Settlement Agreements – Terms & Conditions
The requirements for a Settlement Agreement are set out in employment legislation and certain conditions must be met for the agreement to be legally valid.
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What Is A Settlement Agreement?
A Settlement Agreement is a legally binding agreement, between an employee and employer to terminate the employee’s employment and to settle any employment claims that the employee might have against the employer which arise under statute (e.g. a claim for unfair dismissal or unlawful discrimination) or under contract (e.g. a claim for notice pay).
Seeking Legal Advice
The requirements for a Settlement Agreement are set out in employment legislation and certain conditions must be met for the agreement to be legally valid. In particular, the employee must take advice from an insured independent adviser (usually a solicitor, but certain other advisers are also covered) about the agreement and the claims he/she is giving up.
Who Pays the Legal Fees
Having a Settlement Agreement is more for the employer’s benefit than the employee’s (because it prevents the employee bringing claims against the employer in the future) and accordingly it is normal for the employer to pay (usually a fixed amount) towards the costs of the employee’s legal fees.
Clean Break Agreement
The most important thing to bear in mind is that a Settlement Agreement prevents an employee in the future from bringing claims against their employer arising out of the time the employee was employed or as a result of the termination of the employment, including claims the employee is not currently planning to bring and claims which arise in the future or claims the employee is not now aware that they have.
Without Prejudice/Subject to Contract
Until the Settlement Agreement is signed by both the employer and employee, it remains ‘without prejudice’ or “subject to contract”. This means that if the Settlement Agreement is not signed, its terms cannot be referred to in a court or employment tribunal (except in limited circumstances). This also means that even if the employer and employee agree orally on its terms, it does not become a legally binding agreement until both parties have signed it.
The recitals section in a Settlement Agreement are used to set out the background and so record the employment history and details of any employment claims already made. The recitals do not form part of the legally binding terms of the agreement.
Definitions and Interpretation
It is important that any definitions are checked through carefully as they are terms used in the agreement and therefore their meaning will be limited to what is set out in the definition.
The ‘Adviser’ is the independent legal adviser (usually a solicitor).
Employers always want to protect their confidential information. Employees need to read this section of the Settlement Agreement very carefully. A confidentiality clause usually means that if an employee was aware of any confidential information belonging to the employer then the employee has to keep that confidential information confidential and not disclose that confidential information to anyone else for the rest of their life. If an employee is planning to join a competitor then the agreement needs to be clear about the employee’s obligations as to confidential information. For confidential information to be protected, by an employer, information must in practice have been treated as confidential i.e. restrictions placed on access to it and use of it.
The reference to a group company in a Settlement Agreement is usually included as a definition, as certain of the clauses in a Settlement Agreement refer to company group-wide obligations. Under the Companies Act 2006, a holding company is a holding company of a subsidiary if it is a company which either: (a) holds the majority of the voting rights in the subsidiary or (b) is a member of the subsidiary and has the right to remove or appoint a majority of the directors or (c) is a member of a subsidiary and controls alone, by agreement with the other members, a majority of the voting rights.
Termination of Employment
The Settlement Agreement will record the fact and date when the employment will terminate on the relevant termination date.
£30,000 Tax Free Exemptions for Termination Payments
If an employer agrees to pay a “termination payment” to an employee, then usually the first £30,000 of that termination payment is tax free. HM Revenue and Customs usually take the view that compensation payments under a Settlement Agreement are usually covered by the £30,000 tax free exemption for termination payments. However, in some cases part of the termination payment may relate to the period of employment running up to the termination date as payment being a payment in lieu of notice (PILON) and these types of PILON payments might not be tax free. It is important to be aware that the employee currently takes on the risk of paying any additional tax on the payments because of the tax indemnity clause in the agreement.
Payments up to Termination Date
The Settlement Agreement will usually record that all salary, benefits, and other payments due to the employee up to the termination date will be paid by the employer, usually subject to usual tax deductions.
