What is a Settlement Agreement?

A Settlement Agreement (previously called a Compromise Agreement) is a legally binding contract, often used to settle potential claims employees may have against their employer, or simply to bring the employment to an end on mutually agreeable terms.

It will typically involve the employee agreeing not to bring any Tribunal or other court claims against their employer in exchange for an agreed sum of money and/or an agreed reference or benefits. A Settlement Agreement can also be used where employment is ongoing but both parties want to settle a dispute which has arisen between them.

In order to be legally binding, a Settlement Agreement must be in writing and the employee must obtain independent legal advice on the terms of the agreement. The employer will usually offer to make a contribution towards the cost of that advice. This contribution varies according to the sums involved, the complexity of the situation and even the geographical location of the employee. We can advise you on what level of contribution to offer.

How can Machins Solicitors LLP help?

We adopt a commercial approach in advising on and preparing Settlement Agreements for employers. Of course, the monetary value in a Settlement Agreement is important however there are other significant aspects we consider in order to protect your business, for example, confidentiality provisions and restrictive covenants.

We can assist with all stages of Settlement Agreements from preparing bespoke letters to employees, scripts for managers and HR, advising on the settlement sum to be offered and negotiating and preparing effective settlement agreements. We deal with each matter on a case by case basis and ensure all Settlement Agreements achieve your objectives upon terminating an employee’s employment.

Frequently asked Questions

In what circumstances should an employer consider offering a Settlement Agreement?

It may be appropriate to offer a Settlement Agreement where the employment relationship has broken down, where a redundancy situation has arisen or where, there is a mutual agreement to end the employment contract. A Settlement Agreement may also be a viable alternative to entering into a performance/capability review or a full redundancy process.
It is sensible to take legal advice before offering a Settlement Agreement to an employee as the discussions and documentation surrounding the offer of a Settlement Agreement may have to be disclosed to the Employment Tribunal in any subsequent proceedings brought by the employee.

What terms are usually contained in the settlement agreement?

Each Settlement Agreement is individual and fact-specific; however, some typical terms which are often included are:

  • The date of the termination of employment;
  • Arrangements for payment of outstanding salary, accrued holiday, benefits and notice entitlements;
  • Details of any compensation for loss of employment. This is usually paid tax-free up to a maximum of £30,000.00.
  • Details of any confidentiality provisions and post-termination restrictions;
  • An agreed reference

You may already have negotiated the terms of your Agreement with the employee before seeking legal advice however our solicitors are well-equipped to assist on negotiating terms if required, either before the Agreement is finalised or following our review with you.

What payments should be offered?

We will advise you on what is a fair amount taking into account the value of any potential claim the employee may have against you and the payments due in accordance with the employee’s employment contract. If the sums offered appear insufficient to the employee, either they or their independent solicitor may seek to negotiate an increase of the terms

The Settlement Agreement should provide a breakdown of the various sums offered. These will normally consist of:

  • Notice payment: if you do not require the employee to work their notice period the employer can make a payment in lieu of notice. This should be paid net of tax where the contract of employment contains a payment in lieu of notice (PILON) clause.
  • Bonus and Commission payments: all contractual bonuses and commission should be paid in accordance with the terms set out in the employment contract. Discretionary bonuses may also need to be paid and we will provide advice on this.
  • Pension: the employer may have a contractual obligation to continue to pay pension contributions, particularly during the notice period, if notice is to be paid in lieu.
  • Medical and Life Insurance: some schemes require cover to stop on the date of termination of employment others allow cover to continue up to the date that the employer has paid the relevant premium.
  • Compensation for loss of office: a payment of up to £30,000 can be made to the employee tax-free provided it is an ex gratia payment and not as a result of a contractual term.

How much of the employee’s compensation will be tax-free?

In general, payments made under a Settlement Agreement which are contractual (such as the employee’s salary, notice, holiday and benefits) will be subject to tax and NI deductions. However, in general, the compensation for loss of employment paid under a Settlement Agreement is tax-free up to a maximum of £30,000. Any amounts over that cap will be subject to deductions.

We will provide guidance as to which elements of the Agreement will taxable so you have a better idea of the total payments you will be paying in entering into the Agreement.

Can an employee refuse a Settlement Agreement?

An employee can refuse to terminate their employment on the terms offered. Normally this will be on the basis that they do not want to accept the reason given for termination or because they believe that the amounts offered are insufficient. The employee may attempt to negotiate an increased sum and we can assist with such negotiations on your behalf.

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