A settlement agreement (formerly known as a compromise agreement) is an agreement whereby a current or former employee or worker agrees to waive or settle a claim (or more usually, all possible claims) against their employer in return for a payment, usually on termination of employment.They are most often used in one of two situations, namely:
• The employer (or someone within its organisation) has done something wrong and the employer is paying off the employee or worker; or
• The employer is paying the employee or worker more than their contractual and statutory entitlement on termination of employment (such as an enhanced redundancy package).

In each case, the employee will usually be most concerned with the amount of compensation they are getting (and whether there is the potential to negotiate more) whilst the employer’s aim will be to achieve an effective waiver of all possible claims that the employee may have against it. In the first situation, depending on their bargaining position, the employer may be willing to offer more financial compensation than originally offered to the employee. There may be other additional terms that could be agreed such as payment towards outplacement assistance, a favourable reference, extended private medical cover or agreeing to release an employee from post-termination restrictions. It is often easier to negotiate additional benefits rather than persuade an employer to pay more compensation once they have reached their upper limit.

Points to note about settlement agreements:
Independent legal advice – one of the requirements for the agreement to be binding is that the employee must have received legal advice from a relevant independent adviser on the terms and effect of the proposed agreement and its effect on their ability to pursue the relevant claims before an employment tribunal. It is therefore usual for the employer to agree to pay all or a substantial contribution towards the reasonable legal costs incurred by the employee in obtaining advice on the termination of their employment and the terms of the agreement. The independent adviser must have a current contract of insurance (or professional indemnity insurance) covering the risk of a claim against them by the employee in respect of the advice. The agreement must identify the adviser (who is usually required to sign the agreement too), and confirm that the conditions regulating settlement agreements in the applicable pieces of legislation have been satisfied.

Tax indemnities – there will almost certainly be an indemnity in the agreement stating that the employee will be responsible for any tax and National Insurance (save for PAYE deductions and employers’ National Insurance contributions) due in respect of the payments and benefits being paid to the employee. The employee therefore may also wish to consider taking independent financial advice if there are any complicated tax issues (perhaps relating to share options, commission plans or bonus schemes) to assess the risk of agreeing to such an indemnity and to ensure all payments, where possible, are made in a tax-efficient manner.

References – the parties can agree the wording of a reference that will be provided by the employer regarding the employee to a prospective new employer and attach the reference as a schedule to the agreement. This non-financial benefit could be valuable to an employee who fears an unfavourable reference would be provided should the wording not be agreed, and would be a strong negotiating tool for an employer (not forgetting that the employer must take reasonable care to ensure the information it contains is true, accurate and fair, and does not give a misleading impression). However, agreed references are less important for employees with no concerns regarding their conduct or performance before termination, or for those whose employer only provides very basic factual information about former employees in their references (such as dates of employment and job title) and these facts are not in dispute.

The employer may also wish to impose additional obligations on the employee, such as asking the employee to:
• Waive their entitlement to a bonus or share option scheme;
• Provide ongoing assistance to the employer after termination; or
• Enter into new restrictions regarding who they can work for/with or do business with after termination.

In relation to the bonus or share option scheme, the parties should consider whether the employee has been fairly compensated for the loss of any rights they may have to receive a bonus or participate in a share scheme. If not, the parties could explore whether the employer has the discretion to enable ex-employees to continue to participate in the share scheme and/or receive their accrued entitlement to a bonus at the termination date or at the time when the bonus would usually be paid. If they do, and they agree to exercise their discretion in this way, the employee is more likely to agree to an earlier termination date, rather than try to stay employed until the date that shares vest or bonus payments are made. Agreeing that an employee is classed at a “Good Leaver” for the purposes of any bonus scheme or share scheme is also something the employer may offer to persuade the employee to agree to termination of their employment in this way.

Regarding ongoing assistance, if it is likely that an employee may need to provide assistance to or perhaps evidence on behalf of their former employer following the termination of their employment, the employee may seek to be compensated for any loss of income as well as any reasonable expenses incurred in the course of providing such assistance.

As for asking an employee to sign up to new terms restricting who they can go and work for or perhaps which clients or customers they can deal with for a set period after termination, the employee’s willingness to agree to such new terms is likely to depend on what the employee is getting in return. If the compensation being offered is generous and the employee believes they can still seek suitable alternative employment or deal with customers and clients without fear of breaching the restrictions, then there is little for them to lose by agreeing to the new restrictions. Similarly, if the employee proposes a career change or career break then the restrictions may be irrelevant to them.

However, if the employee’s freedom to trade will be overly limited by the proposed new restrictions, or the timescale for the restriction is unreasonably long, consider whether the compensation being offered is generous enough to cover any potential loss of income that (as far as they are concerned) the employee may encounter whilst abiding by the restrictions. If it is not, there is a risk the employee may refuse to agree to a settlement agreement containing such terms, preferring instead to retain their freedom to go and do what they wish post-termination. Of course, both sides should also consider the reasonableness of the restrictions being introduced, as clauses that are too wide or too long in duration are likely to be unenforceable.

Needless to say, the employee would still be bound by any confidentiality provisions in their contract of employment, in addition to their common law duty of confidentiality.

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The contents of this article are intended as guidance for readers. It can be no substitute for specific advice. Consequently we cannot accept responsibility for this information, errors or matters affected by subsequent changes in the law, or the content of any website referred to in this update. © Mundays LLP 2018.