In summary, a settlement agreement is a legally binding agreement between an employee and employer. They usually include a severance payment (also known as an ex gratia payment or termination payment) made by the employer in return for an employee's agreement not to pursue any claims in the Employment Tribunal or Court.

Why do employers use Settlement agreements?

They are used for various reasons, for instance when an employer and employee feel that their employment relationship is no longer workable and wish to "draw a line in the sand".

They're also used when an employer does not want to follow what could potentially be a very lengthy process, such as the full redundancy, disciplinary or a capability/performance process.

The employment does not necessarily have to end to be offered a settlement agreement. For example, if it is discovered that you have been underpaid for several months, your employer may wish to offer you a settlement agreement with an enhanced ex gratia payment so that you would not be able to bring a claim against them at a later date.

How are they offered by employers?

If your employer wishes to terminate your employment by way of a settlement agreement they may invite you to a meeting to explore and discuss the idea of settlement, although some employers prefer to proceed in writing only. Any correspondence you receive from your employer in relation to the agreement will likely be marked as being on a "without prejudice" basis. Should you respond to any correspondence in relation to the agreement, such as requesting larger sums of monies, you should also state at the top of the letter that it is on a without prejudice basis.

Without prejudice discussions alone can only be used when there is an existing dispute. If there is no existing employment dispute, section 111A of the Employment Rights Act 1996 permits pre-termination negotiation conversations to be treated as confidential. These discussions are often referred to as "protected conversations".

However, without prejudice/protected conversations do not automatically apply to all settlement agreements and their negotiations and do not generally apply for the following potential claims:

  • Discrimination claims based on a "protected characteristic" under the Equality Act 2010 being disability, maternity, pregnancy, age, race, religion or belief, sex, or sexual orientation;
  • Claims for automatic unfair dismissal such as raising health and safety concerns or whistleblowing;
  • Where there has been improper conduct by the employer.

Where there is "improper behaviour" anything said or done during protected conversations will only be inadmissible in an employment tribunal to the extent that the tribunal considers it just. The ACAS code of practice for settlement agreements, provides a non-exhaustive list of examples of what may constitute" improper behaviour" such as:

  • All forms of harassment, bullying and intimidation;
  • Physical assault or the threat of physical assault;
  • All forms of victimisation;
  • Discrimination because of a protected characteristic; and
  • Putting undue pressure on an employee, for example:
    • not giving an employee reasonable time to consider the offer. A reasonable amount of time has been deemed to be at least 10 days .
    • an employer stating that if the settlement proposal is rejected then the employee will be dismissed.

The offer letter from your employer should include a cut off date (typically at least 10 days later) you will need to either accept or decline the final settlement offer. Once you have accepted the offer, you should receive a document titled settlement agreement which tends to be between 8 and 20 pages long. It is this document that you will need to obtain legal advice on for it to be legally binding.

Depending on the circumstances surrounding the agreement, should you decline the settlement offer or fail to respond within the time stipulated, the offer will likely be withdrawn and your employment should continue. If the reason for the agreement was to circumvent the need to conduct the full redundancy, disciplinary, capability or grievance process, then such processes are typically recommenced.

Please note that in some circumstances, such as discrimination claims, protected conversations may in themselves form the basis of a claim to an employment tribunal as evidence of the discrimination an employee has been subjected to.

Can my employer threaten to dismiss me if I do not accept the agreement?

An employer should not threaten to dismiss you if you reject the offer of entering into the settlement agreement. Such a threat would constitute improper conduct and subsequently would be admissible in the Employment Tribunal or Court. Should an employer threaten dismissal if you reject the offer, it may be used as evidence and strengthen any potential claims you might have. For example, if you have a claim for bullying and harassment by your employer, the threat of dismissal could be used as evidence to prove their treatment of you. Furthermore, should you resign as a response to the threat of dismissal you could potentially claim constructive unfair dismissal.

What claims am I settling by entering the agreement?

The purpose of the agreement is that an employee waives their right to bring a claim against their employer. Subsequently, most settlement agreements aim to cover every possible type of claim you could bring against your employer and not just your specific potential claims.

Generally they should not prevent you from making the following claims against your employer:

  1. Breach of the agreement itself, such as your employer fails to pay you the termination payment;
  2. Latent personal injury claims, meaning a personal injury which you might not necessarily be aware of at the time of signing the agreement. For example, you develop asbestosis years after your employment terminated but you can trace back your asbestos exposure to your employer; and
  3. Accrued pension rights. For example, if it is discovered that your employer did not comply with their pension obligations.