Deductions for Sums due to the Employer
If an employee has exceeded their accrued holiday to date or if they have an outstanding loan, then there is usually a clause which requires the employee to repay any outstanding holiday entitlement or outstanding loan back to the employer.
Timings for Payment(s)
The payment date for any monies under the Settlement Agreement is usually up to 30 days after the termination date or the date the signed Settlement Agreement has been returned, whichever is the later. This means that the payment is not released until the Settlement Agreement has been signed off and is legally binding on the employee.
If an employee is being paid for any accrued but untaken holiday which they are entitled to be paid for under their employment contract OR under the Working Time Regulations 1998 then this holiday entitlement will be monetarised and payment will be subject to PAYE and national insurance contribution deductions.
Statutory Redundancy Payment
If an employee is being paid a statutory redundancy payment, the employer must provide a statement setting out how the statutory redundancy payment has been calculated.
Payment for Post Termination Restrictions
Some employers make a separate payment in return for the employee agreeing to new post termination restrictions and any new confidentiality obligations. This is because if a separate payment is not made for these ongoing future obligations, HMRC may view the overall compensation payment as partly taxable and thus not attracting the £30,000 tax-free exemption for termination payments. Any separate payment to the employee for agreeing to new post termination restrictions or additional confidentiality obligations are taxable. Having this separate payment made clear in the Settlement Agreement is therefore to an employee’s advantage as it reduces the risk of extra tax becoming payable.
Pay In Lieu of Notice (PILON)
Any (express or implied) contractual payment in lieu of notice (PILON) is treated as earnings and is therefore subject to PAYE deductions for tax and National Insurance contributions in the normal way. Therefore the HMRC exemption of up to £30,000 for termination payments does not apply to PILON payments.
If there is no (express or implied) contractual PILON entitlement but the employer pays the employee in lieu of notice, then such payment is generally treated as earnings and therefore fully subject to tax (and employer’s NICs). This is achieved via a concept of ‘post-employment notice pay’ (PENP). This requires a calculation to be carried out which provides that only the amount of the termination award equal to the post-employment notice pay is treated as earnings, with the balance eligible for the £30,000 tax exemption.
There is often a clause in Settlement Agreements that states an employee must complete and submit to their employer their final expenses claim (if any) within a certain timescale.
There is usually a clause that states that if the Inland Revenue determine that there is any additional tax to pay in relation to the Settlement Agreement then the employee (and not the employer) must pay that additional tax.
This type of clause protects the employer against any tax liability (the ‘Excess Tax’) arising from the £30,000 HMRC exemption for termination payments not being available or any other tax becoming due for any other reason. Note however that the indemnity cannot cover employer’s national insurance contributions so the employer will remain liable for those.
The indemnity provides that the employee must pay any excess tax if the employer has been required by HMRC to account for it – this is because HMRC will seek recovery of the tax from the employer first and not from the employee. The effect of this clause is that the employee takes on the risk on the tax treatment of any of the payment to be made or benefits to be provided under this agreement.
If a demand for tax is received by the employer, then the employee must be notified and given an opportunity to challenge it and that the employer remains responsible for fines, penalties, etc if caused by its own fault, although fault would not include the incorrect tax treatment by the employer.
Some employers want their employees to enter new restrictions, which were not contained in the employment contract. These new restrictions usually relate to confidential information and/or post termination restrictions.
If an employer wants an employee to agree to new restrictions as part of the overall settlement then it is important for an employee to read these through carefully in the light of any future plans that an employee might have. These restrictions are potentially enforceable so long as they go no further than necessary to protect the employer’s confidential information and/or customer connection and/or client connection and/or workforce stability.
There is usually a clause that prevents the employee from using, copying, or disclosing information. There may be issues about where the employee may have retained confidential information, e.g. in copy documents, on a laptop or on a mobile phone. If an employee is not sure as to the status of any information that they hold in paper form or electronically (e.g. on their home laptop or on their mobile) then they need to make further enquiries and seek legal advice.
