What is a settlement agreement and what should I think about before I sign one?

A settlement agreement is a contract that records an employee’s agreement not to pursue a claim against their employer in exchange, usually, for a payment of money.

It can cover almost any kind of potential claim including:

  • Breach of contract/wrongful dismissal
  • Unfair dismissal
  • Discrimination
  • Unpaid Wages

There are some conditions that need to be in place for the settlement agreement to be legally binding.

For example:

  • The agreement must be in writing
  • The agreement must relate to a specific claim that the employee could raise against the employer
  • The employee must have received independent legal advice

A solicitor will need to make sure that the agreement fulfills all the necessary requirements and is one you should be entering into.

Waiving Your Employment Rights

By signing the settlement agreement you will be agreeing to waive the right to pursue any employment related claims against your employer. This is the crux of the agreement. This is why it is vital that you get specialist employment law advice. You need to know what sort of a claim you may have, what it could be worth and also what else in the agreement might affect you.

It is very common these days to be offered a settlement agreement even if you have no potential claim, for example if you are leaving because you are being made redundant, or where you are leaving your employment on amicable agreed terms. Some, indeed many, employers use settlement agreements as a matter of course just to be on the safe side, belt and braces if you like. So, being offered a settlement agreement doesn’t mean that you necessarily have a claim, it could just be your employer’s policy to use them in all cases where an employee is leaving.

Settlement agreements will usually have a long exhaustive list of potential claims. All you need to understand is that you will not be able to bring any claim at all against your employer once you leave and have entered into the agreement.

It is crucial that you tell your solicitor if you believe that you have a potential claim against your employer. Your solicitor would then be able to properly advise you on whether the compensation payment being offered in the agreement is adequate.

So, what should I expect in the Settlement Agreement?

Firstly, you should expect to receive your contractual payments, that is your notice pay (if you have not worked your notice) and other benefits, any accrued holiday pay, and payment of any outstanding expenses. These payments will normally be taxable.

It is also common, and we would usually always ask for an agreed reference to be included in the settlement agreement along with reciprocal confidentiality and a clause ensuring that neither party makes disparaging remarks about the other after you have left.

Sometimes employees have shares or share options and it is important to agree what will happen to those rights after you leave as they are likely to be affected by the termination of your employment.

The Compensation Payment

You will usually also be offered a compensation payment. How much this will be depends on many factors.

It is difficult to say how much this will or should be because it depends on the circumstances under which you are leaving. However, as you are waiving your right to bring any kind of employment claims, the amount offered should reflect the value of the claims that you’re giving up. However, sometimes the amount also reflects the commercial value to the employer of having you leave quickly, confidentially and amicably.

So, the issues that you may need to discuss with your solicitor include:

  • Do you have a potential claim that you could bring against your employer?
  • If yes, how likely is it that the claim would succeed at a tribunal?
  • If you did succeed, how much would you be likely to recover?
  • Do you have another job lined up?
  • Are there any other factors that would lead your employer to pay you something to leave?

Your solicitor will cover these issues with you and discuss the pros and cons of accepting the amount on offer or negotiating for more. It is important to understand that in making a counter offer you are rejecting their original offer, which may then come off the table. This is rare but still something to think about.

Should You Negotiate?

Very often the compensation payable under a settlement agreement has been agreed and the parties are happy with what has been set out in the agreement. Everyone just wants to move on. In such circumstances your solicitors job will be to ensure that the small print is fair and balanced for you.

However, sometimes what is on offer is not adequate and it is appropriate to negotiate.

In negotiating for you your solicitor will usually put to your employer the potential claim(s) that you have and the likely value of the claim(s) to persuade them to increase the offer to something which relates more closely to the value of what you are potentially giving up.

However, it is important to consider that:

  1. employment tribunal proceedings are likely to take at least 6 months. Therefore, if you pursue this route, you may wait much longer before recovering any money;
  2. employment tribunal proceedings can be stressful and emotionally draining as well as expensive if you instruct a solicitor to act for you;
  3. there is no guarantee that you will be successful in an Employment Tribunal hearing, you may come away with nothing.

Your solicitor will be able to advise you of the best strategy for negotiation.

What about tax?

A common question is whether the amounts you are being paid under the settlement agreement are taxable or tax free.

As a general rule, the first £30,000 of a termination payment (including any redundancy payment) is currently exempt from tax.

Contractual payments, such as salary, holiday pay, commission and bonuses will be taxable.

The tax treatment of a payment in lieu of notice (PILON) will essentially depend on whether it’s contractual or not. If there’s a clause in your employment contract allowing your employer to make a PILON, then the PILON will be taxable. However if there is no contractual right to the PILON and no custom or practice of paying PILON then it should be exempt from tax. Your employer can pay you the same amount but call it compensation for not working your notice period. It can then be paid tax free.

Your solicitor can discuss with you whether your PILON can be paid free of tax or not .You should also consider taking tax advice from your accountant.