Settlement agreements

Reviewed by Tina Chander, head of employment law, Wright Hassall

A man leaves his job after accepting a settlement agreement from his employer

A settlement agreement is a legally binding confidential agreement between an employer and employee. Under a settlement agreement a compensation payment is typically given to the employee by the employer. In return they agree to waive their employment rights and not to pursue any employment tribunal claims arising from their employment or its termination.

A settlement agreement can also provide additional protection for employers, such as reaffirming post-termination restrictions and duties of confidentiality, while preventing employees from making defamatory comments about their ex-employer.

(The employee is not prevented from making any claims in respect of accrued pension rights, latent personal injury, or enforcement of the settlement agreement itself.)

1. When might an employer use a settlement agreement?

There are a range of circumstances in which an employer will consider using a settlement agreement. For example, when undertaking a disciplinary process, especially if the employee seems likely to bring a claim against the employer. Or when terminating the employment of an employee who has been on long-term sick leave, to avoid the risk of the employee claiming against the employer for discrimination.

Settlement agreements can offer employers a quick method of terminating employment, avoiding what otherwise might be a long and difficult process.

2. Are there any risks involved?

If an employer offers a settlement agreement without having previously raised concerns about the employee’s work performance or conduct, the employee may be able to claim constructive dismissal (on the legal basis that the settlement agreement discussion is evidence that the employer has breached ‘the duty of mutual trust and confidence that exists between them’).

Nor can an employer expect to get around this problem by having an ‘off the record’ discussion, or by stating that any documents are ‘without prejudice’ (a legal term which means the document cannot later be admitted in evidence before a court or employment tribunal without the consent of both parties concerned, should settlement negotiations subsequently break down and the dispute come before the court or tribunal).

So the employer needs to be sure that there is evidence of an ‘existing dispute’ before commencing any discussions about the possibility of a settlement agreement. Commencing a formal process such as a disciplinary process is a common way for employers to provide clear evidence of a dispute.

The ACAS guidance on settlement agreements sets out situations which can occur during settlement agreement negotiations that would then entitle an employee to refer to the conversations and submit the relevant documents as part of an employment tribunal claim. For example, an employer placing undue pressure on an employee to accept an agreement.

3. How much should an employer offer to pay under a settlement agreement?

There is no maximum amount which should be offered to an employee under a settlement agreement, however as a minimum the employee should be offered all of their basic contractual entitlements. This includes salary, notice pay, accrued but unused holiday pay and any statutory redundancy entitlements (if the agreement is being offered in the context of a redundancy situation).

It is also recommended that, in addition, an employer offers a tax-free payment to the employee. This is in exchange for them waiving their employment rights and it encourages them to enter into discussions in the first place.

(The first £30,000 of an ex-gratia payment is tax-free. The payment can be made by the employer to an employee who is leaving the business after a dispute or redundancy situation. It is ‘ex-gratia’ because there is no acceptance of blame and no legal requirement to make such a payment.)

4. When should the employee expect to receive the money?

For ex-gratia payments, the employer can set the timescale for payment. It is usually paid between 14 and 28 days of the settlement agreement being signed by the employee and their adviser. But it can be longer or shorter and is a point for negotiation.

In terms of contractual payments that are due (for example salary, holiday and notice pay), the employer can continue making payments through the payroll on the usual payroll date. If the employee is receiving these payments ‘in lieu’ (eg receiving extra salary instead of taking holiday that is owed), it is entirely at the employer’s discretion to run them through payroll at the usual time or pay them alongside the ex-gratia payment.

5. Who pays for the legal advice an employee has to take on a settlement agreement?

Generally, an employer will make a contribution towards legal fees under the terms of the settlement agreement. The average contribution is within the region of £350 - £500 plus VAT depending on the complexity of the agreement. For example, if the agreement covers shares the employer can expect to pay more towards the employee’s legal fees.

If the termination date is a long way into the future, the employer may require the employee to sign a ‘reaffirmation letter’ on or shortly after termination. This letter is to confirm that the terms of the settlement agreement still apply in full, as in theory a new claim against the employer could have arisen in the intervening period. In general, the employer can expect to pay a further £150 plus VAT in respect of this letter.

6. What if an employee refuses to sign the settlement agreement?

If an employee refuses to sign a settlement agreement, the employer should continue with whatever disciplinary or capability process they have openly commenced.

If the ‘without prejudice’ rules apply (see 2, above), the employee’s refusal will not harm the employer, as the employee will not be able to use the discussions against the employer as part of any tribunal claim.

However, if the ‘without prejudice’ protection is not applicable, either because there was no open dispute or because the employer put undue pressure on the employee to sign the settlement agreement during the negotiations, the employee may use the settlement agreement and all associated correspondence to support a claim against the employer.

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