What are the 7 Key things you need to know about a Settlement Agreement?

1. What is a settlement agreement?

A settlement agreement is a legally binding document that records an employee’s agreement not to pursue an employment related claim or claims against his/her employer, such as unfair dismissal, discrimination or breach of contract. In consideration for the employee agreeing to this, the settlement agreement will usually provide for a severance payment (i.e. a cash lump sum) made by the employer to the employee in addition to what the employee is contractually entitled to in any event (e.g. wages and benefits up to the termination date, notice and accrued but untaken holiday pay).

Employers are now increasingly using settlement agreements as a mechanism for preventing possible future complaints to an Employment Tribunal.

2. What does Without Prejudice and Subject to Contract mean?

Settlement agreements are usually marked on the front page, Without Prejudice and Subject to Contract. This means that by being marked Without Prejudice it means that the settlement agreement cannot be used as evidence in Court or Employment Tribunal proceedings. By being marked Subject to Contract it means that the settlement agreement will not be binding on the parties until it is signed by the employee and the employer. There is normally a clause towards the end of the settlement agreement which states that the agreement is without prejudice and subject to contract and will only become open and binding once signed by all parties. As such, until it is properly signed, neither party is bound by any of the obligations contained in the settlement agreement.

3. What conditions have to be met to make the settlement agreement legally binding and enforceable?

For a settlement agreement to be legally binding and hence enforceable the following conditions must be satisfied:-

  • The settlement agreement must be in writing
  • The settlement agreement must relate to the particular complaint raised by the employee
  • The employee must have received advice from a relevant independent adviser, such as a solicitor, as to the terms and effect of the proposed agreement and in particular, its effect on his or her ability to pursue his/her rights before an Employment Tribunal. Normally, the adviser signs to confirm the advice has been given
  • The adviser must be covered by professional indemnity insurance in respect of the advice given
  • The adviser must be identified in the settlement agreement
  • The agreement must state that the conditions regulating settlement agreements have been satisfied

Your solicitor should ensure that all of these conditions are satisfied so that the settlement agreement is indeed legally binding and enforceable.

4. Is a good deal being offered?

There is no generic answer to this question as each settlement agreement needs to be carefully considered on a case by case basis. However, in considering whether what is being offered under the settlement agreement is a good deal and hence should be entered into (as opposed to not entering into it and instead bringing a claim or claims in the Employment Tribunal) the following are examples of factors which may be taken into account:-

  • What claims do you have which are intended to be settled and what is the likelihood of succeeding in an Employment Tribunal based on those claims?
  • How much money are you being offered as a cash lump sum in addition to what you would be entitled to in any event (e.g. in addition to salary, benefits, notice and holiday pay)?
  • The likely amount of money an Employment Tribunal will award you if your claim was successful.
  • The legal costs of taking the matter to a Employment Tribunal as opposed to entering into a settlement agreement (for further information, see Astons Solicitors guidance on funding options  for employees).

Although the question of whether a good deal is being offered is normally the most important consideration for any employee, the case law is such that the independent advice given by the adviser for the purposes of a valid settlement need not include advice on whether the proposed settlement is a good deal for you.

In other words, if you do not ask your adviser if you are getting a good deal, then there is no obligation on the adviser to volunteer their legal opinion on this point. However, as this is ordinarily the most important question, it would be highly advisable that you do ask your adviser this very question. Moreover, given the importance of this advice, you should be satisfied that you will receive full and proper advice. The best way to ensure this is to seek advice from an adviser, such as a solicitor, who is a specialist in employment law.

5. What are the tax implications?

The basic position is that all contractual entitlements such as salary and benefits paid up to the termination date and accrued but untaken holiday are subject to Tax and National Insurance in the normal way. However, the first £30,000 of the cash lump sum being offered for compensation for loss of office or termination of employment in addition to contractual payments is free of Tax and NI.

As such, the settlement agreement should clearly separate out the salary and benefits which are taxable from the cash lump sum payment of which the first £30,000 is not to be taxed.

