There are many reasons why employers or employees may wish to enter into a settlement agreement at the end of their employment relationship. It is not always the case that the parties are at loggerheads with each other and money, whilst clearly a key factor, is not the only consideration when assessing what a successful settlement agreement might achieve. 

Farringford Legal’s experience, acting both for employers and employees in such situations, has shown that commercial factors, reputation and the ability to carry on professional life beyond the current employment relationship are often the primary focus in negotiations.

So, to go back to basics, what is a settlement agreement?

Settlement agreements are used to bring an employment contract to an end where there might be a potential claim against the employer such as unfair dismissal, discrimination, breach of contract or a breakdown in trust and communication. 

They can also be used in redundancy situations to ensure everything is tied up by both sides, especially where senior employees are concerned, and more than just basic statutory redundancy pay is being offered. Equally a settlement agreement might be a quicker option than to go through a lengthy capability process because of illness or a lack of skill or experience.

What makes a settlement agreement valid?

In order for the settlement agreement to be valid, it is a legal requirement that it is in writing and an employee has received independent legal advice from a qualified person, usually a solicitor. A good adviser will advise on the content and effect of the settlement agreement so that an employee can decide whether the employer’s offer is one which it is reasonable to accept or needs further negotiation.

The adviser should always look beyond the routine terms of the settlement agreement to try to  ensure that its contents help the employee to be able to smoothly move on and continue their working life successfully, without unnecessary or unwanted constraints. 

Without an adviser’s certificate confirming an employee has received advice, the agreement, even if it has been signed, won’t stop an employee from bringing a claim. Employers usually pay towards the cost of an employee getting legal advice on the settlement agreement. A typical employer contribution is between £250 and £750 but be wary of employers who only wish to pay the minimum hoping that advisers may pay less attention. 

Typical terms in a settlement agreement

There are a series of typical terms comprised in such a settlement agreement. These include a termination payment to the employee; the employee giving a waiver to the employer in relation to any claims they might have against the employer (excluding of course any personal injury claim of which the employee is unaware at the time of signing the agreement); accrued pension rights under the pension scheme and any public interest disclosures, in other words whistleblowing. But there are less obvious matters which ought also to be considered on both sides.

The provision of references; the ongoing consequences or not of restrictive covenants and continuing access to non-monetary benefits for a period are more controversial and less readily the subject of consensus, event where relationships may not have soured entirely. 

Key considerations

References

There is no legal obligation on any employer to provide a reference for an employee but for many employees when their employment has been terminated, a reference is crucial to allow them to move on and get a new job. Settlement agreements often provide a template reference within a schedule to be provided to prospective employers if they were to request a reference.

However, there is a real reluctance on the part of most employers to provide any written reference of a meaningful character. This is driven by a reasonable concern that if the reference turns out to be incorrect it can form the basis of a misrepresentation claim for damages on the part of the new employer. From an employee’s perspective often the best that can be obtained is a factual statement which sticks to the dates and character of their employment rather than any expression of opinion about their qualities. Employees need to be realistic about the challenges to obtaining a reference in the glowing terms which they might wish.

The contents of any such reference need to be agreed by both the employer and employee prior to finalising the agreement and will typically simply contain the dates of employment, role title and duties. An employer will also  have to follow their own internal policies regarding references and may also be bound by their own regulatory rules. For example: financial institutions are bound by the provision of regulatory reference rules as set out in the PRA Rules book and supervisory statements as well as the FCA Handbook.

Restrictive Covenants

An employee will often be bound by post-termination restrictive covenants set out in their employment contract. However very often they may seek to be released in some part from those covenants to allow them to get another job in the same role elsewhere or to work locally due to family considerations.

An employer will want to reaffirm those restrictive covenants in the settlement agreement to protect their business, their employees and their confidential information. So, it is a matter of negotiation between the two as to what extent those covenants are waived. It is essential that any restrictive covenants are reasonable and do not unfairly limit an employee’s ability to work. The law looks to find a balance between the interests of the employer business and the employee. The key criteria at the heart of that reasonable balance are likely to be limits of time and geography. 