There are often clauses that restricts an employee’s ability to discuss the Settlement Agreement’s existence and/or terms with third parties. It is important to ensure that there are appropriate exceptions to these obligations (sometimes known as ‘carve-outs). For example, an employee is usually allowed to discuss the Settlement Agreement with their spouse and/or immediate family so long as they also agree to keep the details of the agreement confidential. In addition, an employee can usually discuss the terms with their doctor or counsellor or other professional adviser or to the HMRC to clarify any tax issues.
There are often clauses that prohibit an employee from making derogatory or negative statements about their employer after leaving. This includes any statements made verbally, or in writing or on social media. In addition, the employee needs to confirm that they have not already leaked confidential information or made derogatory or negative comments about the employer.
There is usually an equivalent similar obligation on the employer not to make derogatory statements about the employee in return. This kind of obligation can be difficult to police and accordingly it is drafted so that the obligation is to take ‘reasonable endeavours’ only which does not put too onerous a task on the employer.
In the absence of an agreement to provide a reference, there is no legal obligation on an employer to provide an employee with a reference unless a failure to do so would amount to unlawful discrimination. There is usually a clause that the employer will provide a reference in an agreed form. Most employers decide to only provide a very basic factual only reference which confirms relevant dates and posts held.
Some employers arrange and pay for outplacement services for the employee. This will be exempt from tax if the employee has been employed for at least two years and the outplacement service is to help the employee to adjust to the termination of employment or to help the employee find other work.
An employer may need an employee’s help in the future, for example in dealing with litigation or an investigation, so there is usually a clause which provides for the employee to provide reasonable assistance to an employer if they need it in the future on the basis that the employee is paid for that help or a daily fee, plus expenses, if the employee is called upon.
Return of Employer’s Property
There is often a clause that provides for the employee to return to the employer the employer’s property such as security passes, documents, computer, phone, car, other equipment, within a certain timescale.
It is normal for the employer to meet some or all the employee’s legal costs on a Settlement Agreement. Normally the employer suggests an amount which is usually sufficient to cover the costs of an employee obtaining legal advice. This usually means that the employee is able to obtain in effect “free legal advice”. However, it is important for the employee to check with any prospective legal adviser to ensure that the legal adviser’s costs are in line with the amount that the employer is prepared to pay.
In terms of billing, the legal adviser will issue a bill for the agreed legal fees to the employee but marked as payable by the employer and will send a copy to the employer for payment. The legal fees must be paid directly by the employer and not via the employee. This is to take advantage of an HMRC tax concession for the payment of legal fees as otherwise they would be taxable. The legal fees only become payable once the signed agreement and adviser’s certificate are returned.
Full and Final Settlement of Employment Clauses
The “full and final settlement” part of the agreement sets out those claims which an employee will no longer be able to bring or continue. It is necessary to list in detail the various types of claims covered because the legislation provides that the claims must be identified: a generic description of ‘all employment claims’ would be insufficient. It is important also to note the effect of the repayment clause which provides that if an employee later brings a claim against the employer which the employee had agreed they would not, then the employer can require repayment of the compensation it has paid to the employee.
If the compensation or redundancy payable is in excess of what is reasonable to settle the employee’s claims, HMRC may view some of that payment as being in return for this waiver of claims and therefore taxable. The employee would be responsible for any additional tax under this scenario because of the tax indemnity.
Contemplation of Claims
The wording in these types of clauses attempts to cover claims whether or not the employee has actually already contemplated them. The employee is often required to warrant that they have given the legal adviser sufficient information for all potential claims to be identified. When this is read together with the repayment provisions, this would act as a deterrent to the employee bringing claims against the employer in the future.
Exclusions from the Waiver of Claims
At the very end of the list of claims that an employee is giving up, there are usually three main exclusions. These relate to firstly, claims made to enforce the agreement; secondly, latent accident claims; and thirdly, pensions.
