Settlement Agreements – 7 Steps to Success

A settlement agreement is a legally binding contract between an employer and an employee, which settles a claim that an employee might have against their employer. A settlement agreement is normally used in connection with terminating the employment, but this isn’t always the case. We have put together this guide, 7 steps to a reaching a successful settlement agreement, we hope you find the information useful.

1. ‘Without Prejudice’ vs ‘Protected’ conversations

To get the ball rolling on offering a settlement agreement to an employee that you have decided you would like to bring their employment to an end, you will want to have an ‘off the record’ chat which ideally cannot be referred to in future tribunal correspondence should you fail to reach agreeable terms.

There are two mechanisms which you can use to start the ‘off the record’ chat:

• the ‘without prejudice’ common-law principle; an
• a ‘protected conversation’ under section 111A Employment Rights Act 1996.

It’s important to understand how both mechanisms work, and to what set of circumstances they should be applied.

The following are required for a discussion to qualify under the ‘without prejudice’ rule:

• an existing dispute between the parties, (e.g. threat of a claim by the employee);
• a genuine attempt to settle that dispute;
• an agreement to treat the discussions as without prejudice; and
• no ‘unambiguous impropriety’ in the conduct of the parties during the settlement discussion.

If there is no existing dispute then, a different rule needs to be used as if the ‘without prejudice’ rule does not apply and any ‘off the record’ chat (even if the employee agrees to having one) would not be protected and therefore becomes admissible in tribunal proceedings.

The ‘pre-existing dispute’ element previously made it difficult for employers who had come to the decision that they wanted to have an ‘off the record’ discussion about mutually bringing an employee’s employment to an end. The Government responded by inserting statutory provisions into the existing section of 111A Employment Rights Act 1996. This provision permits discussions between you and an employee with a view to terminating their employment on agreed terms to remain confidential and inadmissible in proceedings before Tribunal and can be ‘out of the blue’ from an Employee’s perspective.

Please be advised however that the ‘protected conversation’ is only protected to the extent that unfair dismissal proceedings are included but does not preclude you behaving improperly such as putting undue pressure on the employee to resign, using harassing or bullying behaviour. Protection will also not be extended where discrimination or whistleblowing is alleged.

In summary therefore as a rule of thumb:

• If there is an existing dispute then you should hold a ‘without prejudice’ discussion.
• A protected conversation should be held when there is no existing dispute.

2. Confidentiality and Restrictive Covenants

Confidentiality is a fundamental principle of a successful settlement agreement as it is likely you will want the agreement and the circumstances leading up to the offer of settlement to remain strictly private and confidential. Generally, employers don’t want to be known for settling employees out as it can give rise to opportunistic and baseless claims when another employee departs knowing that there is scope for being paid to go quietly above any notice entitlement. Confidentiality tends to be mutual between the parties and a list of exclusions are provided for within the agreement. In the case of the employee these will include examples such as: immediate family, HMRC and professional advisers who will all adhere to a duty of confidentiality.

Restrictive covenants can often be reaffirmed in settlement agreements and can give you greater comfort that a departing employee will be restricted from damaging your business when they join a competitor for example. If they have been recently negotiated and independently advised upon as part of the settlement agreement they will have a higher likelihood of enforceability in the courts should there be concerns of a breach in the future. Simply by their inclusion and discussion will act as a deterrent for the exiting employee to abide by them.

3. References & announcements

References and announcements can be more important to exiting employees then you might expect in some circumstances. It is therefore very common for parties to agree on the wording for any announcement and subsequent reference which will be requested by a prospective employee. Commonly they are a condition of the settlement agreement and the specific wording for both an announcement and a reference are set out as separate schedules to the main body of the agreement. References tend to be limited to factual references: name of employee, employee’s job role and dates of employment.

4. PILON & notice periods

You have to decide how you wish to treat an employee’s notice period. If you require an employee to work their notice period then you will serve them notice and the settlement agreement might require reaffirmation in they have a long notice period. You might decide that you don’t want the exiting employee working for a competitor immediately and you may elect to put them on Garden Leave. Finally, you may decide that you just want to bring the relationship to an abrupt end and then pay them in lieu of their notice period referred to as a PILON. We would advise that you check the employee’s contract of employment as to whether you have a contractual right to make a PILON (and what payments are included within the PILON) or to put them on Garden Leave. Presently many employers who’d normally make a PILON are not doing so as they can recover furlough grant monies to contribute towards notice pay under the Coronavirus Job Retention Scheme. You should seek advice in such circumstances.

5. Holiday

Your starting point should be to check the employee’s contract of employment as to how holidays are treated on termination of employment. Generally speaking if you are making a payment in lieu of notice you would pay any accrued but untaken holiday up to the Termination Date. The contract of employment will then determine if accrued but untaken holidays are deemed to be taken in notice periods. If the employee is working their notice period or being put on Garden Leave and the contract does not give a right that their holiday is deemed to be taken you could still give the employee twice the notice for the amount of annual leave remaining and therefore it would not need to be paid in addition to the notice period (subject to the length of the notice period of course). Treatment of holiday pay can often be a contentious stumbling block when trying to get a settlement agreement over the line so a well drafted provision in a contract of employment can alleviate any further discussion.

6. Tax and Termination Payments

A few years ago if there was no express payment in lieu of notice clause (PILON) in an employee’s contract of employment you could legitimately gross up an exiting employee’s notice period. This is often an employee’s misconception that you will need to make clear to them during any negotiations. HMRC has recently updated their manual about the tax treatment of termination payments https://www.gov.uk/hmrc-internal-manuals/employment-income-manual/eim13890 and makes clear how post-employment notice pay (PENP) should be calculated.

The basic rule is that anything treated as salary or benefits is subject to deductions for tax and NI (bonuses, notice, holiday pay). Whereas up to £30,000 can be paid tax free in respect of compensation for loss of employment and is usually referred to as an ex gratia payment.

7. Contribution to legal fees

You are expected to contribute for an employee’s legal fees for them to go and seek independent legal advice on the terms of the settlement agreement. You should expect to contribute £500 plus VAT so that an independent adviser (usually an employment specialist solicitor) can advise the employee on the terms. Without such independent advice the settlement agreement will not be legally binding under the relevant settlement agreement legislation.

Disclaimer

• Please note – this guidance is not intended to be taken as legal advice – for individual situations you will need to take specific legal advice.
• The information in this guide is correct as of 14th September 2020.
• All information provided should be read alongside the relevant Government Guidance at https://www.gov.uk. We hope you have found this note useful and if you do have any queries please get in touch with our expert employment solicitors in Leeds.

Marie Walsh
Director, Employment Solicitor and Mediator
Direct Dial 0113 8874670
Mobile 07736252681
Address: 4 Park Place, Leeds LS1 2RU

Victoria Horner
Senior Associate
Direct Dial: 01138874673

Andy Boyde
Employment Solicitor
Direct Dial: 0113 323 0346 Mobile: 07595 520 508