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Using settlement agreements to resolve employment issues

View profile for James Hodgson
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Employment relationships can come to an end for many reasons, including redundancy, dismissal and personality clashes.

Increasingly, employers are using settlements to end an employment relationship. Settlement agreements offer an alternative to wading through a drawn-out disciplinary, performance or redundancy process and the uncertainty of tribunal proceedings.

What is a settlement agreement?

A settlement agreement is a legally binding agreement between employer and employee, usually resulting in the employee agreeing to waive their employment rights and not pursue a claim in an employment tribunal or other court. In return, the employee usually receives a financial settlement, the details of which are set out in the agreement.

Requirements of a settlement agreement

To be valid, the agreement must:

  • be in writing
  • relate to a particular complaint
  • be signed by both parties
  • record that the regulating requirements have been satisfied

The employee must receive independent legal advice on both the terms of the agreement and the effect of those terms on their ability to pursue any rights in an employment tribunal.

When can a settlement agreement be used?

Settlement agreements can be used in a range of circumstances; they are most commonly used to terminate employment on agreed terms, or to resolve a workplace dispute.

The agreement can be proposed by either the employer or the employee, can be offered at any stage of employment and are voluntary for both parties.

Employees are entitled to full employment up to the date of termination set out in the settlement agreement.

What should a settlement agreement include?

Settlement agreements differ, however, aspects that are common to most agreements include:

  • the amount of compensation to be paid. This might include payments for redundancy, unpaid wages, bonuses, pay in lieu of notice and any holiday pay entitlement
  • any restrictions on the employee’s future employment
  • confidential matters, such as restrictions preventing an employee telling anyone they have entered into a settlement agreement
  • an agreement that neither party will make derogatory or disparaging remarks about the other
  • an agreed reference and form of wording for announcement to colleagues and clients

When is compensation paid?

Normally, sums agreed in a settlement agreement are paid within 28 days of the date of termination. The payment date is in the agreement.

What are the tax implications of a settlement agreement?

Up to £30,000 of genuine compensation can be paid tax-free basis in certain circumstances. The employer will deduct any income tax and employee national insurance contributions from the payment.

How much does it cost to obtain independent legal advice for a settlement agreement?

The agreement is likely to include a contribution towards the cost of the employee’s legal fees. The amount can vary but it is usually around £350+ VAT.

All discussions and negotiations between an employee and their employer regarding the settlement agreement should be conducted on a ‘without prejudice’ basis or as part of a protected conversation, so that, if agreement cannot be reached, discussions cannot be used as evidence in any employment tribunal or other court proceedings.

What are the advantages of a settlement agreement?

Settlement agreements end an employment relationship quietly and quickly. They protect the employer because the employee signs away almost all their legal rights that they may have had. In return the employer usually gives the employee more money than they would ordinarily be entitled to.

Settlement agreements offer both parties a clean-break and avoid the time, costs and stress associated with protracted formal complaints or tribunal claims.

What are the disadvantages of a settlement agreement?

There are costs associated with drawing up a settlement agreement and for obtaining independent legal advice. However, this might be a small price to pay in the long term.

Where a settlement is not agreed, ongoing employment relationships can be jeopardised and could have an adverse effect on employment relations with the wider workforce.

Over the past two years, because the pandemic has put a strain on many businesses, settlement agreements are increasingly common. If your employer offers you a settlement agreement, seek expert legal advice before you sign.

For more information and advice about settlement agreements and resolving employment issues, contact James Hodgson or Maureen Cawthorn at our Halifax office on 01422 339600.