Enforcement of Agreement
An employee is usually allowed to enforce the terms of the Settlement Agreement. This could be, for example, if the employer failed to pay the agreed compensation and the employee needed to bring a claim to enforce that obligation.
Latent Personal Injury Claims
Settlement Agreements usually exclude ‘latent’ (i.e. not known about by the employee) personal injury claims (where not already covered by an existing waived claim). It is quite common to exclude these from the waiver of claims because it is generally not possible for the employee to check and know whether they have any such claims before entering into this agreement, when such claims could arise far into the future. In addition, it is not possible to contract out of liability for personal injury under the Unfair Contract Terms Act 1977.
As personal injury claims have been excluded from the waiver of claims, it is common for the employer to require in return that the employee warrant that they are not aware of any such claims at the point of entering into this agreement.
An employee’s pension is usually not part of any Settlement Agreement. The employee can usually claim their entitlement to any pension fund that has arisen during the course of their employment with the employer. Claims arising out of accrued personal pension or group personal pension schemes can validly be waived though it is common to exclude such claims from the waiver so that the employee can retain the benefits of their pension.
Repayment of Compensation
There is often a clause that states that an employee must repay to the employer any compensation paid if the employee brings any of the claims covered by the agreement or breach e.g. one of the warranties given. However, there is a risk that it may be found to be unenforceable as a penalty clause because the amount recouped by the employer might not correlate to the amount of loss the employer has actually suffers because of the employee’s breach. From the employee’s point of view they need to be aware of the potential impact of this clause particularly as the waiver of claims covers claims the employee is not currently thinking of bringing and claims which arise in the future or claims that the employee is not now aware that they have.
If an employee brings a claim in breach of the agreement which would trigger a repayment of the compensation back to the employer, the employee will usually have to repay the difference between the compensation payment and the award, assuming the award is less than the compensation payment. If the award is bigger than the compensation payment then the award would be set off against the amount of compensation already paid by the employer (so it would only have to pay the difference to the employee). For example, therefore, if the compensation were £100 and the award was £50, the employee would have to repay £50. If the compensation were £100 and the award was £120, the £100 already paid by the employer would be offset against the liability to pay the employee the award of £120.
Withdrawal of Proceedings
This clause is relevant if an employee has already brought a claim in the Employment Tribunal or County Court or High Court.
Under the ‘whistleblowing’ provisions in the Employment Rights Act 1996, it is not possible for a Settlement Agreement to prevent an employee from making a ‘protected disclosure’ i.e. blow the whistle. This is particularly relevant to the non-disclosure obligations in the agreement and means that the employee will not breach those obligations if they make a disclosure that is protected under the whistleblowing legislation.
There is usually an ‘entire agreement’ clause, which means that it will not be possible for an employee to rely on oral or other informal agreements or terms in other documents. If there are such understandings or agreements in existence, then the legal adviser needs to know so that if necessary, they can be incorporated into the Settlement Agreement.
Third Party Rights
The Contracts (Rights of Third Parties) Act 1999 apply to a Settlement Agreement because there are third parties who could benefit from it e.g. group companies and/or pension scheme trustees and the employer would want those third parties to be able to enforce the terms that apply to them. This could for example mean a group company covered by the confidentiality obligation could sue the employee for breach of contract directly even though they are not a party to this agreement.
It is sometimes useful to have counterparts so an employee can sign one copy of the agreement and the employer the other.
There is usually a jurisdiction clause which states that the laws of England and Wales apply to the agreement.
This is often a standard form adviser’s certificate where the employee’s adviser is a solicitor or barrister. The adviser’s certification that they are insured is usually sufficient.
The calculation of any statutory redundancy payment must be set out in writing to comply with section 165 of the Employment Rights Act 1996.
We hope the above has been of use. If you have any questions then please contact us on 01536 276300 or contact us online.
Have You Been Asked To Sign A Settlement Agreement?
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We can help you with understanding what settlement agreements (formerly known as a compromise agreement) are all about before you make a decision on whether to sign one.
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