Settlement Agreements and Compromise Agreements – What you need to know

A Settlement Agreement can be used to end a worker’s employment amicably in a way that avoids disadvantaging either the employer or the employee. It was introduced in the UK in July 2013 and took the place of the old Compromise Agreement. The two are quite similar in that both are legally binding and usually entail the employee receiving a financial settlement and an agreed form of reference. From the employer’s perspective these agreements allow them to terminate the worker’s employment without worrying about facing a tribunal.

The key difference between a Settlement Agreement and a Compromise Agreement is that the latter provided a limited degree of protection in some respects. This was because, while the principle of “without prejudice” applied it only did so to pre-termination discussions relating to existing employment disputes. Without prejudice is a legal principle preventing discussions from being brought up in court. It helps to facilitate open discussion without either party worrying their words being used against them later in court. A weakness of the Compromise Agreement was that only existing disputes were covered, which tended either to hamper discussions between employers and employees or to cause issues later in tribunals.

The Settlement Agreement introduced the concept of “confidential” pre-termination discussions, which prevents talks from being used as evidence in unfair dismissal claims, even in cases where an existing dispute does not exist. However, it should be noted that confidentiality does not apply in all cases. If an employee is fired for an unfair reason, such as whistleblowing, trade union membership or asserting their statutory rights as a result of entering into a Settlement Agreement, then the circumstances can be brought up at tribunal. Also excluded are cases brought under discrimination, harassment, victimisation or breach of contract. In addition, if a tribunal considers that improper behaviour by one of the parties has taken place it might also allow the previous discussions to be heard at tribunal. Examples of improper behaviour would include bullying and intimidation, physical assault or putting undue pressure on a party, such as pressurising an employee to make a decision on an offer. ACAS, the employment conciliation body, recommends that employees be given 10 calendar days to consider offers, unless the parties mutually decide to fast-track discussions.

In order to be legally binding the Settlement Agreement must satisfy certain conditions. Details of the specific complaint or proceedings must be included and the document must state that applicable statutory conditions have been met. If all relevant parts are not included the agreement will not be valid – further information about the parts that must be included in the Settlement Agreement can be found here. Where an employee is a senior member of the company, such as a director, shareholder or office holder, a Settlement Agreement – Director should be used. This contains additional clauses dealing with directorships, shareholdings and bonus/commission payments together with confidentiality and restrictive covenants.

AN OVERVIEW OF COMPROMISE AGREEMENTS

A compromise agreement is a formal, legally binding agreement made between an employer and employee (or ex-employee) in which the employee agrees not to pursue particular claims that they might have in relation to their employment or its termination, in return for a financial settlement. Thus, the primary function of a compromise agreement is to stop an employee from making any statutory or contractual claim in connection with their employment.

Compromise agreements are often used in situations where employer and employee want to part company without resorting to redundancy, firing or resigning. They can also be used as a way of settling serious employee grievances, such as claims of constructive dismissal or unlawful discrimination. Generally, compromise agreements are used by employers in order to remove employees from employment quickly and easily, avoiding the possible adverse publicity and uncertain outcome of an Employment Tribunal or court case.

This article considers the overall legal requirements of compromise agreements, but legal advice should always be sought when drafting such an agreement.

Compromise agreements are complex legal documents and they must be specifically drafted according to the facts and circumstances of each particular case. The Legal Stop offers a fixed fee compromise agreement drafting service in addition to our compromise agreement templates. For further details please contact us using our request form.

Legal Formalities

In order for a compromise agreement to be legally binding, the following conditions must be satisfied:

  • The agreement must be in writing.
  •  It must relate to the ‘particular proceedings’.
  • The employee must have received independent legal advice from a qualified adviser as to the terms and effect of the agreement.
  • There must be in force, when the adviser gives the legal advice, a contract of insurance or professional indemnity insurance covering the risk of a claim by the employee in respect of loss arising as a result of the advice.
  • The agreement must identify the relevant adviser.
  • The agreement must state that the conditions regulating compromise agreements are satisfied.

Employee’s Complaints

A compromise agreement can be used to settle one or more employee complaints. It must clearly state each of the specific complaints being settled and refer to the relevant statutory provisions because, as identified above, the compromise agreement must relate to the ‘particular proceedings’. Please note that a ‘blanket agreement’ simply signing away all of an employee’s employment rights, or one which lists every form of employment right known to the law, will not be a valid compromise agreement.

Contractual and Statutory Claims

Compromise Agreements are an exception to the general principle set out in all employment legislation that an individual cannot contract out of their statutory employment rights. Thus, a compromise agreement is necessary to obtain a valid waiver of an employee’s statutory claims. Please note that there is no need for a compromise agreement in order to settle only contractual claims. This is because an agreement to refrain from instituting proceedings in a contract claim is binding without the need for any special requirements to be satisfied. A simple waiver and release of claims will be effective. On the other hand, with statutory claims, any agreement by an employee to waive their statutory rights that is not in the form of a compromise agreement will be invalid and unenforceable. This means that the employee would still be eligible to lodge a claim in the Employment Tribunal, even though they might have already accepted a sum of money from the employer in apparent ‘full and final settlement’.

‘Without prejudice’

Open discussions with employees in relation to compromise agreements are very risky. This is because such conduct, if not protected by the veil of without prejudice privilege, is likely to be enough to constitute a fundamental breach of the implied term of mutual trust and confidence, enabling the employee to resign and claim constructive dismissal. Thus, never invite an employee to resign in return for an exit package on an open basis. The employee might resign anyway and then issue a constructive dismissal claim.

