Settlement agreements – a detailed insight

A settlement agreement – previously known as a compromise agreement – is a legally binding agreement between an employee and an employer which sets out the terms on which the employee will agree not to pursue a claim against the employer. The settlement process nearly always results in the employee leaving the company.

The law states that individuals cannot generally contract out of their employment rights. There are however a few exceptions to this rule. One of those exceptions is where an agreement is reached by way of a settlement.

Key points

• Settling dismissal disputes before they become tribunal claims makes good commercial sense – but employers need to be clear about what they are trying to achieve. A resignation that is really a dismissal could make more trouble.
• Discussions intended to be inadmissible as evidence in future court proceedings (“without prejudice”) can have their status changed by subsequent events.
• Settlement agreements must be “freely negotiated”. If employees have been put under pressure to sign, and the outcome is not to their advantage, settlements can become dismissals.
• Using a disciplinary/grievance procedure prior to a negotiation over an employee’s exit package can be a safer option than accepting a “heat of the moment” resignation, and is less likely to be viewed as a dismissal if a claim is lodged.
• Bear in mind that it is normal for the employer to contribute a set amount towards the employee’s legal fees. We usually advise a minimum of £250 + VAT.

What you need to be cautious about?
Be aware that you could end up providing generous terms without effective protection, potentially putting you in a difficult position. Don’t assume that the standard settlement agreement drafted by your lawyers will necessarily be right for your particular circumstances – if in doubt get HR180 to work with you.

An example of how this could happen is when the employee states that they have no alternative employment lined up and you pay out a large sum in the belief that the employee will be spending a long period looking for work. How would you feel if after the event the employee walked into a lucrative new job the following day, having pocketed a nice little windfall? This kind of situation can be anticipated in the settlement agreement, unless the employer is happy to pay out the money in the knowledge that the employee may receive a windfall of this kind.

It is also galling for employers to find that a departing employee has pocketed a large termination payment and then immediately joined a major competitor, in an apparent breach of post-termination restrictions.

It is usually sensible to reiterate and reinforce such restrictions in the settlement agreement and to ensure as far as possible that they are enforceable. The original restrictions may be too wide to be enforceable or later events (such as an alleged constructive dismissal) may have weakened them.

Total coverage
Naturally, you want total coverage against all possible claims. However, the settlement agreement regime is not designed to provide anybody with a security blanket. It aims instead to allow specifically identified complaints to be settled.

Some claims cannot effectively be excluded by settlement agreements – for example claims for breach of the obligations to inform and consult employee representatives in relation to proposed redundancies under section 188 of the Trade Union and Labour Relations (Consolidation) Act 1992.

The same applies to attempts to settlement information and consultation claims under the Transfer of Undertakings (Protection of Employees) Regulations 2014. However, where such claims are potentially in play, it should be possible to gain some protection by allocating specific sums towards the potential protective awards that could be granted as a result of such claims, and by including an acknowledgement from the employee that any right to such an award has been fully satisfied.

Top reasons why settlement agreements fail

• They do not cover specific complaints
• They don’t include points that have been specifically relied on in negotiations
• They do not deal with post termination restrictions
• They do not deal adequately with the employee’s position as a director and/or shareholder and/or holder of share options
• They fail to recognise claims that cannot be waived
• They do not deal with serious misconduct discovered after the agreement
• They don’t cover claims against other employees
• They fail to take into account the effect of TUPE transfers

The essential message is clear: there should be no such thing as a bog-standard settlement agreement.