What is a settlement agreement?

A settlement agreement is a binding legal agreement, usually between employers and employees. It prevents an individual from making complaints to the Employment Tribunal about breach of his or her statutory rights or contractual rights. This includes claims for unfair dismissal, redundancy, unlawful discrimination and non-payment of salary against their employer, associated companies and employees.

The purpose of a settlement agreement is to provide certainty for both parties. Typically, as an employee, you waive your ability to bring the aforementioned claims on the basis that your employer pays you a discretionary termination payment.

Claims that cannot be waived by a settlement agreement include:

  1. If your employer breaches the agreement, e.g. does not pay you the termination payment, you could make a breach of contract claim
  2. Claims in respect of unknown personal injuries at the time of signing the agreement
  3. Claims in respect of accrued pension rights

The employee must receive independent legal advice

It is a legal requirement that you receive legal advice from a relevant independent adviser on the terms and effect of the proposed agreement and its effect on your ability to pursue any rights before an Employment Tribunal.

The Government introduced this requirement to mitigate the risk of employers putting pressure on employees to waive certain claims by signing an agreement. It is common practice for the adviser to sign a certificate to confirm they have given the necessary advice and that they possess the criteria to be an independent adviser.

Other legal requirements

Settlement agreements are regulated closely by legislation. For a settlement agreement to be valid, the other conditions that must be met are:

  • The agreement must be in writing
  • The agreement must relate to a ‘particular complaint’ or ‘particular proceedings’
  • The independent adviser must have a current contract of insurance, or professional indemnity insurance, covering the risk of a claim against them by the employee in respect of the advice
  • The agreement must identify the adviser
  • The agreement must state that the conditions regulating settlement agreements have been satisfied

Negotiating the terms of the agreement

Save for those clauses which relate to the statutory requirements, the contents of a settlement agreement are largely at the discretion of the parties involved.

You may wish to consider, and consult your legal advisers as to the merit of, negotiating:

  1. The timing and reason for termination recorded in the agreement
  2. The value of the exit package being offered having regard to salary, the value of any potential claims and any contractual provision for bonuses or deferred awards
  3. An agreed reference
  4. An agreed internal and external announcement
  5. A waiver of restrictive covenants in the employment contract

Taxation of the termination payment

The first £30,000 of a termination payment is generally exempt from tax, with any excess being subject to income tax in the normal way. One exception to this is where the employment contract has a provision for a payment in lieu of notice (PILON) or the employer has a practice of making PILONs. In this instance, the amount of the PILON will be subject to income tax and National Insurance Contributions (NICs).

Impending changes

We expect that, in April 2018, the Government will introduce a measure to require:

  • That employer pay NICs on any part of a termination payment that exceeds the £30,000 threshold.
  • That all employees will pay tax and Class 1 NICs on the amount of basic pay that they would have received if they had worked their notice in full, even if they are not paid a contractual PILON. This means the tax and NICs consequences are the same for everyone and it is no longer dependent on how the employment contract is drafted or whether payments are structured in some other form, such as damages.