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Settlement agreements – what employers need to know

19 July 2019

When you need a clean break from an employee, a settlement agreement can be a neat solution, explains Jenny Hawrot, one of our employment law associate solicitors.

When should I use a settlement agreement?

Settlement agreements are frequently used by employers where there is a dispute with the employee (such as poor performance, misconduct dismissal or a clash of personalities) and the parties wish to end the employment relationship.  They can also be used where the employer is paying an enhanced redundancy payment and wishes to obtain some security in return.

Do employees have to be advised by a solicitor, and will I need to pay for their advice?

The employee must receive advice from an independent solicitor on the terms of the agreement, and the effect that signing it will have on their employment rights. Without this advice, the agreement will not be enforceable or legally binding; the employee will still be able to issue proceedings against you.

There’s no legal duty to contribute towards an employee’s legal fees, but it is accepted practice that you do (because without the advice, the agreement will not be binding). However, you will only have to pay the contribution towards the legal fees if the employee signs the agreement.

What about the compensation – how much should I pay? Will I have to pay tax on it?

There is no formula for establishing the amount of compensation that should be paid. It will depend on each individual case, the circumstances of the termination, and the employee’s potential claims waived by the agreement.

All ‘remuneration’, including salary, notice pay (including payments in lieu of notice and post-employment notice pay), contractual benefits and annual leave should be taxed in the usual way.

At present, employers can pay a leaving employee compensation for loss of employment up to £30,000, free of income tax and National Insurance.

However, HMRC always has the last word, so a well-drafted agreement will usually state that if HMRC decides that tax is payable, then the employee must indemnify you for the tax.

Are there any claims that are not waived by a settlement agreement?

Yes. Employees will still be able to bring a claim against you in the following, limited circumstances:

  • Where the employer breaches any term of the agreement (e.g. if you do not pay the sums agreed).
  • For personal injury that the employee is not aware of, or could not reasonably be aware of at the date of signing the agreement; and
  • In relation to their accrued pension rights.

Can I include a gagging clause?

A well-drafted settlement agreement should contain a comprehensive confidentiality clause covering the existence, content, and importantly, the circumstances leading up to the termination of employment and the agreement.  If the employee breaches this clause, you can sue them for breach of contract, and recover the compensation payment, in addition to any losses suffered as a result of the breach.

In cases where an employment relationship has already completely broken down, there will naturally be a concern about the employee’s conduct going forward. As such, we would advise that the settlement agreement includes a carefully drafted ‘non-derogatory statements’ clause.  This will prevent an employee from bad-mouthing your business, or its officers or employees. Breach of this clause would amount to a breach of contract.

Remember that it’s generally not possible to prevent an employee from making disclosures about wrongdoing in your organisation or conduct such as discrimination, harassment or sexual abuse.

Do I have to provide a reference?

Legally, no. However, an agreed reference is commonplace in settlement agreements.

Any reference that is provided must be true, accurate and fair. If it isn’t, you may be liable for negligent misstatement. Many employers often make it their policy only to give out basic information about job title and dates of employment.

Jenny is an associate solicitor in our Legal 500-rated employment law team. She advises clients from SMEs to national organisations on the full range of employment-related matters, including TUPE, contractual matters and defending employee relations. Contact her for practical, commercial advice.

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