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Settlement Agreements: The Basics

What is a Settlement Agreement?

A Settlement agreement (formerly known as a compromise agreement) is a legally binding agreement between an employee and their employer by which the parties compromise an employee’s contractual and/or statutory claims. Settlement agreements are most commonly entered into on termination of employment, although they can be used where employment is continuing. The agreement usually provides for payment to be made by the employer in return for the employee agreeing not to pursue any claims they may have against the employer in a Tribunal or a Court.

Statutory requirements for a settlement agreement

In order for a settlement agreement to be valid, certain conditions must be met:

  • The agreement must be in writing.
  • The agreement must relate to ‘particular proceedings’ or a ‘particular complaint’.
  • The employee must have received legal advice from a relevant independent adviser on the terms and effect of the proposed agreement and its effect on the employee’s ability to pursue any rights before an employment tribunal.
  • The independent adviser must have in force a contract of insurance, or professional indemnity insurance, covering the risk of a claim against them by the employee in respect of the advice.
  • The agreement must identify the adviser.
  • The agreement must state that the conditions regulating settlement agreements are satisfied.

 

Legal Advice

As above, an employee is required to obtain independent legal advice in relation to the Settlement Agreement in order for it to be valid and to effectively prohibit them from bringing claims against their employer in relation to their employment and/or its termination.  The legislation authorising settlement agreements as a means of excluding claims requires employees to be advised on the terms of the agreement and in particular, upon its effect on their ability to pursue any claim against their employer in relation to the termination of their employment.

Employees are not required to be advised in any detail in relation to other matters which may arise in relation to the termination of their employment, such as whether they may have a good claim against their employer for unfair dismissal, for example.  Nor are they required to be advised as to their entitlement under pension or share option schemes or in relation to any restrictions in their contract of employment on what they can do or who they can work for and where, after their current employment ends.  Employees are also not required to be advised as to whether the settlement package offered is a good one or whether they should accept it.

If an employee would like detailed advice about any such issues, the cost of obtaining that advice will not be covered by any contribution to legal fees being offered by their employer, unless the employee negotiates otherwise.

Common Issues

Each settlement agreement will be unique and require careful consideration in light of the parties’ particular circumstances. There are, however, certain points that frequently arise when parties are drafting/negotiating settlement agreements, including:

Future Claims
Where there is a gap in time between the signing of a settlement agreement and the termination of employment, the parties need to consider how they will ensure that any claims arising in the meantime may be fairly and effectively waived. Employers often seek to include ‘future claims’ in the waiver at the time the settlement agreement is signed, preventing the employee from bringing a claim in the event that anything were to happen after the settlement agreement was signed but before the termination date. A better way to deal with this situation is to provide for the employee to reaffirm the waiver on termination.

Annual Leave

It is important that a settlement agreement deals with outstanding annual leave, providing either for leave to be taken prior to termination or for payment to be made in lieu of any untaken leave. If an employee is to receive payment in lieu then the agreement should state the number of days outstanding and the sum to be paid or detail the manner in which any outstanding annual leave payment will be calculated.

Return of Company Property

Settlement agreements generally contain a standard provision requiring the employee to return all company property in their possession to their employer.  It is quite common for the employer to allow employees to retain some items, such as their mobile telephone or laptop. If such an agreement is made then the terms of the settlement agreement should be amended accordingly.  Failure to do so could place an employee in breach of the settlement agreement even if the agreement to retain property is recorded elsewhere, in an email or letter for example.

Splitting Payments over Two Financial Years

If an employee is receiving a sizeable compensation payment under the settlement agreement they may wish to be paid in separate instalments in different financial years. An employee should discuss this issue with their own tax or financial advisor and ensure that the terms of the agreement reflect any decision that they make in this regard.

 

When considering whether to split their payments, an employee should bear in mind that if they choose to do so, they will be an unsecured creditor of their former employer in respect of any part of the compensation payment which they have deferred into the next tax year.  This means that in the event of a financial catastrophe striking the company and forcing it into insolvency before they are paid, they would be unlikely to recover very much, if any, of the deferred element.

 

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