Settlement Agreements Explained

A Settlement Agreement (formally known as a Compromise Agreement) is a contractual agreement entered into between an employer and an employee to settle an employment-related dispute.

Under a Settlement Agreement, in addition to paying the employee their contractual salary and benefits up until the date of termination of employment (to include notice monies or payment in lieu thereof), the employer generally agrees to pay the employee an additional, "ex gratia" payment within a period of time after termination (normally between 14 and 28 days), in return for the employee signing away all their legal rights to bring proceedings against the employer for any claim that relates to their employment and/or its termination, save for: any claim for accrued pension rights (i.e. where the employer has changed or removed any rights the employee has already built up in their pension scheme during their employment); any latent personal injury claim (i.e. a personal injury claim of which neither party is aware at the date of the Settlement Agreement); and any claim to enforce the terms of the Settlement Agreement itself (i.e. where the employer has committed a breach). Whistleblowing claims are expressly excluded from the ambit of Settlement Agreements, as are claims for fraud.

Provided the ex gratia payment can genuinely be classified as compensation for loss of office, the first £30,000 can usually be paid tax free – which is a major incentive for the employee; any amount over and above £30,000 is usually taxed at the employee's prevailing rate. The employee, however, is invariably required to indemnify the employer in relation to any tax that may be payable.

One of the hallmarks of a Settlement Agreement is that, in order to be valid, the employee has to obtain legal advice from a ‘relevant independent adviser’ on what legal claims they have or may have - and thus what claims they are being asked to compromise (those specific claims should be identified and listed in the Settlement Agreement) and the effect that signing a Settlement Agreement will have on their ability to pursue those claims in a court or tribunal. The adviser can be a solicitor or barrister, or a trade union official or a worker in an advice centre such as a Citizens’ Advice Bureau, provided they have been certified by the trade union or advice centre as competent to give the advice. The relevant independent adviser then has to give the employer a certificate confirming they have advised the employee on the terms and effect of the Settlement Agreement, and that they are insured so that, if their advice proves to have been negligent, their insurer will meet any claim made against them by the employee. Because of this requirement, it is usual for the employer to offer to contribute to the employee's costs of obtaining such independent legal advice, and such contribution is usually anything between £250 and £750 plus VAT. The independent legal adviser then addresses the invoice to the employee, but with the invoice stated to be payable by the employer, and sends it directly to the employer. The employer is then able to reclaim the VAT.

Another hallmark of a Settlement Agreement is that the employee is invariably asked to warrant that they have not done, or failed to do, anything during the employment which, had the employer known about it, would have entitled the employer to dismiss them summarily, without notice. Employers frequently seek to include a term that, should this warranty prove to be incorrect, then the employee has to repay all sums payable to them under the Settlement Agreement, together with the employer's legal costs. Whilst such a term may be reasonable, where the employer attempts to extend this right to circumstances where the employee is in breach of any warranty given under the Settlement Agreement, this should be resisted (e.g. if the employee is being made redundant and has 2 years' qualifying service, they are entitled to their contractual payments up to the termination date and a statutory redundancy payment in any event).

Obligations in a contract of employment which are intended to survive termination of employment (particularly in relation to confidential information and restrictive covenants) are not compromised by a Settlement Agreement unless specifically stated.

Whilst there is no legal obligation on an employer to give a departing employee a reference at all, standard practice is for the employer simply to confirm the employee's name, dates of employment and job title at termination. Occasionally, an employee can use a Settlement Agreement as leverage to write themselves an agreed, "glowing" reference, but employers are increasingly concerned about possible claims for negligent misstatement and therefore tend to shy away from such references.

Our employment team, headed up by Ed Macey-Dare, has extensive experience of drafting and advising on Settlement Agreements. Whilst we act for both employers and employees, Ed's practice largely focusses on acting for directors, senior executives and other senior employees in the resolution of employment disputes and, in particular, negotiating - and advising on the pitfalls of -Settlement Agreements.

It is anticipated that there will be whole-scale redundancies following the termination of the furlough scheme at the end of October 2020 and that many departing employees will be offered Settlement Agreements in order to "buy off" any legal claims that they may have. If you require advice in relation to a Settlement Agreement (whether as a result of COVID-19, or otherwise), please contact Ed by email at emaceydare@lbmw.com.