Quick guide to settlement agreements for employers

What should I think about before I offer a settlement agreement?

Many employers use settlement agreements to settle disputes and wrap up the legal aspects of ending an employee’s employment by negotiation. 

Using a settlement agreement will allow you and your employee to come to an agreement about how and when their employment will end, what payments you will make to them and any other arrangements you want to make.  The settlement agreement will also give you the peace of mind of knowing that you’re not going to end up in a court or employment tribunal if you go ahead and end the employee’s employment. 

If you’ve decided to go down the settlement agreement route, here are a few things that you might want to think about before you make an offer to your employee.

Without prejudice discussion/protected conversation

If you’re going to make an offer to one of your employees, then you don’t want the offer to come back and bite you.  To stop this from happening you should make the offer in a without prejudice discussion or as part of a protected conversation. You can make the offer in writing or you can do it verbally.  If you make the offer in a without prejudice discussion or as part of a protected conversation, this will stop your employee from using your offer against you in a court or employment tribunal case if they decide not to accept the settlement offer. 

There is a slight difference between a without prejudice discussion and a protected conversation.  A without prejudice discussion means that what you say in the settlement discussion can’t be used in any type of case.  But you can only have a without prejudice discussion if there is an existing dispute between you and your employee.  A protected conversation, on the other hand, only offers limited protection as it only protects your conversations in claims for unfair dismissal, wrongful dismissal and/or breach of contract.  You can have a protected conversation even where you don’t have an existing dispute with your employee, and in the right circumstances, negotiations can be both ‘without prejudice’ and ‘protected’, at the same time.

At the outset of any discussion or conversation you should make it clear to your employee that what you say is protected and/or without prejudice. The same goes for any correspondence you have with your employee. You can do this by stating it at the top of each letter and email.

When will the employment end and what will happen in the meantime?

You need to consider whether you want your employee’s employment to end immediately or at the end of their notice period.  If you want them to go straight away, then you can pay them in lieu of giving them their notice.   Alternatively, you can give your employee their normal amount of notice.  You can make your employee work as normal during their notice period or, alternatively, you can put them on garden so they have to stay away from work (although they should be available to come into work if you ask them to). 

How much are you going to pay them?

You’ll need to pay your employee what they’re owed under their contract.  This will usually include their notice pay, outstanding holiday pay and any bonus and commission payments that are due.  You should set out these payments separately in the settlement agreement as you’ll need to deduct income tax and employee National Insurance Contributions from them.

In addition, you’ll normally need to make a lump sum payment as a ‘sweetener’ to encourage your employee to accept your offer.  This additional payment is often known as an ex-gratia payment.  How much you offer is up to you and depends on what has led you to take the decision to offer a settlement agreement.  For example, if you’re offering a settlement agreement instead of disciplining an employee, you may be able to keep any lump sum payment quite small.  The fact that the employee is leaving with a clean record and their notice pay may be enough of an incentive for them to accept the settlement agreement.  If, however, you’re looking to end the relationship because you don’t think your employee is the right person for you (but they haven’t legally done anything wrong), then you’re likely to need to give them a bigger sweetener to get them to accept the settlement agreement.

Tax and tax indemnity

You will need to deduct income tax and employee National Insurance Contributions from all payments that your employee is contractually entitled to such as notice pay and holiday pay. 

But you can pay some money to your employee without deducting tax and national insurance.  You can pay the first £30,000 of any additional severance payment that you make (the ex-gratia payment) without any deductions.  You can only pay this sum tax free if it is a genuine termination payment. This means that it has to be a payment that you’re making because your employee’s employment is coming to an end.  It also needs to be a payment that they’re not otherwise entitled to.

To protect yourself, you should include a tax indemnity clause in the settlement agreement. This allows you to recover from your employee any income tax and employee’s National Insurance Contributions if HMRC decides that the tax-free payment (or part of it) should have had deductions made from it.

Return of company property

You may have some company property that you want returned such as a laptop or security pass.  You can either include a generic ‘return all company property’ clause or set out exactly what you want returned.  You may also want to state that the property needs to be returned and a receipt given before you complete the agreement. 

Non-derogatory clauses

Given that the employment relationship with your employee is coming to an end, you should think about including a clause that stops your employee saying anything disparaging or negative about your organisation. You can do this by including a non-derogatory clause.  This will stop your ex-employee bad mouthing your organisation or else risk being in breach of contract.  You can make this clause mutual if you wish so that your employees shouldn’t make any negative or disparaging comments about your ex-employee.  

Job reference

You don’t have to give a reference for an ex-employee so agreeing to give a reference as part of a settlement agreement is a good idea.  It doesn’t cost you anything, but it can be a very useful negotiating point as it will help your employee obtain alternative employment. If you do offer a reference, then you can either make it a basic reference (just setting out the employee’s start date, end date and what they did in between) or you can give a full reference.  Nowadays, the vast majority of employers just give a basic reference.  You should also say that any oral references given should be no less favourable than the agreed written one.    

When should you pay by?

There isn’t any set timeframe for paying, but most settlement agreements say that the employer should pay within either 14, 21 or 28 days of the termination date or receipt by you of the completed settlement agreement.

Legal fee contribution

You don’t have to make any contribution towards your employee’s legal costs.  But it’s generally accepted that you will make a contribution because they must take legal advice on the terms and effect of the settlement agreement for it to be binding. Most employers contribute between £350 and £1,000 plus VAT towards their employee’s legal costs.

Confidentiality clause

You’ll normally want your ex-employees to keep quiet about any settlement agreement and the settlement terms, so you should include a confidentiality clause in any settlement agreement.  This will mean your ex-employee must keep the settlement agreement and its contents confidential or else they’ll be in breach of contract. 

Post-termination restrictions

You should think about whether you need to restrict your employee in any way after they leave your employment to stop them from taking your clients, customers, employees and/or suppliers.  If you do want to include post-termination restrictions, then you need to think about how long these restrictions should apply and what they restrict.  Remember, the tighter and shorter the restriction is, the better chance there is of enforcing it.  if, your employee already has post-termination restrictions in their contract then you can simply carry these over by including a clause in the settlement agreement confirming that they still apply.

Waiver of claims

In the settlement agreement you’ll be asking your employee to settle all and any claims that they may have, except issues relating to accrued pension rights, claims for any unknown personal injury and the right to enforce the settlement agreement. Think about whether there are any particular claims that your employee may have, and these can be specifically set out in the settlement agreement

The reason for your employee’s departure

Do you want to give a specific reason for your employee’s departure?  This could be ‘redundancy’ or even that it was by ‘mutual agreement’.  Remember, this is the reason your employee will be giving as their reason for leaving, so make sure it is in line with how you want to portray their departure.

Bonus schemes, commission an LTIPs

These should all be dealt with in accordance with their rules as a minimum.  But you can always offer more if you wish to.  Think about how you want to deal with your employee leaving and whether they are a good leaver or bad leaver under any relevant scheme.

If you’re thinking about giving one of your employees a settlement agreement, then don’t hesitate to call our HR and Employment Law team on 01284 767 766 for a chat and some guidance.

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Please note this article is provided for general information purposes only to clients and friends of Atkins Dellow LLP. It is not intended to impart legal advice on any matter. Specialist advice should be taken in relation to specific circumstances. Whilst we endeavour to ensure that the information in this article is correct, no warranty, express or implied, is given as to its accuracy, and Atkins Dellow LLP does not accept any liability for error or omission.

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