Settlement agreements, previously known as compromise agreements, are legally binding written contracts that can be used to end relationships on agreed terms. They waive the employee's right to make a claim to an employment tribunal or court on matters that are covered in the agreement. This is usually in exchange for financial payment, but can also be a non-monetary benefit, i.e. an agreed reference. In the majority of cases, both an agreed reference and a financial payment to the employee will be included.
Settlement agreements are voluntary, and the option to enter into them is not compulsory. For this reason, there is often an element of negotiation with offers and counter-offers proposed between both parties.
Either the employee or the employer can initiate a discussion regarding a settlement agreement. Alternatively, sometimes during an HR process, a trade union or HR representative may approach the other party to propose a mutually beneficial exit strategy.
Generally, offers are made verbally during a standard HR process, e.g. a capability procedure. Remember, settlement agreements must not be used to prevent safeguarding concerns from being investigated.
Where a discussion regarding settlement agreements takes place, this will be carried out ‘without prejudice’. This means that the conversation being held is confidential and off the record. Therefore, it cannot be referred to if an unfair dismissal claim was raised, regardless of whether an agreement was reached or not. However, there are some exceptions to this:
For a settlement agreement to be legally binding, there needs to be an exchange of ‘consideration’, e.g. financial payment or an agreed reference.
Typically, the terms of an agreement consist of:
This agreed reference would be provided to prospective employers if they were to request a reference. The contents of this reference will be agreed upon by both the employer and employee prior to finalising the agreement and will be provided to any prospective employer who was to request a reference. If a reference request were to be received as a pro forma, this should be completed in the spirit of the agreed reference.
In line with Keeping Children Safe in Education (KCSIE) 2019, references should not be open, e.g. in the form of ‘to whom it may concern’ testimonials. They should be freshly dated and addressed in response to each reference request. The settlement agreement should stipulate who a reference request should be sent to.
An agreed form of communication may be established in regards to how the School will announce to employees, parents and pupils that an individual is vacating their role.
Under the Finance (No. 2) Act 2017 that came into force in April 2018, where an employee has not worked their notice period, any payment made in lieu of notice (PILON) must be subject to tax and national insurance (NI). A termination payment in excess of contractual notice of up to £30,000 may only be paid as a lump sum free of deductions. However, when exceeding this threshold, tax and national insurance should be deducted.
HMRC will scrutinise payments in settlement agreements to ensure that tax and NI are deducted where due. Notice should run from the date the settlement was ‘agreed in principle'. This is likely to take the form of an email or letter from the employee, agreeing to the proposed terms. If enough notice has not been given between the date ‘agreed in principle’ and the agreed termination date, then a PILON should be made, which will be subject to deductions.
For a settlement agreement to be legally binding, the employee must seek legal advice before signing. If the employee is a trade union member, then such advice will often be provided by the trade union’s legal team. Alternatively, an employee may seek advice from a solicitor.
As seeking advice is a requirement, it is common for the employer to make a contribution towards legal fees. Typically, this is £350 + VAT in the education sector.
By signing a settlement agreement, employees sign away their right to bring a claim against their employer for matters such as unfair dismissal, discrimination, underpayment/unlawful deduction of wages, breach of the working time regulations and personal injury claims.
An employer may also use a settlement agreement to seek arrangements for an employee to stop court or employment tribunal proceedings if they have already raised a claim.
There are some claims which cannot be waived even with a settlement agreement. The most common is personal injury, whereby the employee is unaware of the injury at the time of signing the agreement. Other examples include: