Law guide: Employment

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Settlement agreements

Settlement agreements


Settlement agreements

A settlement agreement (or a 'compromise agreement' in Northern Ireland) is a legally binding contract entered into by an employer and employee who are in dispute over one or more issues arising out of their employment relationship. It is used to settle any disputes that would otherwise have to be settled by the employment tribunal or court, or (in Scotland) the sheriff court or the Court of Session.

A settlement agreement will follow the termination of the employee's employment and will usually provide the employee compensation. In return, the employee will agree not to pursue any legal claims that he or she may have against the employer that relate to their employment and its termination (as well as agreeing to any further conditions that the employer may impose). Consequently, if the employee has signed a legally binding settlement agreement, the employee might be prevented from pursuing proceedings before an employment tribunal.

Legal requirements

Before a settlement agreement can be legally binding, the following conditions must be met:

a) The agreement must be in writing.

b) The agreement must relate to a particular complaint or legal proceedings made, raised or instigated by the employee.

c) The agreement must state that the statutory conditions regulating settlement agreements have been satisfied.

d) The employee must have received legal advice from a 'relevant independent adviser' as to the terms and effect of the proposed agreement and, in particular, its effect on his or her ability to pursue a claim before an employment tribunal or county court, or (in Scotland) the sheriff court or the Court of Session.

The following can be classed as relevant independent advisers:

  • Qualified lawyers (solicitors holding a practising certificate or barristers in practice or employed to give legal advice)
  • Officers, officials, employees or members of an independent trade union, provided they have been certified in writing by the union as competent and authorised to give advice
  • Employees or volunteer workers at advice centres giving free legal advice provided they have been certified in writing by the advice centre as competent and authorised to give advice
  • (In England & Wales) Fellows of the Institute of Legal Executives employed by a solicitors' practice
  • (In Northern Ireland) A person of a description specified in an order made by the Department for the Economy

e) When the relevant independent adviser gives the legal advice, there must be an insurance contract in force, or an indemnity provided for members of a profession or professional body, covering the risk of a claim by the employee in relation to the advice.

f) The agreement must identify the relevant independent adviser.

Essential elements

The contents of a settlement agreement will depend on the requirements of the employer and employee who are in dispute. A good settlement agreement will ensure that an employer's business interests are protected whilst also making sure that future claims are prohibited.

However, generally the following items should be considered when negotiating a settlement agreement:

a) Settlement of all current and future legal claims, allegations and/or complaints against the employer by the employee and the provision of compensation for doing so

b) The payment of any outstanding sums that are owed to the employee by the employer under the terms and conditions of his or her contract. Such sums may include salary, outstanding holiday pay and any bonus to which he or she may be entitled

c) Provision for the payment of the employee's legal fees

d) Provision for the employee's resignation (if applicable)

e) An assurance that a suitable reference will be provided by the employer in respect of the employee (including a template if one can be agreed)

f) Provisions that ensure that the employee will not use or disclose any confidential information

Tax on settlements

An employer can make two different types of payment to an employee under a settlement agreement, the payment of earnings and a termination payment. Payment of earnings will be taxable in the usual way, but special considerations apply to termination payments.

The main tax issues that relate to termination payments are that:

1. The first £30,000 of a termination payment is tax free. Any amount in excess of £30,000 will be subject to tax (but not National Insurance contributions) in the normal way.

2. However, where the payment (or part of it) is made under a contractual term, for example, where the contract gives the employer the right to pay in lieu of notice, it (or that part) will be fully taxable as 'earnings' using the employee's own tax rate (PAYE code 'OT').

3. A statutory redundancy payment or ex-gratia payment will be tax free.

4. Compensation for personal injury is not taxable, and it is strongly arguable that this also applies to compensation for injury to feelings which arises from complaints of unlawful discrimination.

5. Payment of the employee's legal costs (i.e. the cost of obtaining legal advice) by the employer will not be taxable so long as certain rules are followed.

For further information on the tax implications and exemptions that relate to settlement agreements, see: HM Revenue & Customs

Pre-termination negotiations (England, Wales & Scotland)

Pre-termination negotiations are confidential talks held with employees with a view to ending their employment on agreed terms. An employee can't use pre-termination negotiations as evidence in an unfair dismissal claim.

This will apply unless either party has shown 'improper behaviour', e.g. harassment, intimidation, assault, victimisation, discrimination or putting undue pressure on a party (such as allowing insufficient time to consider the offer or threatening dismissal if the offer is rejected). See Acas's code of practice (PDF) for more information.

However, pre-termination negotiations can be used as evidence in the following claims: