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A settlement agreement is a legally binding contract between an employer and employee, and it usually comes into effect when someone’s employment ends.
It is called a settlement agreement because it settles any claims the employee has against the employer.
It can also apply when an employer and employee wish to settle a dispute, even if the employment is ongoing and not ending.
Another name for a settlement agreement is a compromise agreement.
Who is a Settlement Agreement Between?
Normally, a settlement agreement is between an employer and an employee, or a former employee.
Settlement agreements can, in certain circumstances, apply to non-employees. One example would be if someone is an unsuccessful job applicant and has brought a discrimination claim to an employment tribunal.
The agreement must be between individuals, not groups. These individuals are known as contracting parties.
When Can You Use a Settlement Agreement?
The most common use of a settlement agreement is to bring a period of employment to an end.
By using a settlement agreement, the employee and employer can do this in a way they both agree on.
In these types of situation, both parties are looking for a clean break because the relationship between them is no longer working.
The settlement agreement forms the basis for how they agree mutually to end the employment.
Both employers and employees can use settlement agreements for situations where ending employment is the preferred solution.
Here are two examples:
• An employer has a long-standing employee who has changed roles due to restructuring but is struggling to perform their new duties. The employer has a discussion with this demotivated employee and decides to offer a settlement agreement. The employee leaves on agreed terms with a one-off payment and a reference.
• An employee has an ongoing personality clash with a fellow worker and after various attempts to improve these relations, the employee wants to look at the possibility of a settlement agreement. The employer agrees this is a way of resolving things and in the subsequent agreement, provides an agreed sum and a reference for future employers.
An employer can offer a settlement agreement at any point during an employment relationship, and there is no legal requirement to start or go through a disciplinary process.
What are the Benefits of a Settlement Agreement?
Employment tribunals can be drawn-out, taking up to eight months to be heard. The British Chambers of Commerce (BCC) has said that they can cost firms on average £8,500 each.
It is often the case that a settlement agreement will provide a swift, tidy and dignified end to an employment relationship that has run its course.
• A settlement agreement can avoid the drawn-out process of an employment tribunal claim, and the stresses associated with it
• Employers can benefit by avoiding having to go through the time and expense of the tribunal process, and from the fact that the employee is waiving all their employment law claims, in return for an agreement, where the agreed sum is confidential
• Employees may benefit by getting a better financial outcome, and a reference for future work.
By contrast, a tribunal may present either party with a greater degree of litigation risk and uncertainty about a potential outcome.
A settlement agreement may offer a much smoother, and shorter, solution.
Are There Any Disadvantages?
An employer should also be aware of potential disadvantages:
• There is the cost to the employer of paying the agreed sum
• The risk of souring existing relationships with other employees if the settlement agreement is used inappropriately – the employer should use it in place of sound management practices
• And a risk should the parties fail to reach an agreement, damaging the ongoing relationship between employer and employee.
How Do You Make a Settlement Offer?
The employer can open settlement discussions at any time, and make an offer in writing or verbally to the employee.
It is likely to be a helpful first step to talk to the employee about the issues involved and what the settlement will propose.
Putting this proposal in writing may make it clearer and avoid any misunderstandings.
At this stage, the proposal could outline what the terms of the compensation would be, and explain why the employer is making the agreement.
The employer and employee should agree on what the terms of the settlement agreement will be.
These terms will then be written into the final settlement agreement.
What Should the Settlement Offer Include?
Specific circumstances will determine what an individual employer includes in their settlement offer, and the employer must tailor the agreement to suit these particular requirements.
The written settlement offer should include details of:
• Settlement payments, and
• Non-financial terms, such as employee references and a confidentiality clause.
The agreement should have a clear breakdown of any payments to the employee that are part of the offer.
It should also be clear whether or not these are tax-free.
Currently, settlement payments to an employee can be up to £30,000 without HMRC deducting tax. It is best to seek professional advice about ex gratia payments.
