Settlement agreements – A Quick Guide

EM Law helps employers and employees with drafting, advising on and negotiating settlement agreements. Our employment law team is made up of expert solicitors with City and large regional law firm experience.

If you are an employee and your employer has offered you a settlement agreement the chances are you are in the process of being made redundant or your employment is terminating for some other reason. For some individuals, redundancy is a welcome thing – an opportunity to leave a job they wanted to leave anyway with a package they would not have received if they had resigned. For the majority of people, though, being made redundant is a very stressful situation. Quite often, employers will take a hard line – putting pressure on the employee to accept the offer that’s on the table.

This is where we come in.

We help employers follow the correct process and provide pragmatic, commercial advice to help employers achieve the best outcomes. We prevent employers from being exposed to greater claims.

From the employee perspective, we help employees receive the best settlement package they can.

Negotiating settlement agreements

The common aim with settlement agreements is that, once signed, they end the employment relationship. The employee, in return for compensation in cash and other benefits, agrees that they will not bring any claims against the employer.

So it’s important to get settlement agreements right. Loose drafting opens the door for the employee to make claims that they shouldn’t have been able to make. Poor negotiation will leave an employer paying more than they should or an employee receiving less than they should.

Negotiation: common scenarios

Typically, the process of negotiation can take place in one of four scenarios.

Where employment has ended

The employee may be presented with a draft settlement agreement (marked “without prejudice and subject to contract”) and asked to revert to the employer within a fairly short timescale with a response to the settlement offer.

Where employment and active duties continue

The employee is approached by their manager or human resources department (either in a without prejudice discussion or a pre-termination negotiation). They are made an offer and potentially given a draft settlement agreement (marked “without prejudice and subject to contract”). They are told to take it away and consider its contents, usually within a fairly short timescale. The employee will remain in the workplace, actively carrying out their duties, but will be asked to keep the settlement discussions confidential, including the existence of the settlement agreement.

Where employment continues but the employee is not actively carrying out duties

A variant of the above is where the employee is still employed but not actively carrying out their duties They may be on long-term sick leave or family related leave. As above, the employee will be given a draft settlement agreement (marked “without prejudice and subject to contract”) and asked to respond within a certain timescale.

Where employment continues but employee is sent home

The employee may be given the draft settlement agreement, or an outline of settlement terms, and asked to remain at home while they consider the offer over a certain timescale. They may be placed on garden leave, or else just told it is better for them to remain at home while they consider the position. They will be asked not to have contact with colleagues or clients and their computer access may be disabled.

Possible steps in a settlement discussion (employee still employed)

Step 1: invitation to meeting

The employer invites the employee to a meeting at a mutually convenient time and place.

Step 2: at the meeting

At the meeting, the employer explains its concerns (for example, performance issues or the breakdown of the working relationship) in a neutral manner, and proposes an exit with an agreed settlement package. The employer should provide enough information for the employee to understand what has led to the offer and the potential consequences if they do not depart.

Where inadequate information is provided, this could support an argument that there is a discriminatory basis for the offer.

Step 3: written offer

If the employee agrees to explore the suggestion of settlement, the employer produces a written offer.

The employee must have a “reasonable period” in which to consider the formal written terms.

Step 4: settlement agreement

If the employee is interested in proceeding with the settlement, the employer can provide the employee with a settlement agreement documenting the terms, if they have not already done so. The employee will need to take independent legal advice on the implication of entering into the agreement.

If the employee is not interested in exploring settlement, the employer should cease settlement negotiations and seek to tackle the underlying problem.

Acas guidance on conducting settlement discussions

Acas has produced the following guidance and resources:

• A Code of Practice on Settlement Agreements which focuses on the admissibility provisions regarding pre-termination negotiations.
• A guide to settlement discussions to help employers and employees understand when settlement agreements can be negotiated.
• Two template letters (putting forward settlement offers) and a model settlement agreement; these are contained in the guide.

Allowing time to consider offers

The Acas Code on Settlement Agreements states that parties should be given a reasonable period of time to consider the proposed settlement agreement and that, as a general rule, ten calendar days should be allowed to consider the proposed formal written terms of a settlement agreement and to receive independent advice, unless the parties agree otherwise.

Allowing employees to be accompanied

Although the Acas Code on Settlement Agreements acknowledges that there is no legal right for employees to be accompanied during pre-termination negotiations, it suggests that employers should allow this.

“Subject to contract”

Correspondence about the settlement agreement (and drafts of the agreement itself) will usually be marked “subject to contract”. The intention is to make it clear that nothing said or written in negotiations should give rise to a legally binding contract until all the terms have been agreed and the contract signed by both parties.

Typical contents of settlement agreements

The contents of a settlement agreement are largely at the discretion of the parties, except for those clauses which relate to the statutory requirements.

In a typical case, termination of employment will have occurred or be imminent. The agreement will usually provide for the employee to receive a termination payment in return for waiving certain claims.

Examples of typical clauses are:

• Arrangements on termination (dealing with issues such as untaken holiday and salary payments)
• Termination Payment (what cash compensation will the employee receive?)
• Benefits (what other benefits will the employee receive?)
• Pension (dealing with treatment of the employee’s pension)
• Legal fees (usually all of the employee’s legal expenses are covered)
• Waiver of claims (where the employee agrees not to sue the employer)
• Return of company property (where the employee agrees to return all company property)
• References (where the employer agrees to provide a reference that is in a form agreed with the employee)
• Restrictive covenants (usually these repeat any restrictive covenants in the employee’s employment contract)
• Confidentiality (the parties agree that the terms of the agreement are confidential)
• Other standard clauses to be found in most contracts such as English law applying, the English courts having jurisdiction to hear any claims etc

Issues relevant to drafting settlement agreements

Prior to drafting a settlement agreement, a number of issues will need to be considered, including:

• The proposed timing of the termination, including the implications if there is going to be a significant delay between signing the agreement and the proposed termination date.
• The reason for termination, including how this will be reflected in the agreement (if at all) and how any associated announcements will be handled.
• The value of the settlement package on offer (having regard to the employee’s salary and contractual entitlements, together with the value of any potential claims).
• Where there is a discretion to be exercised by the employer (for example in relation to bonus or share options), how this discretion will be exercised.

Termination payment

The amount of the termination payment is likely to be an important focus of the settlement discussions. The employee will usually seek to improve this, or to enhance the overall value of the package in other ways. This may be done by:

• Negotiating a higher lump sum, having regard to the merits of any claims.
• Seeking a more tax efficient way for the sum to be paid, for example having part of the termination payment paid into a pension scheme.
• Negotiating the payment of discretionary sums under discussion, for example in relation to bonus, commission or share options.

Tax status of payment

Where a payment is made to an employee on the termination of employment, it is either taxable in the normal way as earnings under the Income Tax (Earnings and Pensions) Act 2003 or taxed as a termination payment under sections 401 to 416. The first £30,000 of payments that fall within section 401 is exempt from tax and any excess will be subject to income tax in the normal way, with the employer being responsible for accounting to HMRC.

Legal fees

It is usual for the employer to make a contribution to the employee’s legal fees, since one of the statutory conditions for a settlement agreement is that the employee has received legal advice.

If you have any questions concerning a settlement agreement please get in touch.