Getting settlement agreements right

10 May 2019 By Emily Kearsey

Emily Kearsey outlines the top five mistakes made by employers when drafting settlement agreements

When used properly, settlement agreements can be a simple and pragmatic tool to resolve employment disputes. The employee usually benefits by receiving a severance payment and the employer achieves peace of mind knowing that the employee has left and can no longer sue them. 

However, as employment lawyers, we tend to see the same drafting mistakes again and again. At best, these errors cost management time and legal costs by drawing out negotiations. At worst, a simple error can invalidate the settlement agreement, leaving employers exposed to future claims. 

Not complying with the requirements for a valid settlement agreement

A settlement agreement will only operate as a valid waiver of statutory claims if all of these conditions are satisfied:

• The agreement must be in writing and relate to a ‘particular complaint’ or ‘particular proceedings’

• The employee must receive advice from a ‘Relevant Independent Adviser’ (as defined in the legislation) on the terms and effect of the proposed agreement

• The adviser must have insurance covering the risk of a claim against them by the employee

• The agreement must identify the adviser 

• The agreement must state that the conditions regulating settlement agreements under statute have been satisfied.

If any of these conditions are not complied with, an employer could be exposed to precisely the claims it was so anxious to settle in the first place. 

Failing to provide consideration for new contractual restrictions

If the settlement agreement includes any post-termination covenants or confidentiality obligations which go beyond the employee’s existing contractual obligations, specific consideration should be allocated, which will be subject to tax and NICs. If this is not done, HMRC might treat some of the tax free payment as taxable consideration. Even if there is a tax indemnity, these issues can prolong negotiations as the employee (if properly advised) is likely to take the issue seriously. 

Including warranties that the employee isn’t able to give

While this is more of a best practice point, including warranties an employee isn’t able to give causes unnecessary delays in getting the agreement signed. Most employees will not be able to warrant that they have never said anything negative about their employer in the past (who hasn’t had a moan after a bad day?) or that they have never discussed the circumstances surrounding their employment ending with anyone (which is very broad). Only include retrospective warranties if you have good reason, eg you want to check whether the employee has done something naughty prior to signing which could be a deal-breaker for the employer. 

Getting the tax wrong

The settlement agreement should state clearly how each payment will be taxed, ie whether it will be subject to tax and/or NICs, or whether it will be paid free of tax (and if so on what basis). Also, don’t forget the PENP (post-employment notice pay). A calculation to work out the employee’s PENP should be referred to in the settlement agreement to show HMRC that it is not being short-changed on tax for the employee’s notice period.

Some employers might take the view that tax issues are the employee’s problem, so long as a tax indemnity is included which allocates risk to the employee. However, it’s important to remember that an indemnity is only worth what the employee can pay. 

Referring to the settlement agreement in open correspondence or discussions

All correspondence referring to settlement should be clearly marked ‘Without Prejudice and Subject to Contract’ or ‘Protected under s 111A of the Employment Rights Act 1996’ as appropriate. Any verbal discussions about settlement should also be clearly expressed as such. This helps ensure you can negotiate freely and that any admissions made to try and settle the matter cannot be used against the employer in court or in the tribunal should settlement fail.

Bonus tips

• Don’t date the settlement agreement until it has been signed by both parties.

• Allow the employee a reasonable amount of time to get advice (Acas advises 10 calendar days).

• If the employee is receiving no consideration (eg no payment) for signing, then the agreement must be signed as a deed, otherwise it will be invalid.

Emily Kearsey is an associate in the employment team at Goodman Derrick LLP

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