Partner Sue Dowling, in our Employment Law team, explains why it is important that a settlement agreement is correctly drafted.
What is a settlement agreement?
A settlement agreement (in the correct terms) is a legally binding contract between an employer and an employee in order to terminate employment on a full and final settlement, agreed basis. It may be offered as part of a redundancy situation but also may be offered by the employer (or sometimes, first raised by the employee) as part of an “off the record” or “protected conversation” (under the Employment Rights Act 1996), to achieve a mutually agreeable exit, finalising the employment relationship in binding terms.
Any settlement agreement will generally require the employee to waive all of their employment rights (most commonly, any potential claims for compensation for Unfair Dismissal and/or Unlawful Discrimination), on a confidential basis, typically in exchange for an ex gratia payment.
For a settlement agreement to be binding on the parties and enforceable as a contract, a number of fundamental conditions must apply, as set out in s.203(3) the Employment Rights Act 1996, including the fact that the employee/worker must have received independent legal advice from a ‘relevant legal adviser’ as to the terms/effect of the proposed agreement and how, once signed, it will affect their ability to pursue claims in the employment tribunals.
Terms of a settlement agreement
A settlement agreement will usually contain various types of payment. These include:
- Any outstanding entitlement to notice;
- Any accrued but untaken holiday;
- A compensation or ‘ex gratia’ payment.
The compensation payment acts as the incentive for the employee to sign away their employment rights.
The tax treatment of the payments will differ and it is important to review this as the employee will usually indemnify the employer for any excess/unpaid income tax. The first £30,000 of any genuine compensation payment (inclusive of any statutory redundancy payment (if any)) will generally be paid tax and employee National Insurance (NI) free.
Other clauses within the settlement agreement will typically include:
- Warranties and indemnities;
- Confidentiality and other restrictions;
- Reference.
The employer will also often contribute an amount (often nominal) towards the employee’s legal fees to encourage the employee to obtain the requisite legal advice for the agreement to be actually binding once signed (but possibly not be encouraged (due to the limited contribution) to get too much legal advice regarding their position).
An employee can choose to accept and sign the settlement agreement; may decide to negotiate with the employer on terms and/or the amount the employer is offering as compensation or can refuse to sign the settlement agreement. All of these options should be discussed in detail with the employee’s legal adviser.
Get in touch
Our Employment Law team can advise on all aspects of Employment Law, including settlement agreements and exit arrangements.
For further information or legal advice, please contact law@blandy.co.uk or call 0118 951 6800.
This article is intended for the use of clients and other interested parties. The information contained in it is believed to be correct at the date of publication, but it is necessarily of a brief and general nature and should not be relied upon as a substitute for specific professional advice.
