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What is a Settlement Agreement?

We look at some of the key issues you will need to consider when entering into a Settlement Agreement.

A Settlement Agreement (formerly known as a Compromise Agreement) is a legally binding agreement between an employer and an employee under which the employee gives up his or her rights to pursue or bring future claims against their employer. Usually, the employee will receive a sum of money in return and, at the same time, leave the employment of the employer.

A Settlement Agreement is often a clean, dignified and quick way to end an employment relationship. As businesses are increasingly looking to downsize and save costs in the face of the COVID-19 pandemic, we are seeing a significant increase in the numbers of employers using Settlement Agreements to exit employees from the business.

Why is it important to get expert advice on a Settlement Agreement?

Settlement Agreements are often lengthy and complex agreements that address a number of issues that arise out of the employment relationship and its termination.

The following are just some of the key issues you will need to consider when entering into a Settlement Agreement:

  • The termination date
  • Outstanding salary and holidays. When will any outstanding salary be paid? Will you be required to take your holidays during your remaining period of employment?
  • Benefits. How will any benefits you received be dealt with under the Settlement Agreement? For example, company car, private health insurance.
  • Notice period/pay. Will you be required to work out your notice period or will you be leaving the employment of the employer with immediate effect and receiving a payment in lieu of your notice?
  • Deductions. Is the employer proposing to make any deductions from your final salary/compensation payment? For example, travel loan, training costs.
  • Pension. You will need to understand what impact leaving your employment will have on any pension.
  • Tax. It is important that any payments made under the Settlement Agreement are structured as tax efficiently as possible. Outstanding salary, notice pay and holiday pay will be subject to tax and national insurance contributions in the normal way. However, under current HMRC rules, the general rule is that the first £30,000 of any compensation payment for loss of employment, inclusive of any statutory redundancy payment, can be paid tax-free. In complex termination arrangements you may well need specialist tax advice.
  • Claims. It is important you fully understand what claims you are actually signing away as you may well want to exclude certain claims from being ‘settled’.
  • Restrictive covenants. Your contract of employment may already contain restrictive covenants and the Settlement Agreement may well deal with how these will apply moving forwards. If not, you may want to try and seek to the limit the scope of any existing restrictive covenants as part of any agreement. It is also quite common for the employer to look to introduce new restrictive covenants via the Settlement Agreement. Any new restrictions will therefore need to be carefully considered. Any new restrictions may also give rise to tax issues.
  • Directorships. The Settlement Agreement will often require you to resign any directorships at the same time as leaving your employment. You will need to understand the impact, if any, that resigning any directorships will have.
  • Shareholdings/share options. If you are a shareholder, you will need to carefully consider how your shares will be dealt with as you may well be required to sell your shares back on the termination of employment. If you have any share options, your reason for leaving will also be important because this may well determine what, if anything, you receive in consideration for your share options.
  • Confidentiality. The Settlement Agreement may well simply refer to any existing confidentiality provisions in your contract of employment or, alternatively, seek to introduce new confidentiality provisions. You will need to understand what information is confidential and what is not.
  • Reference. The provision of a good reference is often a key issue and may well involve a certain amount of negotiation.

How we can help you

For the reasons detailed above, and before you sign up, it is critically important that you obtain specialist legal advice on the terms and effect of the Settlement Agreement.

We can provide you with advice on all of the legal and tax issues which can arise out of a Settlement Agreement as well as how to progress any negotiations. Our advice is always best sought early on in order to maximise the likelihood of getting a good deal.

Find out more about our expert team of settlement agreement solicitors.

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