Settlement Agreements: an overview
A settlement agreement (sometimes also called a compromise agreement) states that in return for a payment, you give up your right to bring claims against your employer at the employment tribunal or in the courts.
Such agreements are individual contracts between you and your employer. Their content is not set in stone and there is absolutely no standard way to do them. There are certain minimum contents set out by statute, such as it must be in writing and signed by an independent adviser, but the money element is often open to negotiation.
Your independent adviser – who will usually be a lawyer – must also explain the agreement to you. This is so that you fully understand exactly what you are signing. A good lawyer will also be able to answer any questions you might have and give you advice on the terms of your agreement. You usually pay nothing for advice from a lawyer on the agreement, because it’s standard for employers to pay the legal fee of having the document signed.
However, if your lawyer assesses that your agreement should be offering you more, they will explain this to you and offer to negotiate with your employer on your behalf. This additional service would require you to pay a separate fee.Many law firms offer a form of ‘no win no fee’ whereby the fee is a small percentage of the increase the lawyer achieves for you over and above the amount your employer originally offered.
We see hundreds of settlement agreements and can tell you whether yours contains any unusual clauses in the small print, or doesn’t maximize potential benefits to you. If anything in your agreement seems strange or unfair to you, don’t be afraid to ask questions and check what could be done as part of the initial assessment.
At Monaco Solicitors, we believe in going through all the possible outcomes with you in detail, all as part of the service.
Top 3 Tips
- If you sign a settlement agreement you will give up all rights to sue your employer – even for existing contractual rights
- Ensure you remain entitled to all payments you are contractually due
- Ensure you understand the tax treatment – you will ultimately be liable
Settlement payments: when and how?
Your agreement should clearly state how and when the payment(s) will be made and when your employment will end. Payment dates are normally around 14 to 28 days after signing the agreement or after your last day of employment, whichever is the latest.
Some organisations tend to process payments in the relevant monthly payroll. We would generally try to ensure a shorter payment date and in some cases we’ve succeeded in getting payment from an employer within 24 hours of signing, but anything up to a month is standard.
A good adviser will ensure that the payment mechanism is stipulated within the agreement itself, in terms of both the payment date and also any payment method you prefer if it’s not the bank account into which your salary is paid.
Some payments are pretty obvious and straightforward, while others are less so and we discuss some of both in the checklists below
Settlement payments checklist
Check your agreement for all of the following:
- All outstanding salary
- Any expenses owed
- Your contractual notice or statutory notice if that is greater
- Holiday pay
- Car allowance
- Bonus payments
- Pension payments
Consider non cash benefits:
- Company car
- Health insurance and life insurance, is there the option for these to continue?
What deductions, if any, will be made, for example:
- Some employers ask for contractual maternity pay to be repaid if you leave before a specified amount of time has passed after your return to work (normally around six months).
- Do you have a season ticket loan or any other loans with your employer?
- Have you taken more leave days than you will have accrued at the end of your employment?
Taxation of settlement agreements
Employers usually ask for one of these and they are a very standard clause in nearly all settlement agreements. The way they read is that if, after the agreement is signed, HMRC deem that tax is due on a payment made to you, they will look to your employer to pay this tax. The indemnity means that you have promised to pay this money back to your employer and if you don’t pay, your employer can sue you for this money. In practice however these are extremely rarely used – hardly ever in fact. So they are not something which you should worry about.
What can usually be paid free of tax (“gross”) ?
The following payments can generally be paid tax free:
- Compensation for loss of employment up to £30,000 (over and above any monies paid in respect of the notice period)
- Payment of legal costs
- A payment for injury to feelings caused by discrimination or personal injury during your employment
- Payment for outplacement services
- Payment made into a pension scheme
Although it was previously possible to pay notice pay tax free, for terminations after 6 April 2018, all notice pay is taxable. Where you are not employed for some or all of your notice period, the £30,000 tax free limit only applies to the portion of any settlement payment which exceeds the amount of income you would have received if you had been employed for the entirety your notice period. The portion equivalent to what you would have received, if you had been employed for your notice period, is taxed.
What payments are taxable?
- Holiday pay
- Compensation for loss of employment over £30,000
- A payment in lieu of notice or other payment equivalent to any period of notice not worked
- A payment for a restrictive covenant
Tax on salary and benefits
Salary and benefits payments made until the last day of your employment are subject to tax and national insurance (NI).
