What is a Settlement Agreement?

You should maintain a transparent working relationship with your employees. This includes resolving workplace disputes through mediation where possible. If you're unable to do so, you could use a settlement agreement.

A settlement agreement can help end an individual's employment in an amicable way. This happens under certain circumstances, where both the employer and the employee benefit from it. If you don't use it, you could face an employment tribunal claim.

In this guide, we'll discuss the terms of a settlement agreement, its advantages, and the employment law surrounding it.

What is a settlement agreement?

A settlement agreement is a legal document which helps bring an employment contract to an end. The agreement - previously known as a compromise agreement - usually involves two parties; an employer and their employee.

Once both parties reach an agreement, the employer provides the staff member with a severance payment.

Usually, the employee will agree not to pursue any grievances – and to waive a future claim to an employment tribunal. Settlement agreements help avoid tribunal proceedings as a whole. And brings an employee's employment to an end in a way that benefits both parties.

When do employers use a settlement agreement?

There are several instances where employers might wish to use a settlement agreement. These include:

Workplace disputes

Settlement agreements can benefit employers during workplace conflict. For example, an employee might argue their employer has acted in a way that constitutes unlawful behaviour. Such as discriminating against them.

Both the employer or employee can negotiate payment - in exchange for the employee signing a settlement agreement. This confidentiality clause would ensure the employee keeps the agreement confidential.

There are some exceptions, however, such as if the law requires disclosure of information. Overall, it helps to protect the employer's reputation.

Termination

Another instance where an employer might wish to use a settlement agreement is to end employment. This could be in instances of workplace conflict, or simply to end employment amicably.

For example, a senior director might resign from a company - and join a competitor business. A settlement agreement would prevent the former director from competing with their ex-employer's business - when their employment ends.

In simpler terms, it stops staff using their ex-employer’s trade secrets - if they decide to move to another company.

Redundancies

A settlement agreement can also be useful when making staff redundant. It won't be suitable to use one in every redundancy scenario, but it might make the process easier for both parties.

For example, an employee may feel less stress if their employer uses a settlement agreement during redundancy. This is because it removes the uncertainty of redundancy, and – if they choose to sign - places legal requirements which they must then both fulfill.

This might include contractual payments, or asking the employee to return company property.

Is a settlement agreement legally binding?

Yes, a settlement agreement is a legally binding contract. But, there are several factors to consider when drafting one. This includes being aware of the statutory rights of your employees. Failure to note this could prevent the contract from being legally enforceable.

The Employment Rights act 1996

For the proposed settlement to be valid, The Employment Rights act 1996 requires an employer to:

• Put the agreement in writing.
• Ensure the agreement relates to the particular proceedings.
• Ensure the employee has received independent legal advice.
• Ensure the agreement states that its terms comply with the relevant statutory provisions.

Once the employer and the employee have agreed to the terms and signed the contract - it's officially legally binding.

Who can advise on a settlement agreement?

A legal advisor can advise on a settlement agreement. But they must have relevant insurance - in the event a loss occurs as a result of their advice.

What does without prejudice mean in a settlement agreement?

Without prejudice means the agreement can't be brought up in a future tribunal claim. For example, if you don't reach a settlement and have to follow court proceedings.

It specifically relates to comments either party makes during dispute resolution. And encourages both parties to speak freely during settlement discussions, so they can reach an agreement.

What’s the difference between a protected conversation and without prejudice?

You can only apply without prejudice to conversations where there is an employment dispute. Whereas, you could use protected conversations at any point during pre-termination negotiations.

Ultimately, both confidentiality provisions offer both parties peace of mind during settlement discussions.

Do employers have to pay legal fees for settlement agreements?

No, the law doesn't require you to pay the legal costs of your employees during settlement agreements. But, most employers provide a contribution at least.

What should be included in a settlement agreement?

Naturally, every business will have its own template when it comes to settlement agreements. Terms and conditions are based on individual cases, but seek legal advice where necessary.

A standard settlement agreement negotiation typically includes:

• Notice pay and holiday entitlements.
• Contractual bonuses and shares.
• Ex-gratia or compensation payments.
• Relevant NDAs (Non-Disclosure Agreements).
• Post-Employment Notice Pay (and any tax indemnities).
• Internal restructures (like resignations, handovers, returning company property).
• The legal costs the settlement includes.
• Employer and employee discussions of agreements.

Is a settlement agreement the same as redundancy?

