Advice & Guidance On Settlement Agreements For Employers
A settlement agreement is a legally binding agreement between an employer and employee that usually includes 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 are also used to allow an employer to avoid potentially lengthy processes, such as full redundancy, disciplinary or a capability/performance process.
Are settlement agreements only used to dismiss employees?
Not necessarily. For example, if you have underpaid an employee’s salary and expenses for several months, you could offer your employee a settlement agreement with an enhanced ex gratia payment. This is offered on the condition that they would not be able to bring a claim against you at a later date.
In what circumstances is it appropriate to consider offering a settlement agreement to your employee?
It is very important to consider if there are any existing employment disputes at this stage. If there is not, the process should be easier. If there is, there are more factors you need to consider.
No existing employment dispute
If there is not an existing employment dispute, and you feel that a settlement agreement would be a pragmatic solution for both parties, 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”.
Usually, employers would invite the employee to invite to a meeting to explore and discuss the idea of settlement, although some employers prefer to proceed in writing only. Under a protected conversation, you are free to make a reasonable offer to an employee to leave their employment and not bring a claim at a later date.
In our experience, this is a sensible tactic for employers to consider when there is not an existing employment dispute. We have worked with a large range of organisations to help execute this procedure successfully and gain outcomes that satisfy both parties.
Existing employment dispute
The ‘protected conversations’ mechanism does not specifically apply to all potential claims or causes of action and as such the protected nature of the conversations do not apply for the following 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;
Whilst the protected conversation regime does not necessarily apply to such potential claims such conversations can be useful to seek to resolve such potential issues.
The protected conversatin regim and protections do not apply where there has been “improper behaviour” in the way the protected conversation is undertaken and any offers are made. 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 (e.g. not giving an employee reasonable time to consider the offer – a reasonable amount of time has been deemed to be at least 10 days – or an employer stating that if the settlement proposal is rejected then the employee will be dismissed).
So, if the existing dispute is not covered above, you still have the opportunity to explore a settlement agreement with your employee.
What are the next steps after protected conversions?
Send a settlement offer letter to an employee
The letter from you should include the summary of your protected conversation and the points you have agreed on. It should also include a cutoff date (typically at least 10 days later) where the employee will need to either accept or decline the final settlement offer. If the employee accepts the offer, you can proceed to sending the final settlement agreement document.
However, if the employee declines the settlement offer or fails to respond within the time stipulated, the offer could be withdrawn and their employment should continue.
You should not threaten to dismiss your employee if they 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.
Send the settlement agreement
At this point your employee needs to seek independent advice on the proposed agreement you are asking them to sign. Without receiving legal advice, the settlement agreement will not be legally binding.
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.
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.
If you make a contribution to the cost of obtaining legal advice, you will only pay such fees in the event that the settlement agreement is entered in to. Should the employee reject the settlement agreement, they will be liable for the costs of obtaining the advice.
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 you.
Termination payments less than £30,000 should usually be tax-free. If you offer 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 the employee will provide a tax indemnity to their employer in the event that HMRC challenges the payments. This means that the employee will be required to reimburse their 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.
The agreement should include the employee’s notice 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 the employee is not paid in lieu of notice and is not required to work, you should place the employee 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, the employee should still receive the same pay and contractual benefits they would have if they had worked your period of notice. As they are still bound by your employment contract during garden leave, they are required to be available to answer and address any work-related queries during the garden leave.
If they have outstanding holiday entitlement the agreement should either require them to take any outstanding accrued holiday before the termination date or make a payment in lieu of accrued but untaken holiday. If they 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 they have taken more holiday than accrued, you could deduct an appropriate amount from their final payment if there is a right to do so in their 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 they are due bonuses or commissions then the amounts owed should clearly be set out in the settlement agreement and will be subject to tax and NICs.
Entire agreement clause
The settlement agreement 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 employee. 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.
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 the employee enter into new or tighter post-termination restrictions.
If you would like advice, please contact GA’s employment team today by calling 01752 203500. You can also email me directly via Kayleigh.arthurs@GAsolicitors.com.