Settlement agreements are technically complex documents. This is because they must conform to strict statutory requirements aimed at protecting employees and workers from undue pressure from the employer, who is regarded as being in the stronger negotiating position.

Settlement agreements conform to a standard format but differ significantly in terms of their scope. Most will include a provision for the payment by the employer of an agreed amount of compensation in return for the employee or worker waiving a number of identified employment claims. However, some go on to include quite onerous provisions concerning responsibility for excess tax and restriction on what the ex-employee can say or do after the agreement is entered into.

There are benefits to both employers and workers. For the employer, the biggest concern about an employment dispute is time and cost. Even if the employer feels they have a strong case, the cost of preparing for tribunal is tens of thousands of pounds and hours of time away from running the business. This fact can be an important bargaining tool for an employee whose case is weak because there is still an economic incentive for the employer to settle.

For an employee or worker, there are similar concerns about legal costs. Unlike other types of claim, the general rule in employment tribunals is that the parties each bear their own legal costs – win or lose. It is pointless pursuing a claim – even a strong claim – if the amount of compensation they hope to recover is swallowed up in legal costs.

Another benefit for employees is the possibility of including in the settlement an agreed reference. This is a particularly valuable aspect of the settlement since it provides the employee with a contractual promise to respond to a reference request from a new employer in the terms agreed. Departing from the agreed terms would amount to a breach of contract.

For a settlement agreement to be enforceable against the employee or worker, the employer must have provided the opportunity for him or her to seek independent legal advice. The independent adviser is usually named in the agreement and provides a certificate to confirm that advice has been received. It is customary for the employer to offer a contribution to legal costs.

Is a settlement agreement the same as a compromise agreement?

Yes. ‘Compromise’ agreement is the old name and you will still hear it used. The name was changed some years ago with the intention, presumably, of making the purpose clearer. The change was cosmetic, however. The substance remains the same.

A word about tax

Many people believe that the first £30,000 of any settlement monies paid under a settlement agreement are ‘tax free’. This is not necessarily the case. Settlement monies may be subject to tax below £30,000 even where they otherwise meet the requirements for exemption. This is because of an amendment to tax legislation brought into force a few years ago which introduced the concept of ‘Post-employment Notice Pay’ or PENP. In a nutshell, tax must be paid on an amount equivalent to contractual notice entitlement, regardless of the basis of the settlement payment, unless due notice has been worked by the employee (and tax paid) or there is a separate, taxed payment in lieu of notice.

It is important both for employers and employees to have regard to the possible tax implications when negotiating a settlement agreement. Employers are primarily liable for unpaid or underpaid tax and can only recover such sums from the former employee if the agreement contains a suitable indemnity.

We are specialist employment solicitors, based in central Manchester. We have been advising and negotiating settlement agreements on our clients’ behalf for over 30 years.

Our specialist support and guidance helps ensure that our clients achieve a satisfactory resolution allowing all parties to move on.

For help and assistance on any queries relating to settlement agreements, please contact our employment team on 0161 832 6131 or fill out our online enquiry form.