Settlement agreements are an extremely useful tool available to employers and employees who wish to terminate their employment relationship.
A settlement agreement is a legally binding contract wherein an employee sacrifices all claims that they have against their employer in return for an enhanced termination package usually made up of a compensation payment and a reference. There are, however, 3 claims that an employee can never sacrifice under a settlement agreement namely;
- any claim relating to accrued pension rights,
- any claim relating to personal injury that the employee is not aware of at the date of entering into the agreement arising out of their employment with that employee
- any claim to enforce the terms of the agreement.
A settlement agreement provides employers with peace of mind that no employment claims will be brought against them following the termination of the employee’s employment. An employer can therefore use a settlement agreement to avoid the need to go through the procedures required in a dismissal or redundancy situation or to waive the notice period which must be given to the employee, allowing the employment relationship to be brought to an end quickly, without any admission of liability.
However, an employee is not obliged to accept a settlement agreement offered to them. An employer therefore needs to offer incentives to persuade the employee to enter into the agreement. Such an incentive is normally a compensation payment in excess of the statutory and contractual payments the employee is entitled to receive. There are also tax benefits for employees entering into such agreements, as the first £30,000 of any such compensation payment may be paid tax free. The contractual notice period an employee is required to work may also be waived, or paid in lieu as a lump sum to allow an employee to seek alternative employment immediately.
By signing a settlement agreement, an employee is waiving their employment rights and their right to bring a claim against their employer. It is therefore a legal requirement that the employee obtains independent legal advice on the terms and effects of the agreement before signing. It is normal practice for an employer to make a contribution towards the employee’s legal fees incurred seeking this advice. The level of the contribution varies, but is often in the region of £250 - £500 plus VAT.
The settlement agreement will include a number of standard terms including the termination date, the payments being made to the employee and the taxable status of such payments. It will also include terms to ensure confidential information relating to the employer is protected, and to ensure company property is returned promptly. There is also likely to be a clause preventing the employee from making derogatory comments about the employer and to prevent the employee from discussing the terms or existence of the settlement agreement. The agreement will also make clear that the employer will have the right to recover sums paid under the agreement from the employee should he or she breach its terms.