Settlement Agreements - a guide for employers
By Julian Cox, Partner at Fletcher Day
December 18 2013 - Whilst Christmas is traditionally a time for 'glad tidings of comfort and joy', it is potentially also a difficult time of year for both employers and employees. Whilst there are some signs of economic recovery, as the Chancellor's recent Autumn Statement with its talk of continuing austerity measures has highlighted, there are still tough times ahead for businesses as they continue to make their way out of the economic recession. December is traditionally a time for employers to review the performance of their business over the preceding twelve months and to start to plan for the future. Depending on business performance levels, they may be required to make difficult decisions about staffing levels going into the New Year. At the same time many financial institutions in the City facing the prospect of having to pay out on bonuses at the end of their current financial year early next year use December as a time to identify staff that are surplus to requirements.
Because of the various protections built in for employees under UK employment law, dismissing an employee often requires employers having to go through long and time consuming redundancy, disciplinary or capability procedures to ensure the process is carried out fairly and avoid unwanted claims in the Employment Tribunal and the accompanying cost of defending these. A single case of unfair dismissal can cost an employer up to £88,000.
Faced with this potential financial exposure, the Settlement Agreement offers employers a useful tool offering a relatively clean way potentially of terminating someone's employment without having to undertake a potentially long and difficult procedure involving substantial management time. At the same time, there are various risks attached for an employer in offering a Settlement Agreement to an employee, of which employers need to be aware so as to avoid unanticipated claims and liabilities for their organisation. This handy guide has been put together with this in mind to help employers considering using a Settlement Agreement.
What is a Settlement Agreement?
A Settlement Agreement (previously known as a compromise agreement) is a legally binding confidential agreement between you and your employee. A severance payment is typically provided for in return for the employee's agreement not to pursue any claims in either the Employment Tribunal or civil courts arising out of their employment or its termination. A Settlement Agreement can also provide additional protection for employers including re affirming post termination restrictions, duties of confidentiality and preventing employees from bad mouthing their employer.
What is the benefit of entering into a Settlement Agreement?
From an employer's viewpoint a Settlement Agreement also gives them the comfort of knowing that the circumstances leading up to the termination of their employment and the terms being offered, in particular the amount of the payment being offered remain confidential.
From an employee's perspective it gives them the comfort of knowing their employer is legally obliged to pay them the settlement sum being offered. The employer needs the employee to take independent advice on the terms and effect of a settlement agreement before it will be considered legally binding.
How is a Settlement Agreement different from a Compromise Agreement?
Settlement Agreements were known as Compromise Agreements prior to 29th July 2013. Practically speaking though, there is very little difference between a Settlement Agreement and its predecessor in terms of its terms and effect.
When might an employer use a Settlement Agreement?
Settlement Agreements are used by employers in a wide variety of different situations. For example when faced with an employee with work performance or misconduct issues and the employer is concerned about having to instigate formal performance or disciplinary procedures and not confident that doing so will achieve the required improvement within a reasonable period of time.
Settlement Agreements are also used when employers are faced with having to make redundancies and they are faced with having to go through a full redundancy procedure before being able to terminate.
A Settlement Agreement is a useful instrument in such circumstances, offering employers a quick and clean method of terminating someone's employment without having to undertake a potentially long and difficult redundancy, disciplinary or capability process involving substantial management time.
Is there any risk in offering a Settlement Agreement?
In certain circumstances, there is substantial risk attached to offering an employee a Settlement Agreement. For example, where the employer offers the Settlement Agreement prematurely in a situation which the employee would consider to be 'out of the blue' - where the employer has not raised any concerns about the employee's work performance or conduct with them previously. In such circumstances, there is a risk that whilst employers may try to claim such discussions or supporting documents regarding a Settlement Agreement being offered (including both soft and hard copy written correspondence, attendance notes of meetings and the Settlement Agreement itself) are "off the record" or "without prejudice" they are not entitled to treat them as such. Consequently, the conversations and documents used will not be afforded legal protection and if the employee refuses to accept the Settlement Agreement they may argue the relationship of trust and confidence between employer and employee has been irretrievably eroded. In such circumstances, the employee may seek to rely on the conversations and documents as evidence as part of a formal grievance against the employer. The employer also risks all such "off the record" and "without prejudice" documentation being presented in evidence as part of a claim constructive dismissal and/ or discrimination (where appropriate) in the employment tribunal.
Settlement Agreements will also only guarantee conversations are "protected" in a narrow set of circumstances, where the employee could only bring an ordinary unfair dismissal claim against your company. If there is potential for your employee to bring a claim of discrimination due to a 'protected characteristic' (e.g. race, sex or disability) then these conversations and documents will not be afforded such protection. An example would include if you offered a Settlement Agreement to an employee who told you she was pregnant or to an older employee to encourage them to retire.
Similarly, where there is potential for your employee to bring a claim for automatic unfair dismissal such as where they have raised a health and safety issue or in cases of whistleblowing then the details of any "off the record" conversations you may have had with your employee relating to a Settlement Agreement, and any relating documents (including the Settlement Agreement itself) will not be protected and may be shown in evidence to an Employment Tribunal as part of an employee's claim should they decide to reject the settlement being offered.