Tax on payment in lieu of holiday
If you have unused holidays, your employer is required to pay you in lieu of these and this payment would attract tax and NI as usual.
Tax on ex gratia payments up to £30,000
Ex gratia payments are generally exempt from tax for the first £30,000.00 .
Tax on ex gratia payment exceeding £30,000
If your settlement agreement includes compensation in excess of £30,000.00, the excess is subject to income tax and national insurance contributions. To work out how much tax would be applicable, see our article on calculating settlement agreement tax.
If your employer wants you to enter into new restrictive covenants it is important you get specialist advice on the level of compensation offered; there may be tax implications if HMRC later consider the amount paid too low.
Read more detail in our article on calculating settlement agreement tax
Other clauses and factors to look for in a settlement agreement
Pay in lieu of notice (PILON)
Pay in lieu of notice means getting paid for your notice period in your contract but not having to work it. For example if your employer has to give you one month’s notice to terminate your contract, then, instead of asking you to work for that month, they could just terminate your employment and let you go home but still pay you for it. This is especially valuable if you have a long notice period.
Pay in lieu of notice is available from many companies if there has been some kind of dispute or disagreement at work, because in such circumstances employers actually prefer to see the back of you rather than risk you carrying on and having an adverse effect on your colleagues. So it can be just a case of asking your employer to pay you in lieu of notice – you may not need to negotiate this at all. Of course if your employer offers you pay in lieu of notice then try not to smile too much, and just make out that you expected this as standard; then continue to negotiate the ‘ex gratia’ element of the deal. See our article on Pay In Lieu of Notice for further information
Statutory notice is the minimum notice period which you should have by law. This is different from your contractual notice period, which is the minimum notice period set out in your contract of employment. Sometimes your statutory notice period is greater than your contractual notice period, in which case the correct notice period to use is the statutory one. This is more common where you have been employed for a long time, because statutory notice increases, the longer you stay in the same job.
To calculate the statutory minimum notice period that you are entitled to, add up the amount of time worked continuously for your employer. If you have worked for one month or more, your notice period must be at least a week. If it’s between one month and 2 years, you are entitled to one week’s notice. For anything above 2 years’ service, you are entitled to one week per year worked, up to a maximum of 12 weeks for 12 years or more of continuous employment.
So, if you have worked for seven and a half years, you are entitled to 7 weeks’ notice. If you have been employed for 12 years or more, you would legally be entitled to 12 weeks. This minimum applies no matter what your contract says.
Sick pay in your notice period
If you are off sick and you have gone down to reduced pay, and then you hand in your notice, should you receive only sick pay during your notice period, or should you receive full pay?
The answer depends on the length of your notice. According to the Employment Rights Act 1996 (ERA) ss.86-89, if your contractual notice period is a week or less above the statutory notice period, then you will be entitled to receive full pay throughout your notice period, despite being absent due to sickness or injury.
If on the other hand your contractual notice period is over a week above the statutory minimum notice period, then you cannot benefit from the provisions of the ERA ’96 and you will only be entitled to receive your contractual sick pay (or statutory sick pay as the case may be).
So to give a practical example, let’s say that you have been employed for 4 years. Therefore your statutory notice period is 4 weeks. Now imagine that your contractual notice is one month. In this situation you can benefit from the ERA because your notice period (one month) is not more than a week above statutory notice (4 weeks). On the other hand if your contractual notice is 2 months, then you can’t benefit from the ERA because your notice is more than a week over statutory notice.
If this seems complicated to you that’s because it is. It’s worth asking your settlement agreement lawyer to check this and confirm it for you – that’s part of the job as far as we’re concerned.
Whatever your age it is important to consider your pension, but particular care should be made if you are nearing retirement. The following should be considered:
- Will pension payments continue after your employment has ended?
- Will a lump sum be paid into your pension?
- Do you have all the information, documents and contact details (of your pension provider) from your employer about your existing pension?
- Does the payment in the settlement agreement adequately account for any loss of employer pension contributions and pension rights?