There are some circumstances where settlement agreements cannot be used to settle claims, such as claims relating to:

  1. The right to statutory maternity pay, statutory paternity pay, statutory adoption pay or shared parental pay;
  2. The Agency Workers Regulations 2010 (SI 2010/93);
  3. An employer's duties relating to employees working beyond retirement;
  4. An employer's failure to inform and consult with appropriate representatives on collective redundancies; and
  5. An employer's failure to inform and consult or failure to pay compensation equivalent to the protective award under the Transfer of Undertakings (Protection of Employment) Regulations 2006.

Acas cannot assist with point 1 above but are able to conciliate in relation to claims 2 to 5 or other claims not suitable for settlement agreements which have not been listed. Should you have a claim in relation to point 1, you are able to pursue this in an employment tribunal.

In regards to personal injury claims, the default position is that the right to bring a personal injury claim (which usually relates to injuries already happened) is waived. However, in some settlement agreements, personal injury claims are specifically excluded, especially in industries in which long-term industrial injury claims are more common. Such a right to be able to bring a personal injury should be clear and unambiguous within the settlement agreement.

Please note that they cannot prevent you from making a protected disclosure.

What payments are usually included in an agreement?

Settlement agreements usually state the full breakdown of payments due and also whether any sums are to be paid free of tax. However, below is a brief summary of the payments that might be included and whether they are tax free.

Compensation for loss of employment

The agreement will likely include a termination payment from your employer.

Termination payments less than £30,000 should usually be tax-free. If you are offered more than £30,000, the first £30,000 of the termination payment should usually be deemed tax-free. The balance of the termination payment over the £30,000 will be subject to income tax at the appropriate rate.

It is possible that HMRC may review the termination payment. The agreement should normally include a provision that you will provide a tax indemnity to your employer in the event that HMRC challenges the payments. This means that you will be required to reimburse your employer for any sums paid to HMRC in relation to the termination payment and any interest, penalties, costs and expenses on those sums. This might happen in the event that HMRC deems the payment not to be a genuine compensation payment, if for example, notice period is not dealt with separately.

If you have questions in regards to taxation of a severance sum, it is advisable to seek advice from a financial adviser or accountant (we cannot provide tax or financial advice).

Notice payment

The agreement should include your notice pay and detail whether it is to be worked or paid in lieu. Notice pay is always subject to tax and NICs even when paid lieu.

If you are not paid in lieu of notice and are not required to work, you should be placed on what is known as 'Garden Leave'.

Garden leave is when an employee is still bound by the terms of their employment contract (until their termination date) but are no longer required to attend their place of work or carry out their day to day duties.

Whilst you are on garden leave, you should still receive the same pay and contractual benefits you would have if you had worked your period of notice. As you are still bound by your employment contract during garden leave, you are required to be available to answer and address any work-related queries during the garden leave.

Holiday entitlement

If you have outstanding holiday entitlement the agreement should either require you to take any outstanding accrued holiday before the termination date or make a payment in lieu of accrued but untaken holiday. If you are placed on garden leave, the agreement might include the provision that any accrued but untaken holiday are deemed to have been used during garden leave.

If you have taken more holiday than accrued, your employer should not be entitled to deduct an appropriate amount from your final payment unless there is a right to do so in your contract of employment or any other relevant agreement.

Holiday entitlement payments are always subject to tax and NICs even when paid in lieu.

Bonus and commission

If you are due bonuses or commission then the amounts owed should clearly be set out in the settlement agreement and will be subject to tax and NICs.

Entire agreement clause

It should include an entire agreement clause which means that the settlement agreement itself (and any other documents specified) constitutes the whole agreement between you and your employer. Should there be any "side agreements" in place such as bonus or commission agreements, the settlement agreement (and documents referred to) will supersede and override any other agreement in place. If any such agreements are in place, they should be referenced within the settlement agreement itself.

How do I know if the severance sum is fair?

In order to assist you in determining whether the severance sum offered is fair, we will consider the facts of your individual circumstances and the reason for the settlement agreement. We will advise on the strength and weaknesses of potential claims and calculate what you may be awarded by an Employment Tribunal (should you be successful) and compare the potential value of your claim to what is being offered in the settlement agreement.