When considering how much to offer in payment, there are aspects about the employment the employer should consider:
• How long the employer has worked for them
• The reasons for offering a settlement agreement
• How long it would take to resolve matters without a settlement
• The potential cost and liability of a tribunal and defending an employment claim
• How difficult it would be to fill the employee’s position
• How long it could take the employee to find a new job.
There are several non-financial terms that a settlement agreement can include.
One is an agreed reference, which the employer provides to the employee. When making the settlement deal, the contracting parties should agree on the wording of this reference.
There can also be various clauses that the employee must agree to. A confidentiality clause prevents them from disclosing how much they have received in payment as part of the settlement.
This clause may also stop them disclosing the reasons for the settlement and the terms of the settlement.
Another common clause in settlement agreements prevents employees from making derogatory comments about the employer once they have left their employment.
The settlement agreement can also have specific exclusions such as:
• Pension rights
• The freedom to pursue an injury claim.
An injury claim can apply if the injury takes place during the period of employment, even if the employee is unaware of it at the time.
What Makes Settlement Agreements Legally Binding?
A settlement agreement must meet certain statutory requirements if it is to be legally binding:
• It must be in writing
• It must relate to specific complaint or proceedings
• The agreement must be made by an independent lawyer, and include their name
• It must set out what it intends to do
• It must state that it meets the statutory regulations covering settlement agreements.
If the agreement does not meet these statutory requirements, then it will not be a legally valid document. If this happens, it means that the employee could still bring a claim against the employer.
This makes drafting the settlement agreement extremely important.
Any discussions involving the parties involved must also meet legal requirements, or they risk becoming evidence in any legal proceedings should the agreement not go ahead.
How to Discuss and Negotiate a Settlement Offer
Reaching a settlement agreement that both parties agree on is a process. This process may take time. ACAS, the advice and conciliation service, recommends a minimum of 10 calendar days, in its code of practice, for the employee to consider a proposed offer.
Without allowing a reasonable time for consideration of an offer, the employer may risk this becoming evidence in an unfair dismissal claim.
It’s important that these discussions are transparent, and that parties involved in them agree that they would be inadmissible in any subsequent legal proceedings.
The discussion process is voluntary, and either party is free to decide not to enter into them. They can also turn down an offer of a settlement agreement.
Again, this is why including a reasonable time to consider an offer is vital to the process.
The main parties involved are the employer and the employee. But the employee can ask for someone else to be present, such as a work colleague, trade union official or representative.
The key to reaching an agreement is usually the quality of the discussions and how well the parties interact.
What Does the Formal Written Agreement Involve?
The formal written agreement is essential if the parties wish to proceed with a settlement.
There are certain legal requirements to this:
• The employee must receive legal advice from an independent legal adviser, if they are going to enter into an agreement that waives their right to bring legal proceedings
• The agreement must name this independent adviser.
What is the Solicitor’s Role in a Settlement Agreement?
Typically, the independent adviser in a settlement agreement will be a solicitor.
The agreement will only become legally binding once the employee has taken this independent legal advice about the terms of the agreement.
Once the employee has a written copy of the agreement, they should meet with their chosen independent adviser, who will then advise them on the terms of the agreement.
The employee should also bring their current employment contract for the solicitor to go through, to help when going through the clauses in the agreement.
In this meeting, the solicitor will advise the employee of the effect of the settlement agreement on their legal rights to pursue any employment claims.
The solicitor will sign a certificate to confirm they have given the employee the relevant legal advice.
It is the legal role of the solicitor to explain to the employee the terms of the settlement agreement and its effects.
They can also advise the employee about their employment rights, to help them weigh up the settlement and its compensation against giving these up.
The solicitor can also advise on specific wording in the agreement, and whether the employee wishes to negotiate this.
Getting a Satisfactory Settlement
It is important that the employee feels they are getting a fair deal. The solicitor’s primary role is to advise on the settlement, and to ensure the employee is satisfied with the written agreement.
Wilson Browne specialises in employment law services for employees and we can provide the essential legal advice you need for your settlement agreement.