For the ‘without prejudice’ rule to apply, the employee must have genuinely consented to the meeting being held on a ‘without prejudice’ basis, there must be a pre-existing dispute between the parties and the discussion must be a genuine attempt to settle the dispute.

Compromise Agreement Clauses

Common clauses found in a compromise agreement include:

  • An agreement by both parties to keep the details of the settlement confidential and not to make detrimental statements about one another.
  • A requirement for the employee to return the employer’s property.
  • The provision of an agreed form reference for the employee.
  • A requirement for the employee to resign as a director or as company secretary.
  • A requirement for the employee to transfer their shares in the company.
  • An agreement by the employer to contribute towards the employee’s legal costs.
  • A tax indemnity from the employee.
  • Post-termination restrictive covenants (if these are new, there should be a separate monetary payment, called ‘consideration’, given to the employee for agreeing to them).
  • Confirmation that the employee has not knowingly committed any breach of their employment contract or breach of duty owed to the employer.

Generally accrued pension rights cannot be waived under a Compromise Agreement (as the trustees of the pension fund are not party to the agreement).

If the terms of the Compromise Agreement are breached by the employer, the employee could pursue a claim for breach of contract.

Taxation

Employers often wrongly believe that all payments made on the termination of employment are subject to a tax exemption of £30,000. Not all sums payable under a compromise agreement are tax-free. In determining what tax is payable in respect of termination payments, the key is to identify each element of the termination package and then consider the tax provisions applicable to the individual elements.

Outstanding wages, bonuses, commission and holiday pay are fully taxable, being payments made under the employee’s contract of employment. Ex gratia (non-contractual) sums paid as compensation for loss of employment under the terms of the compromise agreement are taxable, but subject to the £30,000 tax-free exemption.

Where an employee receives a contractual payment in lieu of notice, the payment is chargeable to tax as earnings from employment. However, where there is no contractual entitlement to a payment in lieu of notice, a non-contractual payment will be regarded as compensation for loss of employment, making it subject to the £30,000 tax-free exemption.

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Compromise Agreement

A Compromise Agreement (also known as “Termination” or “Severance Agreement”) is an agreement which enables an employee and the employer to agree that the employee will not pursue a statutory claim or claims against the employer in return for compensation.

Compromise Agreements are recognised by statute and they are an exception to the general principle set out in all employment legislation that an individual cannot contract out of their statutory employment rights. They are the only way in which an employee can contract out of their rights under employment law. They enable employees to agree to compromise their own statutory employment rights in return for compensation. The main employment rights most often compromised relate to withdrawing an existing, or subsequently refraining from bringing a, claim to an Employment Tribunal and/or the courts.

Compromise Agreements are becoming increasingly common. They are often used to safeguard the interests of both employer and employee redundancy situations. In these situations it is common practice to offer a compensation payment (also known as “Ex-gratia Payment”) above and beyond the employee’s statutory redundancy payment.

Compromise Agreements are most commonly used:

  •  To settle an existing claim an employee might have against the employer
  • To prevent an employee from claiming before an Employment Tribunal and/or the courts
  • To avoid legal challenge in redundancy situations

Provided that the Compromise Agreement is legally binding once the agreement is signed, the former employee cannot subsequently lodge a case with an Employment Tribunal or the courts. That is a major plus for the employer. In return, the employee receives an ex gratia payment and both parties agree to keep the terms of the agreement secret.

In order for a Compromise Agreement to be valid it must comply with stringent statutory conditions. There are strict and well-defined requirements to be fulfilled to ensure that a Compromise Agreement is valid. A correctly structured Compromise Agreement will be legally binding on both parties.

The following conditions must be satisfied in order for the Compromise Agreement to be valid. If these conditions are not satisfied then the Compromise Agreement is not legally binding:

  • It must be in writing
  • It must clearly identify the complaints being settled. The Agreement must specify what specific claims the employee is agreeing not to pursue
  • The employee must have received independent legal advice
  • It must be signed by a qualified adviser who must have properly advised the employee of the statutory employment rights he has agreed to compromise
  • The adviser must be covered by a suitable insurance policy. The policy must cover the adviser against the risk of a claim for losses because of the advice that has been given
  • The agreement must contain a statement to the effect that the conditions regulating compromise agreements have been satisfied

Compromise Agreements are generally marked “without prejudice and subject to contract” to prevent an employee subsequently using evidence of an offer before an Employment Tribunal or court, should an agreement not be reached between the employer and the employee.

N.B. It is a common mistake to think that, where any payment is made on termination of employment, it is not taxable unless it exceeds £30,000.

The taxation of payments made on termination of employment depends on the type of payment made to an employee. If a payment or benefit is an entitlement under the contract of employment or the payment or benefit derives from the employment, it will constitute employment income and will be subject to tax. If a payment or benefit is not employment income, it is not taxable. Thus, if a termination payment and the value of any post-termination benefits is not taxable, the first £30,000 will be tax free.

Under a Compromise Agreement an employee receives all that is due to them by way of salary and benefits up to the termination date. A payment by way of ‘compensation’ is also made to the employee. In return for this the employee agrees not to bring any claims against the employer whether through the Employment Tribunal or the courts. Effective use of Compromise Agreements helps to prevent lengthy, costly and time consuming litigation by providing the parties with a clean break.

For a fully comprehensive Compromise Agreement, suitable for settling the claim of any employee please visit: http://www.thelegalstop.co.uk/Employment/Compromise-Agreement.html