Settlement agreements with employees

Understanding the strict legal rules on settling employee claims can help protect your business avoid significant costs.

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How can I settle or waive employment claims?

There are only two ways to settle statutory employment claims. The first way is to use a qualifying settlement agreement (previously called a compromise agreement). The other method involves a COT3 agreement, made with the involvement of ACAS (not covered in this note). 

When do I use a settlement agreement?

You can use a settlement agreement whenever employer and employee wish to resolve potential statutory claims without litigation. It can be used after dismissing an employee or to achieve employee departure by mutual consent, whether or not the employee has started a formal legal claim.

If employment is not ending in connection with the agreement then Ask a lawyer.

How can I get the employee to sign a settlement agreement?

The employer will normally make a payment in return for the employee’s waiver of claims, reflecting the likely value of those claims and the likelihood of their success.

Settlement agreements are normally concluded after negotiation between the parties. Since the employee must receive legal advice before signing the agreement, the employer will normally also instruct a lawyer or HR expert in connection with the overall settlement process so the parties are on an equal footing. 

Be very careful when talking to employees about settlement agreements or departure, as you risk constructive dismissal.

All written communications about settlement agreements or agreed departure terms should be marked 'Without Prejudice and Subject to Contract' and oral discussions should be agreed by employer and employee to be 'without prejudice', which essentially means inadmissible in court.

Never threaten to dismiss an employee if they don’t agree to leave. Raising the prospect of a departure 'out of the blue' (ie where there is no previous dispute, grievance, claim or formal disciplinary/performance procedure ongoing) or where the suggestion of departure might be said to be discrimination is particularly tricky.  We recommend in this case that you Ask a lawyer.

What are the legal rules on settlement agreements?

It is essential that the settlement agreement records all the specific relevant claims or complaints that the employee is waiving. Settlement agreements often state that they waive every employment claim that exists at law but without specifics this is unlikely to be valid.

If the employer thinks the employee has potential claims that haven't been raised then they must make a tricky decision as to whether to specifically mention them in the agreement. If they're not mentioned then they may not be waived, but if they are the employee may renegotiate settlement terms.

Settlement agreements must also be in writing, can only be executed after the employee has received independent advice from a lawyer or other qualifying adviser and must contain certain information.

Some claims just cannot be legally waived (eg failure to inform and consult under TUPE).

Remember that settlement agreements cannot be used to bypass standard procedures. For example, you cannot offer a settlement agreement to an employee on long-term sick leave without first considering reasonable adjustments (i.e. a period of long-term sickness is a strong indicator that an employee may be disabled). Proceeding directly with an offer to terminate a contract alongside a settlement agreement could provide evidence of an employer's failure to consider and make those adjustments.

What else should I think about? 

Including an agreed form of reference in the agreement can avoid future disputes but you must not mislead the reference recipient. 

Make sure that any agreements that need to stay in force are preserved as valid in the settlement agreement (for example, agreements governing share option rights, pensions or other benefits).

The rules on taxation of termination payments are tricky. Make sure that you deal with the payments correctly. See this HMRC page for further information. If in doubt about any of these issues, Ask a lawyer.

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Create your Settlement agreement

Answer a few questions. We'll take care of the rest