In the case of settlement agreements to circumvent the need to undergo a redundancy procedure, we will calculate your statutory redundancy entitlement and compare it to the sums offered in the settlement agreement.

Why do I need a solicitor?

When you enter into a settlement agreement, you waive your rights to bring an employment claim, as such section 203(3) of the Employment Rights Act 1996 requires that an employee obtains "advice from a relevant independent adviser" on the "terms and effects of the proposed agreement" in order for the settlement agreement to be binding. Without receiving legal advice the settlement agreement will not be legally binding.

In accordance with s203(3) the independent adviser must also be named in the settlement agreement and have a current contract of insurance, or professional indemnity insurance, covering the risk of a claim against them by an employee in respect of the advice.

Independent advisers include qualified lawyers – such as us at GA Solicitors.

How much will it cost to obtain legal advice?

As it is a legal requirement that an employee receives legal advice on "terms and effects" of the settlement agreement, it is usual for the employer to make a contribution to the employee's legal fees.

Should your employer make a contribution to the cost of obtaining legal advice, they will only pay such fees in the event that the settlement agreement is entered in to. Should you reject the settlement agreement you will be liable for the costs of obtaining the advice.

Can I negotiate the severance sums or other terms of the agreement?

Yes, you can negotiate terms. However, if the terms are complex, or you require us to negotiate with your employer on your behalf, then your legal fees may be higher than your employer's contribution and you may be liable for the costs of such negotiations. Alternatively it is possible ask the employer to increase the legal fee contribution to cover the cost of negotiations.

Alternatively, should you wish to negotiate but do not wish to incur additional legal fees, you have the option of negotiating with your employer directly.

Will the agreement include a reference?

Not always, however it is quite common for a settlement agreement to attach a copy of the reference which the employer agrees to provide upon request from a prospective employer.

It is common practice that a reference is brief and states only the factual details of your employment such as job title, start date and end date. The reference will also likely include a disclaimer against any third party losses or damages resulting from reliance on the reference. That being said, some employers choose to provide further factual details such as performance, attendance or disciplinary record. It is likely that your employer will have a standard reference policy which they will wish to use.

It is possible to negotiate a more detailed reference with your employer.

Will it include post-termination restrictions?

They can.

Post-termination restrictions, also known as restrictive covenants, are used to prevent an outgoing employee from competing and/or poaching clients, customers and/or staff. The most common restrictive covenants prevents an outgoing employee from:

  • Soliciting or poaching clients/customers after they have left.
  • Soliciting members of staff.
  • Working for a competitor or setting up in competition.
  • Dealing with any clients.

Post termination restrictions can be dealt with in various ways within a settlement agreement. For example, it might not introduce any new post-termination restrictions and simply refer you back to the post termination restrictions, if any, contained within your employment contract.

Alternatively the settlement agreement might require that you enter into new or tighter post-termination restrictions. In consideration for you entering into such post-termination restrictions, employers may provide a nominal taxable payment.

Can my employer and I discuss it with others?

As mentioned above, the negotiations surrounding the agreement are confidential as they are without prejudice.

Settlement agreements themselves should usually include a confidentiality clause, stating that neither you nor your employer are permitted to discuss the existence or contents of the agreement. However, you are usually permitted to discuss this with your immediate family (who must ensure it remains confidential), your legal adviser, HMRC or your insurers.

How can GA Solicitors help me?

We have an experienced employment team which consist of qualified solicitors and will provide you with comprehensive advice as to the implications of signing the agreement.

If necessary we can complete settlement agreements quickly, often usually within a couple of days of first contact.

Do I need to attend your office?

It is up to you whether you wish to attend the office. We can either arrange a meeting at our office located at 25 Lockyer Street to discuss the contents of the settlement agreement or we can arrange a telephone of video conference call to discuss this.

Can I sign the agreements electronically?

It used to be custom that 'wet signatures' were required, even when being advised over the telephone, meaning that you would need to physically print and sign a copy of the settlement agreement and then scan a copy back. However, electronic signatures are now widely accepted. Electronic signatures can be in many forms but should not be typed in, for example using a Microsoft Word font. Examples of acceptable electronic signatures include Adobe Fill and Sign and DocuSign.

Originally published 25 Feb, 2022

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.