The recently published ACAS Guidance on Settlement Agreements ('the ACAS Guidance') also sets out examples of "inappropriate behaviour" on the part of employers in terms of offering a Settlement Agreement which would result in the employer losing the veil of protection and entitle the employee to refer to the conversations taking place and any supporting documents as part of an Employment Tribunal claim.
- All forms of victimisation;
- Bullying, harassment and intimidation (e.g. pressurising a female employee who has raised a complaint of discrimination into signing the Settlement Agreement or risk dismissal);
- Not providing your employee a reasonable length of time for to consider your Settlement Agreement offer - the ACAS Guidance recommends a period of 10 calendar days to consider an offer under a Settlement Agreement;
- An employer saying before any form of disciplinary process has begun that if a settlement proposal is rejected then the employee will be dismissed;
Because of the potential pitfalls involved in offering a Settlement Agreement, we recommend that appropriate legal advice ought to be obtained before doing so.
How much should an employer offer to pay an employee under a Settlement Agreement?
There is no prescribed sum in terms of what an employer ought to offer to pay an employee by way of a severance payment under the auspices of a Settlement Agreement. How much to offer will very much depend on the surrounding circumstances of the case leading to your wish to terminate, the terms in the employee's contract and any potential claims that the employee may have against you. As a rule of thumb, an employer is effectively compensating am employee for not filing a claim with the employment tribunal (as well as termination of their employment usually). At the same time, the employer will need to ensure that all contractual entitlements (e.g. notice or payment in lieu, accrued but untaken holiday entitlement are properly provided for).
Tax advice ought to be taken in relation to the payments that are to be made under a Settlement Agreement. An ex gratia payment genuinely representing compensation for loss of employment can be made of up to £30,000 without deductions for tax.
The Settlement Agreement may also need to make provision for the following contractual payments depending on what is contained in the employee's contract of employment:
- Bonus and commission
- Medical and life assurance
- Consideration for the employee reaffirming post termination restrictions
Given the various different legal and contractual aspects and accompanying tax issues involved in correctly pitching a settlement offer to ensure it represents a fair (and therefore attractive) settlement package to offer under the auspices of a Settlement Agreement, we recommend obtaining professional legal advice first before putting such an offer forward and that the Settlement Agreement itself be professionally drafted also.
When should the employee expect to receive the money under a settlement agreement?
Settlement Agreements usually provide that any ex gratia settlement amount is to be paid between 14 to 21 days of the agreement itself being signed. However, employers may want to make certain payments such as salary and accrued holiday and bonuses or commission payments through the payroll on the usual payroll date.
How much does it cost to prepare a Settlement Agreement?
The amount your legal advisor will charge to draft a Settlement Agreement will very much depend on the complexity of the issues surrounding the employee leading to the Settlement Agreement being offered, the complexity of the proposed terms of settlement, in particular the payments being made and how they relate to the relevant tax rules.
Who pays for the legal advice an employee has to take on a Settlement Agreement?
It is in the employer's interests for the employee to sign the settlement agreement, giving them the comfort of knowing the employee is effectively waiving their legal rights against them employer in relation to any legal issues arising out of their employment or the termination thereof and any claims in the employment tribunal or civil courts relating to the same. For this reason, in the overwhelming majority of cases, the employer agrees to make a contribution of between £250 to £500 plus VAT towards the employee's legal fees in having to seek independent advice as to the terms and effect of the Settlement Agreement. It is not recommended to offer a cost contribution beyond this as by doing so the employer may end up paying the employee's legal fees in terms of their lawyer seeking to improve their negotiating position and with it any settlement amount under the settlement agreement.
In certain situations, employers take the view of not offering any contribution towards the employee's legal costs, for example where there are very strong grounds to dismiss the employee if they won't sign the agreement, making it very much in the employee's interests to do so rather than have a blemish on their CV.
What if an employee refuses to sign the Settlement Agreement?
An employee may elect not to sign a Settlement Agreement on the advice of their adviser, for example if the terms are too onerous. Alternatively the employee may turn down the Settlement Agreement if the amount on offer is insufficient and the employer is not prepared to agree to any counter proposal put forward.
If an employee refuses to sign the Settlement Agreement then there is a risk that they may rely on it and the conversations surrounding it as evidence in bringing a grievance and resigning and claiming constructive dismissal and discrimination and any employment proceedings arising as a result as already explained.
Advantages of offering Settlement Agreement
As identified in the ACAS Guidance, Settlement Agreements provide both employers and employees with a number of advantages and disadvantages.
In terms of the advantages, Settlement Agreements can:
- provide a swift and dignified end to an employment relationship that is not working
- avoid the time, cost and stress involved for both parties in a tribunal claim
- provide compensation and often a reference for employees
Disadvantages of offering Settlement Agreement
In terms of the disadvantages, the following considerations that need to be taken into account:
- The cost of paying an agreed financial sum to an employee
- The potential risk to the ongoing employment relationship with the individual if settlement is not agreed (and potential that they may use the Settlement Agreement and any conversations or documents relating to it in resigning and making a claim in the Employment Tribunal)
- The potential risk to employment relations in the wider workforce if used inappropriately or as a substitute for good management practices.
Julian Cox, Partner at Fletcher Day
Julian Cox heads the Employment Law team. He is a specialist employment law solicitor with over fifteen years' experience and covers all aspects of employment law.
Fletcher Day is a full-service commercial law firm located in Central London, who advises UK and international client base on a broad range of legal matters.