees over and above the employer contribution will normally be payable by you (although it is often possible to negotiate an increased contribution with the employer).
It is important to note that employers will only contribute to your legal fees if the agreement is actually signed. If you decide not to go ahead, there will be no employer contribution.
Am I getting a good deal?
It is the job of your legal adviser to advise you as to whether you are getting a good deal under the proposed terms of the compromise agreement. They will do this first by discussing the background to the settlement agreement (i.e. how you have ended up here) in detail with you. This will allow them to consider the potential claims you may have and the potential value of those claims. They will then work out the payments you are entitled to receive under contract and / or statute (e.g. notice pay, redundancy pay, accrued untaken holiday pay, bonus due etc). The settlement payment should be more than the payments you are entitled to receive, otherwise there is no incentive / benefit for you to waive your rights, so cannot be a good deal. If you have a reasonable case to pursue in the employment tribunal (or civil courts) as an alternative to signing the settlement agreement, you will want to ensure that the settlement payment offered includes a reasonable sum to reflect this.
Your solicitor will also need to consider the wording of the compromise agreement to make sure that this is fair. It may well be that the settlement payment is reasonable but some of the terms of the agreement are not, meaning the overall deal isn’t a good one.
If your solicitor does not think you are getting a good deal, you may decide to try and negotiate an increased payment with the employer and / or amendments to the wording of the agreement. This would usually be done via your solicitor.
For more detailed information on ensuring you get a good deal, please see Settlement Agreements – getting you the best deal.
Is it true that my settlement payment can be made gross?
It is likely that some of the payments and / or benefits under the settlement agreement will be taxable and others will not.
Generally, any payments which an employer is under a contractual obligation to make must be subject to deductions for tax and national insurance before they are paid to you. This may include, for example, holiday pay, contractual bonus payments and other contractual payments or benefits.
Notice pay will be taxable if you work your notice period. However, if you are paid in lieu of notice but the employer does not have the contractual right to do this (i.e. if there is no payment in lieu of notice (PILON) clause in your employment contract), there is a chance that it can be paid to you gross – i.e. without deductions for tax and national insurance.
The ex-gratia element of the settlement payment should not be a contractual payment, so can be paid free of tax, as long as it is below £30,000. Any ex-gratia payment over £30,000 will be subject to deductions in the usual way. However, sometimes employers will ‘lump together’ sums in the settlement payment which should rightly be subject to deductions. Your solicitor should be able to help you identify whether there is any tax risk on a payment like this.
It is now common for settlement agreements to include an indemnity clause in favour of the employer. This basically means that if HMRC considers that any aspect of a settlement payment not subjected to deductions should have been and issues a demand for further tax and national insurance contributions to the employer, the employee must reimburse the employer for this. This is to give the employer certainty on the amount they are paying out. Most employers will now insist on you agreeing to an indemnity clause. It is therefore important for you to properly consider and be comfortable with the extent of any risk you are taking on before signing the settlement agreement.
Taxation of settlement payments is complex, and in some circumstances employees may need to seek specific tax advice from a tax specialist.
Should I expect to see any ‘standard’ or common clauses in my settlement agreement?
Settlement agreements usually contain a number of “standard” provisions, though the wording of those provisions will differ from agreement to agreement. Examples of common clauses are:
- A clause setting out the agreed termination date;
- A clause setting out the agreed arrangements up until your employment termination date, if the termination date is in the future;
- A clause setting out the payments and benefits to be made up to termination (e.g. normal salary, payment in lieu of accrued untaken holidays etc), and the tax status of those payments and benefits;
- A clause setting out the settlement payment and the tax status of that payment;
- A clause setting out when the settlement payment will be made;
- A clause setting out arrangements in relation to the independent legal adviser (e.g. requiring them to sign a certificate to confirm that they have advised you, and setting out the employer’s contribution to their fees);
- A “waiver” clause setting out a list of claims you are agreeing to waive in return for the payments and benefits set out in the agreement;
- A tax indemnity (see above);
- A confidentiality clause (see below);
- A clause requiring one or more of the parties not to speak detrimentally about the other party;
- A clause confirming that various statutory requirements have been complied with;
- A repayment clause if, despite the agreement, the employee brings a claim or otherwise breaches the agreement; and
- A warranty that the employee has not guilty of any misconduct which would entitle the employer to dismiss them without payment of notice.
Employers will normally want to stop you from talking to other people about the settlement agreement and its terms. This is because they will not want to set a precedent for making payments. As such, settlement agreements usually contain confidentiality clauses which state that you cannot tell anyone about the agreement and / or its terms. Any breach of a clause like this would give the employer the right to bring a breach of contract claim against you.
To ensure that you are not restricted to an impossible extent, it is important that any confidentiality clause contains a list of exceptions, for example, to ensure that you can discuss with your spouse or partner, professional advisers and insurers to the extent necessary to process a claim for loss of employment (if appropriate). It is also important that you do not waive your right to make a “protected disclosure” (i.e. to report a legal wrong) in accordance with whistleblowing legislation.
What happens if there is a breach the terms of the settlement agreement?
Once a settlement agreement has been signed by both the employer and the employee, it becomes a legally binding document. If either party breaches the terms, for instance, if the employer fails to pay or if the employee brings a claim, the wronged party will be entitled to raise a claim in the courts for breach of contact. The usual remedy for breach of contract is a claim for damages for loss suffered as a result of the other party’s breach. If there is an enforceable repayment clause in the settlement agreement, an employee who later breaches the terms of their settlement agreement may be ordered to repay all or some of the money they were paid by the employer, together with any legal fees incurred by the employer as a result of the breach.
What happens if I don’t sign?
You do not have to sign the agreement if you do not want to. This would only usually happen if, after taking legal advice, you do not think the deal offered is fair in the circumstances, so decide to bring an employment tribunal claim instead.
If you do not go ahead with the agreement, your employer will not make any contribution to your legal fees, and these are likely to be payable by you.
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