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Settlement agreements - what they are and when to use them

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Settlement agreements, formerly known as compromise agreements, have been commonly used by employers for many years as a means of ending the employment relationship with an employee.  They are binding contracts signed by the employer and employee whereby the employee gives up his or her employment and most associated employment rights (such as the right to bring claims for unfair dismissal or discrimination) in return for consideration from the employer, usually in the form of a termination payment.

They can arise in a number of different ways and can be used where there is an entirely amicable parting of the ways, or to settle the most contentious of workplace disputes before a Tribunal claim is brought.  For example, they can be used in a voluntary redundancy situation where the employee is happy to be leaving, and is receiving an enhanced redundancy payment.  In return, the employer can be safe in the knowledge that they are protected against any claims in the future.  Alternatively, they can come about as a means of settling a dispute or grievance brought by an employee that has every chance of escalating into something a lot more time-consuming and expensive for both parties, such as a Tribunal claim.

Settlement agreements should not be used as a substitute for good practice and company management.  It is a risky and often expensive approach to dispense with proper procedures (e.g. in disciplinary, grievance and redundancy situations) and instead simply produce a settlement agreement.  This can also send out the wrong signal to employees – the immediate use of a settlement agreement rather than going through a proper process can give out the message that the employer (a) doesn’t want to or know how to deal with the issue properly; (b) is concerned as to the strength of the case against them; or (c) both of the above.  This can immediately put the employer on the back foot when it comes to negotiating the terms of the agreement.

Unless the situation is entirely amicable and the employer and employee have come to a mutual agreement to end the relationship on terms beneficial to both, settlement agreements should generally only be used by employers after alternatives have been explored both at board level, and, depending on circumstances, with the employee.  How they are proposed is also important as there are rules in place protecting employees.  Offers of settlement agreements should never be made in a threatening or discriminatory way.

Turning to the content of the agreement, most settlement agreements we see look roughly similar as they are all attempting to ensure the same thing: to ensure that the employee cannot, as far as possible, pursue any claims against the employer.  They also often contain other common clauses such as dealing with the monies to be paid to the employee; confidentiality both in terms of the agreement itself and the employer’s confidential information; a clause ensuring that all company property is returned by a certain date (usually the termination date); ensuring that neither party says anything derogatory about the other, and all sorts of other warranties to which an employee must adhere.

In order to be legally valid, binding and enforceable, all settlement agreements:

  • Must be in writing;
  • Must relate to a particular complaint or particular proceedings;
  • The employee must have received independent legal advice from a ‘relevant independent adviser’ on the terms and effect of the agreement and its effect on an employee’s right to pursue rights before a Tribunal;
  • The adviser must be insured against any claims arising out of the advice given to the employee;
  • The agreement must identify the adviser; and
  • The agreement must state that the conditions regulating settlement agreements have been satisfied.

Given the need for the employee to be independently advised, there is a convention (as opposed to a rule) that the employer will make a contribution towards the legal costs of the employee in obtaining such advice.  Such a contribution is usually in the region of  between £250 - £500 plus VAT.

Many of the terms are subject to negotiation between the parties (they are contracts, after all) and, although most agreements end up looking roughly similar in content and length, they do vary on the amount of the termination payment and the scope of some of the terms.  Such clauses are almost always driven by the individual circumstances of each settlement situation, and the respective bargaining power of the parties.  An employer looking to use a settlement agreement to end the employment relationship on favourable terms for the employer is likely to have a more difficult time if they are negotiating terms with an employee who otherwise has a strong claim for discrimination against the company, as opposed to an employer negotiating with an employee otherwise facing a  gross misconduct allegation.

It can be said that settlement agreements play a useful role for employers and employees alike and are often a more attractive proposition for both parties than the cost and time incurred in bringing or defending an Employment Tribunal claim.  When entering into negotiations, consideration should be given on both sides to a range of issues such as the potential alternatives, how much/little is each party prepared to accept/pay and the costs involved on both sides.

If you are an employer who is considering using a settlement agreement to end an employment relationship, or you are an employee who has received such an agreement from their employer, please contact a member of the Chattertons employment team.