Two recent developments trigger the need for in-house employment lawyers to review and refresh their precedent Settlement Agreements.
Firstly, changes are needed to reflect the recent reforms to the taxation of termination payments regime. Secondly, changes may be necessitated by the recently-issued SRA Warning Notice on the improper use of non-disclosure agreements (NDAs). The warning notice applies to solicitors (including those working in-house) advising clients on the use of NDAs, where the other party to the agreement is an individual.
Changes to reflect the reforms to the taxation of termination payments
The tax regime in respect of payments paid in connection with the termination of employment (sections 401 and 403 Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003)) was amended on 6 April 2018. The new regime applies in respect of termination dates falling on or after 6 April 2018.
Whilst the £30,000 tax-free threshold has been retained, the types of payments that fall within the threshold have changed. New section 402D ITEPA 2003 introduces a concept of "post-employment notice pay" (PENP). In essence, the PENP is the basic pay equivalent for any unworked notice period calculated using a specified formula.
Where an individual is not employed for the full notice period, any "relevant termination award" made post-termination will be taxed as general earnings (and therefore subject to income tax and Class 1 employer's and employee's NI) in so far as it is equal to (or less than) the PENP.
In light of these reforms, you may wish to consider making the following amendments to your precedent Settlement Agreement:
Consider defining "PENP" by way of a cross reference to the formula given in section 402D of ITEPA 2003, and possibly also by reference to a worked calculation set out in a schedule to the Settlement Agreement (see below).
Termination of employment clause
Consider clarifying whether the employee has completed all, part or none of their contractual notice period. The amount of notice served is relevant for the calculation of the PENP and so it is helpful to have this detailed in the Settlement Agreement.
Compensation and payments clause
It is already common practice to separate out the different types of payments being made to the employee and their respective tax treatment (e.g. statutory redundancy payment, contractual PILON payment, payments in consideration of confidentiality / covenants and the compensation payment). You may now wish to clarify that:
the part of the compensation payment equal to the PENP is taxable as earnings and will be subject to deductions for tax and national insurance contributions; and
the remainder of the compensation payment can be paid free of tax to the extent that it does not exceed £30,000 (inclusive of any statutory redundancy payment).
New schedule setting out the PENP calculation
Both parties to the Settlement Agreement may find it helpful to set out the PENP calculation in full in a separate schedule. This would set out the PENP formula given in ITEPA 2003, the meaning of the terms used in the formula (e.g. "basic pay") and, finally, the application of the formula to the employee's termination payment.
For further guidance on navigating the reforms you can read our comprehensive guide for employers, which outlines the changes in detail and provides worked examples of how the PENP formula should be applied in a number of different scenarios.
Changes to reflect the guidance in the SRA Warning Notice
The Solicitors Regulation Authority (SRA) recently issued a Warning Notice to law firms on the improper use of NDAs. The Warning Notice governs the use of NDAs by law firms, however, it applies equally to solicitors advising clients on the use of NDAs where the other party to the agreement is an individual (whether represented or not).
As Settlement Agreements typically contain secrecy provisions, the Warning Notice prompts a review of precedent Settlement Agreements. Failure to comply with the Warning Notice by solicitors will be treated as a breach of the SRA Principles and could result in disciplinary action.
What does the SRA Warning Notice say?
The Warning Notice provides that the "inappropriate use" of NDAs may put solicitors in breach of one or more of the SRA Principles 2011. It goes on to say that NDAs will be used improperly where they are used as a means of preventing, or seeking to impede or deter, a person from:
- reporting misconduct, or a serious breach of our regulatory requirements to the SRA, or making an equivalent report to any other body responsible for supervising or regulating the matters in question (i.e. any other regulator);
- making a protected disclosure under the Public Interest Disclosure Act 1998 (i.e. a whistleblowing disclosure);
- reporting an offence to a law enforcement agency; and/or
- co-operating with a criminal investigation or prosecution.
Additionally, the Warning Notice provides that NDAs must not be used to:
- influence the substance of such a report, disclosure or co-operation;
- improperly threaten litigation against, or otherwise seek to improperly to influence, an individual in order to prevent or deter or influence a proper disclosure; and/or
- prevent someone who has entered into an NDA from keeping or receiving a copy.
The Warning Notice also states that NDAs or other settlement terms must not stipulate, or give the impression, that such reporting or disclosure is prohibited.
What changes should your consider making to your precedent Settlement Agreement?
In light of the Warning Notice, you may wish to consider making the following amendments to your precedent Settlement Agreement:
The best course of action would be to amend the secrecy provisions in your Settlement Agreement to expressly carve out the items referred to a 1 – 4 above. Indeed, this coheres with the SRA's guidance that "it may be appropriate for the NDA itself to be clear about what disclosures are not prohibited by the NDA". Settlement Agreements should already contain carve out whistleblowing disclosures (item 2 above). Therefore, it is a case of ensuring the other items are similarly permitted.
Seeking to restrict any negative or adverse comments by the employee post-termination could be viewed as an attempt to influence the substance of a report or disclosure covered by 1 – 4 above. Therefore, it may be appropriate to include an appropriately-worded carve out in respect of such reports or disclosures.
Repayment and/or indemnity clause
If you elect not to introduce the carve outs to the secrecy and non-disparagement provisions then you may wish to reconsider the drafting of any clauses which require the employee to either repay monies or indemnify the employer where they commit a material breach of the terms of the Settlement Agreement. Without the carve outs, such repayment and indemnity clauses could be viewed as a means of seeking to prevent or deter or influence such reports or disclosures.