• Employment
  • January 28, 2022

Everything You Need To Know About Settlement Agreements

Difficult decisions have to be made to help your business survive or grow better as trading conditions evolve. That sometimes means a very close look at the numbers of staff you employ and their skills. This is something that can be challenging for both sides, so getting the right process in place from the outset is critical.     

Understanding how Settlement Agreements work provides you with a win-win option when it comes to ending your employment relationship with some team members.  

In this article, we will explain everything you should consider before entering into a Settlement Agreement with an employee, including how and when to use Settlement Agreements.

What is a Settlement Agreement?

A Settlement Agreement is a legally binding contract between an employer and an employee. Generally, the Agreement states that in return for compensation (which is usually financial) the employment relationship will come to an end and the employee will waive their right to bring a claim against the employer in the Employment Tribunal.

Settlement Agreements are used in situations where there is a serious dispute between an employer and their employee, discrimination claims, where an employee is to be made redundant, or in cases where the employment relationship is not working out and it is best for all involved that it ends.  

Another common reason for a Settlement Agreement to be proposed is where a senior employee finds their position unsustainable following a merger or acquisition. A Settlement Agreement provides a solution that protects the reputations of both the highly skilled employee and the company. 

>>Download our free Dispute settlement agreement

What is the process for putting in place a Settlement Agreement?

A Settlement Agreement can be proposed by either an employer or employee; however, it is usually the employer who makes the first approach.  

To be legally valid, a Settlement Agreement must:
  • be in writing     
  • relate to a particular complaint or disciplinary proceedings     
  • only be signed after the employee has received independent legal advice from an identified advisor who holds the required professional indemnity insurance     
  • state that the conditions regulating Settlement Agreements under the relevant statutory provisions have been satisfied     

How is a Settlement Agreement financial compensation package calculated?

Several factors, such as employee’s age, seniority, future employment prospects and salary will be considered when calculating the financial compensation package. A Settlement Agreements usually comprises of the following:

  • payments that are part of the employment contract
  • payment in place of notice
  • a termination payment, including an ex gratia payment
  • bonus payments     /     share schemes/     long-term incentive plans (LTIPs)
  • consideration for any confidentiality clauses and/or restraint of trade
  • all other statutory/contractual claims 

Settlement Agreements are meant to be negotiated and your employee’s Solicitor will likely ask for more than you are offering. Obtaining expert legal advice before negotiations begin will ensure both you and your employee achieve a positive outcome. 

Is a Settlement Agreement confidential?

For employers, one of the biggest advantages of a Settlement Agreement is that most contain a Confidentiality Clause (also known as a Non-Disclosure Clause or NDA).  Employers and employees need to take legal advice regarding Confidentiality Clauses.  Following the Harvey Weinstein sexual abuse scandal, where some of his victims were pressured to sign NDAs which prevented them even talking to a councillor, Confidentiality Clauses are coming under heavy scrutiny.  Recently, the Archbishop of Canterbury told staff that NDAs must no longer be used in the Church of England after discovering that the agreements were being used to prevent those who received pay-outs over racist abuse from speaking publicly about the incidents.

An experienced Employment Lawyer can assist you with drafting a Confidentiality Clause that protects your reputation and withstands any future challenges to its legitimacy.  

Is the compensation element of a Settlement Agreement subject to tax?

The financial element of a Settlement Agreement includes a) contractual payments and b) compensation. The contractual payments are made up of the money you are entitled to under your employment contract, for example, holiday pay, bonuses, etc. Contractual payments will be subject to income tax and National Insurance (NI).

Because the compensation payment is designed to offset the employee’s loss of income and their waiving of the right to bring a claim in the Employment Tribunal the first £30,000 of compensation payment is tax-free.

Can non-monetary compensation be included in a Settlement Agreement?

The compensation element of a Settlement Agreement does not have to be only money. It can include non-financial benefits such as:

  • the right to keep a work laptop and/or mobile phone
  • a paid-for career/business coach
  • a company vehicle
  • gym membership and/or health insurance
  • a strong reference

Depending on their circumstances, non-financial compensation may be highly valuable to your employee. Therefore, if your cash flow does not allow for a large financial settlement, you can offer your employee other forms of compensation. Don’t assume that money overrides all other needs – if your employee is looking to start their own business, benefits such as a career coach or laptop could be of great help.

Can I offer a Settlement Agreement to anyone else other than a current employee?

Yes, you can enter into a Settlement Agreement with anyone who has the right to bring a claim against you in the Employment Tribunal. This could include a worker or a job applicant who alleges they were the victim of discrimination.

Five key points about Settlement Agreements

  1. A Settlement Agreement benefits all parties. An employee receives compensation for losing their job and this is normally greater than what would be achieved in an Employment Tribunal claim. For the employer, they can be confident that the details of the dismissal will be kept confidential, and the employee is contractually barred from bringing a future claim in the Employment Tribunal.
  2. To be legally valid, a Settlement Agreement must be in writing and the employee must receive independent legal advice.
  3. A Settlement Agreement can include financial and non-financial compensation and the first £30,000 is tax-free.
  4. A confidentiality clause is normally included which will ensure both parties’ commercial reputations are protected.
  5. Settlement Agreements allow for parties to negotiate terms, providing an opportunity for a win/win situation.

Please contact us to find out how our Employment Law Solicitors can advise and represent you on a Settlement Agreement.

In closing

Nothing in this article constitutes legal advice on which you should rely. The article is provided for general information purposes only. Professional legal advice should always be sought before taking any action relating to or relying on the content of this article. Our Platform Terms of Use apply to this article.

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