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Settlement Agreements - How do they work?

View profile for Manisha Chauhan
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You’ve employed a Sales Executive for 4 years. Around  6 months ago you noticed a change in his work, failure to meet targets and a lack of commitment to the role which is having an impact on the company’s performance. You’ve met with him on a few occasions to discuss any issues but he isn’t willing to communicate. It has now reached the stage where you don’t feel there is a place for him within the company – what can you do?

One option is to end the relationship by having a “without prejudice” discussion with the employee with a view to entering into a  Settlement Agreement. Remember, the without prejudice rule will only apply where discussions are a genuine attempt to resolve an existing dispute between the parties.

Settlement Agreements can be a great tool for employers. The effect of these agreements is to draw a line under the employment relationship and in return for paying some money to the employee, you take comfort that the exiting employee cannot bring employment related claims against you. Sounds much better than spending management time and money on defending a claim in an Employment Tribunal (even if you win).

But what if your employee is seeking more to the agreement? There are other ways you can try to encourage your employee to enter into a settlement agreement. Common options are:-

  • Continuation of employee benefits post-termination, i.e. healthcare and car allowance;
  • Outplacement services; and
  • An agreed reference – this bargaining tool can prove very useful in instances where the employee is leaving due to performance related issues. Remember that any reference must be true, accurate and fair.

In order for a Settlement Agreement to be legally binding, your employee will be required to take independent legal advice before they sign the agreement. Some of you will have experienced solicitors coming back with amendments to the agreement. Here are some reasons why:-

  • No specification of when payments will be made – the settlement is the entire agreement between the parties and therefore needs to clearly set out what will be paid to your employee and when;
  • Contractual and non-contractual payments are amalgamated – this can affect the tax status of the ex gratia payment so needs to be expressly separated in the agreement;
  • Payment of a PILON (payment in lieu of notice) when the contract does not allow it – if the contract does not allow a PILON and you pay it anyway, this is effectively a breach of contract. In order to ensure the tax status is protected, make this payment as a “damages payment;” (note we are not tax advisors).
  • Accrued holidays – specify the number of days accrued and the actual payment due;
  • Mutuality of obligation – an employee is more likely to sign the agreement if they agree to keep the agreement confidential and not make derogatory comments and you, in return, agree to do the same.

Some employers can be of the opinion that Settlement Agreements are standard documents because you have used the same document for a number of years. In some cases, the agreement produced may never have been challenged by a legal advisor. Remember that employment law is forever changing and one size does not necessarily fit all.

When drawing up a settlement agreement, make sure you draft the agreement correctly, distinguish contractual payments from non-contractual payments, think about what will happen if there is a future termination date and also consider whether restrictive covenants should be inserted for those which previously had no such covenants in their contract of employment.

Remember, a Settlement Agreement is in place to protect you, the employer, so make sure you take the time to ensure that it is properly drafted to begin with.

If you would like some advice on Settlement Agreements please contact a member of the Employment Team.

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