Settlement Agreements: a guide for employers

Settlement agreements have always been an effective tool.

This is particularly true now, given the significant increase in the number of Employment Tribunal claims since the abolition of tribunal fees, and with claim numbers likely to rise as a result of disputes and dismissals arising out of the COVID-19 pandemic.

Settlement Agreements can also be a guard against Employment Tribunal claims – if done correctly.

We are seeing a significant increase in the number of enquiries about settlement agreements, from employers and employees.

So, what do you need to know?

1. What is a settlement agreement?
2. Why choose a settlement agreement?
3. What is commonly included in a settlement agreement?
4. Are settlement payments tax-free?
5. Does the employee have to be legally represented in relation to a settlement agreement?
6. Want to know more about settlement agreements?

What is a settlement agreement?

Settlement agreements (formerly known as compromise agreements) are legally binding contracts between employers and employees to settle disputes and/or to end the employment relationship on agreed terms. They can also be used where the employment relationship is ongoing.

The employer typically agrees to pay a sum of money to the employee, in exchange for which the employee waives their right to bring certain claims against the employer.

There are certain legal requirements, to ensure that the agreement is legally effective and that the claims are properly waived.

You should therefore always take legal advice in relation to drafting of settlement agreements to ensure they are as robust as possible.

Why choose a settlement agreement?

Using a settlement agreement avoids the costs, time and uncertainty involved in court or tribunal proceedings.

It also allows the parties to agree the terms, and both therefore retain an element of control.

However, there can be risks if it isn’t done properly.

For example, an employee may still be able to bring a claim or claims, and there can be tax implications and recourse from HMRC if the correct tax treatment is not applied to the payments agreed.

What is commonly included in a settlement agreement?

Every settlement agreement is different, and will depend on the reason for entering into settlement agreement discussions and the potential claims that the employee may have.

However, typically a settlement agreement will include what has been agreed in relation to:

• salary
• notice pay
• holiday pay
• compensation payments
• references

Parties can also agree what will happen in relation to company property, and can include post-termination obligations e.g. in relation to confidentiality, non-disparaging comments and restrictive covenants.

Are settlement payments tax-free?

Generally speaking, contractual payments such as salary, notice pay, holiday pay, and so on, will be subject to income tax and national insurance contributions in the usual way.

Compensation payments up to £30,000 can generally be paid tax-free. However, this will depend on the particular circumstances and can be more complicated than is often thought (particularly since the introduction of the Post Employment Notice Pay rules in April 2018).

Specialist tax advice should always be sought.

Does the employee have to be legally represented in relation to a settlement agreement?

It is a legal requirement for an employee to be independently advised on the terms and effects of the settlement agreement.

An employer will often contribute towards the employee’s legal fees in taking this advice.

Want to know more about settlement agreements?

We are running an Introduction to Settlement Agreements webinar next week, on Thursday 8 October 2020 at 1-2pm. Click here to register.

This is a must-attend for managers and business owners, HR professionals and in-house solicitors, who are looking for an introduction to the law in this area.

For further information about settlement agreements, contact Jamie Meechan or your usual Burness Paull contact.