Exit strategy: the pros and cons for businesses of drawing up a settlement agreement

Settlement agreements, formerly known as compromise agreements, are used to deal with exits and dismissals that occur for a number of reasons, including redundancies, ill health, performance issues, conduct and more.

For the employer, they guarantee that no claims will be brought by the employee, providing peace of mind that there will be no litigation fees or the need to attend a tribunal which means internal resources and management time is taken up. And for the employee they deliver a guaranteed result, without the need for potentially lengthy and costly litigation, which often includes a tax-free compensation payment, lump sum payment of notice pay and an agreed reference for prospective new employers.

How do they work?

An employment settlement agreement typically involves the employee, the employer and any legal representation that is being used by their party. It is a legally binding contract between an employer and employee that outlines an agreement to settle any potential claims, usually in return for a compensation payment that is paid by the employer to an employee.

Sometimes a settlement agreement will be offered where there is a potential redundancy situation, or pending disciplinary action, and an employee can receive enhanced payments to save employers the management time of having to go through the consultation processes.

Dos and don’ts 

Dos:

For a settlement agreement to be considered valid, it must meet the following conditions: 

• The agreement must be in written form
• The employee must seek legal advice from a qualified professional
• The agreement must specify the adviser
• It should relate to a specific complaint or proceedings 
• Independent advisers should hold a valid contract of insurance or professional indemnity
• The agreement should state that the applicable statutory conditions that regulate it have been met.

If the agreement fails to meet any of the above conditions, or if the two parties fail to come to a resolution, the settlement agreement will not be enforceable and employees may potentially still pursue claims against their employer through the employment tribunal.

Don’ts

There are several potential pitfalls that employers can face when offering a settlement agreement. One is when an employer misunderstands the nature of a protected discussion and considers themselves to be protected by the ‘without prejudice’ principle when they are not.

Another is when the employer does not realise that the confidentiality obligations in a settlement agreement only come into effect when it is signed by both parties, and that confidentiality must also be covered in the initial protected conversation. Other issues can arise when the employer fails to treat payments correctly for tax purposes.

There is no duty to provide any reference to an employee except in certain sectors of activity such as the financial services sector. However, the reference provided must ‘in substance be true, accurate and fair’. You have a duty of care not only to your ex-employee but also to future employers. 

Compensation

Negotiations can determine the specifics of a settlement agreement, such as compensation amounts, references and benefits. How much compensation is offered depends on the circumstances, such as whether an employee has been working for the same employer for more than two years or not, whether there is any discriminatory treatment involved, or how much evidence there is of any unfair treatment. Typically, settlement agreements will include a confidentiality clause, which requires the employee in question to keep both the existence and the terms of the agreement confidential.

For employers in particular, this confidentiality clause is considered as vital, to prevent the settlement becoming common knowledge, such as to other employees within the business.

Settlement agreements can be used as an alternative solution to terminate an employee’s employment from a company, or as a form of protection for employers, whereby if a disgruntled employee leaves the business, part of the settlement agreement can be that the employee must not be bringing the company into disrepute.  

However, it is important to know that if you and your employee are, for any reason, unable to reach an agreement, then any discussions regarding the agreement may be unable to be used in any subsequent unfair dismissal claims.

Alexandra Bullmore is a settlement agreement expert at Smith Partnership