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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Our Compromise Agreement Templates are:

• Compromise Agreement
• Compromise Agreement – Director