What is a settlement agreement and when is it used?

Settlement agreements, or compromise agreements as they used to be called, are increasing in popularity.   Employers now routinely use settlement agreements when parting ways with an employee.  By and large, they can provide both parties with peace of mind in an uncertain time.  They can be used in a variety of situations although they are most commonly used when an employer terminates the employment of one of its employees.  The reason for the termination may be due to a disciplinary or performance matter, a redundancy situation or other termination.  Settlement agreements can (more rarely) be used to resolve issues such as where there have been grievances or complaints but the employee is still employed or changing a term of the employee’s contract. 

The essence of a settlement agreement is that an employee gives up the right to make a claim against the employer in return for financial compensation (and/or other benefits such as an agreed reference).

How settlement agreements arise

Most of the time an employer brings up the possibility of a settlement agreement in confidential or “without prejudice” discussions with the employee.  Often, a redundancy consultation has begun or performance issues have started to be investigated.   The settlement agreement is often raised as an alternative to continuing with the correct procedures.  

At times, employees may wish to leave and will request a “package” which, if agreed, will be in the form of a settlement agreement.

Things to watch out for

A well drafted agreement will specify what claims the employer believes you have.  Most agreements however will often try to exclude all claims  – even those an employee does not know about.  This is unlikely to be enforceable but your adviser will discuss this with you in detail.

The reason for the termination could also be important to some if they have some sort of income insurance so this should also be discussed with your adviser.  This may well be relevant for benefits also.

You should discuss any other benefits you are entitled to with your adviser so these can be included in the agreement.

Tax free payments

Whilst contractual payments such as accrued but unused holiday pay or notice must be taxed as usual, some payments can be paid tax free. The first £30,000 of a redundancy or ex gratia payment can often be free of tax and National Insurance.   However, the tax regulations are complicated and specialist advice on this is crucial. 

Other benefits

An agreed reference can often be an important factor for employees when considering whether to accept a settlement agreement.  Other benefits include matters such as the employer paying for outplacement counselling or an agreed announcement to staff and/or clients. 

Legal advice 

For a settlement agreement to be valid, employees must have taken ‘independent legal advice’ from a ‘relevant independent adviser’. The adviser can be a solicitor or barrister, or in some cases a trade union official or a worker in an advice centre such as a Citizens’ Advice Bureau. The adviser will need to have insurance covering any claim arising from the advice given to their client and they will need to sign a separate certificate confirming this.  Because a settlement agreement is not valid without such legal advice employers routinely offer to pay for the employee to receive this legal advice (up to a set maximum) so there is rarely any cost to the employee.

It is important that you tell your adviser everything there is to know so that they can properly advise you.

For further advice on offering or accepting settlement agreements, please contact our Head of, Ilinca Mardarescu.