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In this handy guide for employers and HR, Partner & Head of employment Sarah Rushton explains her top ten tips on settlement agreements.


What is a settlement agreement?

A Settlement Agreement is a legally binding agreement entered into following or in anticipation of, the termination of an employee’s employment. Usually the employee is paid compensation in return for an undertaking not to bring any claims against the employer.

Here are our top tips for employers regarding settlement agreements:

Tip 1

Settlement agreements will only be effective in preventing an employment tribunal claim if they satisfy certain statutory requirements. That includes the need for an employee to take independent legal advice.

Tip 2

Despite what many people may think, it is not possible to settle all employee claims by way of a settlement agreement. An employer therefore runs the risk of making a payment only to find that the employee still brings a claim. 

Tip 3

It is a mistake to assume that the first £30,000 of any compensation can always be paid tax free.  Employers often insist upon a tax indemnity in a settlement agreement, but HMRC will usually look to the employer to make good on any underpayment of Tax and NI and may impose penalties if tax should have been paid and was not.   

Tip 4

Care needs to be taken when approaching an employee in relation to a settlement agreement.  An ‘off the record’ conversation may not really be “without prejudice” “protected” or ‘off the record’. That means that if an employee does not sign the agreement, they can use the fact and content of the conversation, in any subsequent dispute.

Tip 5

It is often sensible to include a warranty in the settlement agreement from the employee, that the employee has not been engaged in any conduct, which if the employer had known about it, would entitle the employer to terminate the employee’s employment without notice. This is because it is sometimes the case that a settlement agreement is signed, but before payment is made, serious misconduct comes to light, meaning that the employer would want to try and avoid having to make a  payment.

Tip 6

There is no legal obligation to provide a reference, but if one is provided it needs to be accurate and honest. If a reference is provided as part of a settlement agreement, then the employer should reserve the right to amend or alter the reference if new matters come to light. 

Tip 7

In certain regulated environments employees are required to be ‘fit and proper’. This means that the employer may be required to provide a report to a regulator when the employee leaves. It is important to take this into account as there will be an obligation of full disclosure. The reasons for dismissal and the settlement agreement need to be consistent.

Tip 8

Consider whether there needs to be any confidentiality undertakings or post termination restrictions from the employee and if so, what they really need to cover. If the undertakings are new then it may affect the tax position of any compensation payment.

Tip 9

Thought needs to be given if the employee is also a shareholder or had share options. If so what is going to happen to the shares? Are there any ‘good leaver’ or ‘bad leaver ‘provisions? Thought also needs to be given as to whether or not the settlement agreement is sufficiently wide to cover any potential shareholder claims.

Tip 10

How are you going to manage the departure internally? Do you need to agree a form of words for circulation within the business? Employees are often more amenable to agreeing terms of settlement if they feel that they have been treated with dignity.

If you wish to learn more about settlement agreements or need any assistance with your business, contact Sarah Rushton by clicking here.


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