No, a settlement agreement is not the same as redundancy. Staff who are made redundant are entitled to statutory redundancy pay - if they have two years’s service or more. The notice period, also depends on their length of service.  

In a settlement agreement, both parties negotiate the terms for ending the employment relationship. This helps you to reach a fair settlement and avoid an employment tribunal claim. Depending on the case, the employee might seek:

• Contractual payment: A contractual payment is something you must pay upon a staff member's termination. For example, this might be holiday pay entitlement or pension contributions.
• Pay in lieu of notice: In some instances, the agreement may state that you have to make a payment in lieu of notice (PILON). This allows you to bring forward the staff member's termination date, without them having to work their notice period. This termination payment is usually in the form of a lump sum.
• Financial compensation payment: If your employee believes you've acted improperly, the settlement may outline a compensatory payment. For example, if the employee believes they could submit an unfair dismissal claim to an employment tribunal. But, settlement agreements usually include a compensation payment even if the employer hasn’t behaved improperly – to ensure the agreement is legally binding.

How long does it take to negotiate a settlement agreement?

The length of putting a settlement agreement together varies on a case-by-case-basis. This could be a small number of days, weeks or months - depending on how negotiations go. As a general rule, you should provide your employees with ten days to review the agreement.

In some instances, the legal advisor may suggest the employee accepts the agreement as it is. Which would mean it would only take a matter of days.

In contrast, if changes need to be made and an agreement is difficult to reach, it may take longer. For example, you and your employee may disagree on the amount of financial settlement they receive.

Can you change the terms of a settlement agreement?

Once both you and your employee sign a settlement agreement, it is final and cannot be withdrawn. However, if both parties agree, you can then make variations. But you must keep a record of these discussions and final amendments.

Do you pay tax on a settlement agreement?

Settlement payments - including compensation, is normally paid tax free (for up to £30,000). This also includes statutory redundancy payments. However, you should seek financial advice on the matter before agreeing to anything.

What happens if a settlement agreement is breached?

The consequences of breaching a settlement agreement depends on the party at fault. If the employer breaches the agreement, the employee can make a breach of contract claim to an employment tribunal.

If your employee breaches the settlement, you might ask them to repay the financial settlement they received. If they breach confidentiality provisions within the agreement, you could also sue for loss or damages as a result of the breach.

The benefits of a settlement agreement

A settlement agreement won't be suitable or necessary for each of your staff's end of employment. But, they can provide certain security that can uphold your business's services and reputation.

Let's explore these benefits further:

Cost effective

One advantage of using settlement agreements is that it could be more cost effective in the long term. This is mostly applicable in cases where there is a risk of claim.

For example, if an employee believes you have mistreated them, they might quit - and make a constructive dismissal claim. Which might mean your business pays a hefty compensation payment. But if you use a settlement agreement, you and your employee can agree to a fair financial settlement.

This is in exchange for your employee not making unfair dismissal claims - which can be a long and costly process. Once you settle with your employee, you won't have to worry about further legal proceedings and costs arising in the future.

Assurance of outcomes

Settlement agreements also provide an assurance that protects your business. Since both parties dictate the terms, both parties can benefit. For example, if an employee believes they have experienced an unfair disciplinary process, they may want to make an unfair dismissal claim.

With a settlement agreement, in exchange for compensation, you could prevent an employee from threatening dismissal claims. If you outline this in the settlement, any attempt to make a claim afterwards would breach the agreement.

Therefore, it prevents your business from experiencing further costs, tribunal proceedings, and even damage to your company's reputation.

Uphold your business's intellectual property

Protecting your business's intellectual property is important when it comes to maintaining investors and customers. And using a settlement can help you with this.

For example, if you ask employees to agree to a confidentiality clause, it will require them to keep the information surrounding your services and products confidential. In addition to any company secrets.

Make sure you avoid putting undue pressure on your employees when asking them to sign this however, as it could cause them to withdraw from negotiations. And may mean you fail to reach an agreement.

Get expert advice on settlement agreements from Peninsula

If you ever need to use settlement agreements, you should ensure it follows legal requirements. This ensures the proposed settlement is legally enforceable. And considers your staff's statutory employment rights.

If you don't, your agreement will be invalid. This means employees could make legal claims against you. Consequently, you could face further legal fees and reputational damage. Or even an employment tribunal hearing.

Peninsula offers expert advice on settlement agreements. Our teams offer 24/7 HR advice which is available 365 days a year. We take care of everything when you work with our HR experts.

Want to find out more? Contact us on 0800 028 2420 and book a free consultation with an HR consultant today.