See also below as well as our article about tax payments on pension payments
Personal injury and pension rights
While the settlement agreement will state that you give up all your claims to sue your employer, there are two exceptions which the law says can’t be settled even if you sign a settlement agreement. These are:
- claims for an unknown personal injury where you are unaware of it at the time you sign a settlement agreement, but which later develops into an injury. This might happen, for example, if you were in contact with a substance at work that was believed to be harmless, but many years later caused a disease. In that case you would still be able to bring a personal injury claim when you discovered it, even though you had previously signed a settlement agreement.
- claims for accrued pension rights: your pension is always protected and can’t be settled, so if it later transpired that your employer failed to pay into your pension when they were supposed to, then you could still sue them for that even if you signed a settlement agreement at the time giving up all claims
- If you hold shares you should check your shareholders’ agreement. You may be required to sell back shares on your employment ending
- Check the share option scheme and what it states about leavers, it may be important that you do not leave as a “bad leaver” or as someone who has left with “cause” and if the share options are valuable to you it should be stated within the settlement agreement that you leave as a “good leaver”. Ask the employer to confirm and in any event ensure you know what will happen to your share options
See our article on shares and share options for more detail
Employers often ask the employee to agree not to make disparaging remarks or to “bad mouth” the employer. There should be a reciprocal clause in which they agree or use their best endeavours to ensure that they and their staff do not make derogatory comments about you.
Employers often want the terms and existence of the agreement kept confidential. Be aware of this especially if you have discussed your problems at work. Where possible try to be discreet regarding who knows that you are in negotiations with your employer. In that way, if you are later asked to confirm that you haven’t discussed the issues, you won’t be in difficulty. Employers usually agree that confidentiality can exclude your immediate family, professional advisers and prospective employers.
Some employers offer outplacement services as part of an exit package in addition to the financial payment. This consists of specialist support in looking for work that can include career counselling, CV writing and interview preparation. It can be excellent and it’s worth asking your employer to include it, particularly if you are leaving an organisation that has employed you for a long time.
An agreed reference commonly forms part of the settlement agreement, but this is one of the things that’s often forgotten. Some employers will only confirm dates of employment and duties, whereas others are willing to comment favourably on an employee. What is agreed will depend on the employer’s usual practice and the circumstances surrounding your departure.
There is no obligation on any employer to provide a reference and it is one of the advantages of settling a case that a reference can be agreed as part of the agreement. So, if your settlement agreement doesn’t have a specific clause dealing with references, then ask for one!
After your employment has ended you may be able to claim job-seekers allowance (JSA). It is worth making a claim for JSA if you meet the eligibility criteria, as for the first six months this benefit is not means tested. Check with the DWP for more information and any recent changes in their criteria.
If you want to claim JSA, the reason for leaving in your settlement agreement should be carefully considered and where appropriate be labelled as “redundancy” as there is a risk that, if the agreement says you resigned, the Department for Work and Pensions (DWP) will not pay you. Having said that, it is notoriously difficult to convince employers to confirm in writing a reason for dismissal. It is worth asking but may not be worth making this a deal breaker.
Depending on your situation you may also be entitled to other benefits and you should check with the DWP to see if you are entitled to these, for example housing benefit, council tax benefit, tax credits. If you are long term sick or disabled you may be entitled to claim incapacity benefit and/or disability living allowance or its equivalent.
Mortgage/income protection insurance policies
If you have an insurance policy that will pay your mortgage or replace some or all of your income upon redundancy/dismissal, it is essential that you check out the terms of your insurance policy before you sign any settlement agreement. Some policies will only pay out if you have been dismissed or been made redundant. This means that if appropriate the agreement should make clear that the termination was dismissal and/or redundancy. However the same difficulties apply here as mentioned above – employers don’t like admitting why they forced you to leave.
Still not sure whether you should sign?
If your employer has offered you the option of signing a settlement agreement rather than just dismissing you and leaving you to claim your statutory and contractual entitlements, this is a often clear sign that you have the potential to do something your employer would really like to prevent, such as bring a claim or leak trade secrets.
You are therefore in an advantageous position and should be well-placed to negotiate for a better settlement. If you’re not confident about your negotiation skills, get a professional to negotiate on your behalf.
If you leave without signing a settlement agreement, then you will not receive any ex-gratia payment from your employer. You will only be entitled to receive any statutory redundancy pay and any contractual benefits (eg notice pay, holiday pay and any salary outstanding). Your contractual entitlements are sacrosanct – an employer cannot take these away from you. Of course if you don’t sign, you will still be entitled to make an employment tribunal claim.