Settlement Agreements

If your employer has asked you to sign a Settlement Agreement, you may wish to seek fast and independent legal advice before you do anything else. Pearson Solicitors specialise in advising and representing employees in all aspects of settlement agreements and redundancy packages.

What is a settlement agreement?  

A settlement agreement is a legally binding agreement between and you and your employer. It documents the terms that have been agreed when your contract of employment is terminated, or where your employment is continuing but a dispute needs to be resolved. The employer usually pays you a sum of money, and in return you agree to waive any claims that you may otherwise pursue in either an Employment Tribunal or a Court.

The agreement will provide certainty for both you and your employer. You will be sure that you will receive your compensation within a fixed period of time, and your employer will know that you cannot bring a claim against them.

Why do I need to meet a solicitor about my settlement agreement?  

In order to use a settlement agreement to validly settle the claim or claims you have against your employer:

  • the agreement must be in writing;
  • the agreement must relate to a particular complaint that you have raised;
  • the agreement must record that the various statutory conditions governing settlement agreements have been satisfied;
  • you must receive independent legal advice from a ‘relevant independent adviser’ i.e. a solicitor;
  • the advice must cover the terms and effect of the proposed settlement agreement and in particular its effect on your ability to continue proceedings before an Employment Tribunal;
  • the agreement must identify your adviser; and
  • there must be an insurance policy in force covering the adviser at the time of his or her giving the advice.

We will advise you on any potential claims that you may have against your employer and whether the compensation that your employer is paying is adequate for the claims that you are compromising. We will ensure that you understand the legal issues and how the terms of the settlement agreement affect your ability to pursue those claims.

How much will it cost me?  

It is common for employers to pay a contribution towards your legal fees. In most cases we will be able to provide you with the relevant advice for the sum that your employer has agreed to pay.

If you are unhappy with the terms of the settlement agreement, and extensive amendments or negotiations are required, you may have to pay a contribution towards your legal fees. For example, we may be able to agree a reference that will be given to your future employers or negotiate a higher compensation payment for you.

When will I receive the amount due under the settlement agreement?  

The payment date will be specified in the settlement agreement.

Will I have to pay tax on the compensation payment?  

HM Revenue and Customs will try and attack these types of settlements and claim tax on the whole compensation payment.

In most cases the first £30,000 of genuine compensation paid for the loss of your employment will be paid to you tax free. Any compensation paid above £30,000 will be subject to income tax and national insurance in the normal way.

Your employer may require you to work your contractual notice period or may release you early and include your notice pay in the compensation payment. If your employment contract contains a payment in lieu of notice clause, that is a clause entitling your employer to pay your notice pay as a lump sum rather than making you work your notice period, HM Revenue and Customs may tax that sum as an 'emolument' of employment. It is therefore crucial that you bring a copy of your employment contract to your meeting with us so that we can properly advise you on this point.

Settlement agreements usually include a 'tax indemnity' clause. This will state that if HM Revenue and Customs determines that additional tax is payable on the compromise payment it will be your liability and not your employer's. If the employer pays any additional tax on your behalf you will be required to repay the tax to the employer. We will review the terms of the compromise payment and ensure that any risk of additional tax being found payable is minimised as far as possible.

You will be paid your salary and benefits up to the termination date in the normal way. If you have any accrued but untaken holidays outstanding at the termination date you will ordinarily be entitled to payment for them. If you have taken more holidays than you are entitled to your employer is entitled to recoup this overpayment. These payments will be subject to tax and national insurance as normal.

In certain circumstances the timing of the compensation payment will require consideration. Since 6th April 2011 where the compensation payment exceeds the £30,000 exemption and is paid to you after your P45 has been issued the excess will fall to be taxed at your prevailing notional rate i.e. 20%/40%/50%. For PAYE purposes employees who are paid monthly are only deemed to have 1/12th of the basic rate band and, if appropriate, 1/12th of the higher rate bands available to them in the month in which the compensation payment is paid. This means that you may effectively overpay income tax in the relevant tax year if you have little other taxable income in the tax year. You will have to apply directly to HM Revenue and Customs for a rebate. This issue is avoided where the compensation payment is paid before the P45 is issued as your employer will apply a flat 20% PAYE deduction.

What claims will I be able to make, if any, once the agreement is signed?  

Not all claims can be settled by means of a settlement agreement. The employer's aim will be to ensure that you give up any rights to bring a claim in relation to your employment or its termination. A settlement agreement can cover more than one type of claim, for example both claims that have been issued in the Employment Tribunal and those which you have merely raised with the employer, but it must clearly identify the specific claims that are being compromised in order to be binding on the employee.

You will retain three rights once you have signed the settlement agreement:

  • You can sue the employer for any breach of the terms of the settlement agreement e.g. if the compensation payment is not paid by the agreed date;
  • If you have a pension your accrued pension rights are not affected by the settlement agreement; and
  • Whilst a settlement agreement will include a waiver of all existing personal injury claims, it will not normally waive any personal injury claim that you are unaware of when you sign the agreement.

What happens if I am not happy with the settlement agreement?  

You are not required to sign the settlement agreement if you are unhappy with it.

If you refuse to sign the settlement agreement you are free to make a claim to the Employment Tribunal. It is your responsibility to ensure that any claim is issued within the relevant limitation period.

However, in doing so you may lose some of the compensation that you have been offered. For example your employer may refuse to pay you an enhanced redundancy package and pay you the minimum statutory redundancy payment instead. We will discuss your concerns with you and attempt to negotiate suitable amendments with your employer.

Is my employer required to give me a reference?  

Your employer is not legally obliged to provide you with a reference and is entitled to refuse to do so.

Settlement agreements commonly provide that an employer will respond to any request for a reference in line with an agreed reference that is usually attached to the agreement. These references are usually limited to factual points e.g. job title, start date, end date and reason for termination. We can negotiate the wording of the reference with your employer if you want us to do so.

Are there any restrictions on what I can do after the termination date?  

Your employer may seek to use restrictive covenants to ensure that you do not harm its business after your employment has been terminated.

Restrictive covenants can last for the duration of your employment, for a limited period after your employment has ended or, in some cases, remain binding on you forever. Such restrictions may cover:

  • Dealing with customers or suppliers of the employer that you have dealt with during your employment;
  • Enticing employees to work for your new employer; or
  • Disclosing or using your employer's confidential information.

Your contract of employment may contain restrictive covenants and the settlement agreement may provide that some of these restrictive covenants remain binding after your employment has ended. This is most common in relation to the use of the employer's confidential information. A settlement agreement can also be used to impose new restrictive covenants. If this is the case it is important that the settlement agreement states that a specified amount of the compensation payment is being paid to you in consideration for entering into the new restrictive covenants. Payments for restrictive covenants are taxable in full and, if the payment for the restrictive covenants is not separated out from the compensation payment, HM Revenue and Customs will argue that the whole compensation payment is a taxable payment for the restrictive covenants.

The information in this guide is designed to provide you with a brief outline of the key issues you need to consider when your employer offers you a settlement agreement. It is not intended to be a replacement for formal legal advice.