Special rules apply in the case of payments in lieu of notice. Whether a payment in lieu of notice is taxable will depend firstly on whether there is a pay in lieu of notice (PILON) clause in your contract of employment or not.  If there is such a clause then notice is normally subject to tax and NI deductions.  If there is no such clause then often the sum can be paid free of tax and NI deductions depending on what the custom and practice has been for your employer to make such payments.  If they never make employees work their notice and always pay in lieu, tax and NI may be payable as it has become a contractual term by custom and practice.

Finally, if the settlement agreement contains a new restrictive covenant (e.g. not to solicit the business of any customers of the employer for a period of 6 months following termination of the employee employment) then there should be a separate and identifiable payment in respect of this which would be subject to deductions for tax and national insurance. If there is such a covenant included in the settlement agreement but no separate payment in respect of it identified in the settlement agreement, HMRC may seek to claim that some or all of the cash lump sum being paid free of tax by the employer is in fact in consideration for entering into the new covenant and thus seek to tax it.

There will normally be a tax indemnity in the settlement agreement whereby you agree to indemnify the employer against any tax and National Insurance arising on the cash lump sum (being paid free of tax) should HMRC subsequently seek to tax it. It is for this reason that it is important that the above tax issues are recognised and dealt with appropriately in the settlement agreement.

6. What rights are being given up?

A settlement agreement must set out clearly those employment claims that you are giving up. As such, a total blanket “full and final” settlement of all possible claims will be ineffective. This means that normally the settlement agreement will list individually each of those claims which the employer wants you to give up (e.g. unfair dismissal, breach of contract, unauthorised deductions from wages). The list can be quite exhaustive as the employer will want to cover as many specific claims as possible. Your adviser should nevertheless go through each of the claims with you in order that you fully understand the rights you are giving up.

The settlement agreement should not however seek to settle any claim for accrued pension rights or personal injury you are not aware of at the date of the agreement.

7. What to do once a settlement agreement has been offered?

You should source a relevant independent adviser, such as a solicitor, suitably qualified to advise on the terms and effect of the settlement agreement, preferably someone who specialises in employment law. You should then contact the solicitor to find out the cost for advising you on the settlement agreement and, if satisfied with the cost, book an appointment to talk to or meet with the solicitor. In terms of the legal costs, there will usually be a contribution payable by your employer within the terms of the settlement agreement towards the legal costs.  Legal costs do vary so you should satisfy yourself that the cost is reasonable and competitive.

You should provide a copy of the settlement agreement to your solicitor together with any other documentation he/she may request. You can either have a face to face meeting with the solicitor or the advice can be given over the telephone.  When speaking to your solicitor, it is advisable to:

(a) Ask as many questions as necessary in order for you to be able to fully understand the settlement agreement and be comfortable with it before signing;

(b) Ask if what is being offered is a good deal for you. If it is not a good deal ask what would be and what steps can be taken to negotiate a better deal for you and the cost/benefit of doing so.

Once the settlement agreement is in order and signed by you, the solicitor will normally sign the agreement either directly in the agreement or by completing an Advisers Certificate annexed to the settlement agreement. The solicitor will then send this to the employer.

Upon receipt of the settlement agreement by the employer, it should be signed for and on behalf of the employer at which point the settlement agreement becomes open and binding. Until it is signed by the employer it is not a binding agreement. As such, your solicitor should ensure that it is signed preferably upon receipt or failing that within a reasonable period of time after receipt. Your solicitor will also normally ask for a copy of the agreement to be returned for his/her and the employee’s records. Following that, it is up to the employer to process all the payments due within the time limits stipulated in the settlement agreement.

Hopefully this guide will have given you a better understanding of how to get what is best for you. It is important that you get proper legal advice from an expert in their field.

Make sure you invest in a solicitor who will answer all your questions, makes certain you have a full understanding of the agreement and its implications, ensuring the best possible outcome for you.

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