One recognised balancing tool is the use of a period of garden leave or notice period that creates a vacuum of space and time between employer and its retained personnel, clients and suppliers and its former employee to allow business as usual to progress without the presence of the former employee. The consequent effect is that information which needs protecting from the business’ perspective, such as new client deals or designs, becomes ‘old news’ by the time that period is over. Or where such a notice period is in place, the settlement agreement may provide for some of the restrictive covenants to be waived if the employee informs the employer of any job offer he or she may receive. This could save the employer money and gives the employer some oversight over where the employee is going.

Other items to consider

Other considerations for parties to negotiate are:

  • whether the employee continues to receive such benefits and other non-monetary compensation they are entitled to under their contract for a period of time including accrued salary, accrued holidays, bonuses, commission payments, shares, private health cover for the individual and their family, company car or car allowance and gym/sports club memberships. These must be specifically set out in the agreement because if they are not included, they will be lost once the agreement is signed. These benefits will have a value so there will be tax implications to consider.
  • an agreed approach to publicity and informing clients, suppliers, retained employees and any other relevant third parties about what has happened;
  • changes to the clauses dealing with tax or tax indemnities;
  • deleting clauses that are unreasonable in order to remove or minimise risk; 
  • determining who can know about the fact of the settlement agreement and its contents. It is usual to let professional advisors know but often an employee would want their recruitment company to know or the benefits’ office so that they can claim their employment allowance; and
  • agreements to refrain from making any derogatory comments about either party. A company will not be able to ensure complete radio silence, but they can use all reasonable endeavours to procure that no one says anything negative.

Money

Whilst this is not the most important element, it is nevertheless high on the list from both sides. How much should an employer pay/an employee receive? Each case is different but there’s a clear list of matters to bear in mind when trying to determine an amount which might work for both sides:

  • the length of employment;
  • the circumstances giving rise to the need for the settlement agreement; 
  • the length of time and likely costs (both actual and in terms of wasted resource) it would take to settle the dispute if agreement was not reached; 
  • the potential loss to the employer commercially in dealing with the matter; and
  • the potential reputational and financial cost of having to defend a claim in an Employment Tribunal and of the possibility of losing that defence.

Any payments to be made under the settlement agreement must be clearly identified. Each payment must state whether it will be subject to deductions for tax and national insurance contributions (NIC). For example: any outstanding pay in lieu of holiday entitlement will be subject to tax under PAYE.

Payment in lieu of notice (PILON)

Where an employee has not worked their notice period, any payment made in lieu of notice (PILON) must be subject to tax and NIC. A termination payment in excess of contractual notice of up to £30,000 may only be paid as a lump sum free of deductions. Above that level, the excess will be subject to deductions for tax and NIC.

Any payments made under settlement agreements will be subject to HMRC’s scrutiny to ensure that tax and NIC are deducted when due. Notice should run from the date the settlement was ‘agreed in principle’. This is likely to take the form of an email or letter from the employee, agreeing to the proposed terms. If enough notice has not been given between the date ‘agreed in principle’ and the agreed termination date, then a PILON should be made, which will be subject to deductions. There are various tax elements to be considered so each party is advised to talk to their advisers on what these could entail.

What our clients say

Sarah-Jane with her excellent legal expertise and negotiation skills ensured I was fully aware of my legal obligations and made amendments to the settlement agreement to safeguard my rights and reputation.

I felt I could trust her to handle matters on my behalf as she was extremely knowledgable and provided examples of similar scenarios she had worked on, which helped me to understand the extent of the agreement I was signing.

So, to reiterate it’s not just about the money

Both parties to settlement agreement negotiations need to have an eye to the future.

Express consideration needs to be given to how the suggested terms of a non-financial character being proposed might affect each of the employer and the employee going forward. For an employer, it is more than just the termination of employment, there are many commercial factors and potential risks to the business to think about. After all, the employer wants to move on, focus on the employees it has who are staying and the clients/suppliers that need their attention.

The employee also wants a fresh start but without any hindrance from their former employment. A ‘What if’ analysis of how things might play out should enable both sides to see the worst, but plan for the best, and to settle on final contents of the agreement which manages risks reasonably for both parties.

Our employment law team is Sarah-Jane Butler and Philip Davies.