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What is a Settlement Agreement?

20 December 2023

A settlement agreement is a legally binding agreement made by two parties, usually an employer and one of their employees. The purpose of a settlement agreement is to resolve employment disputes over subjects such as pay, performance and redundancy. In many cases, an amount of severance pay will be negotiated in exchange for the employee’s explicit agreement not to pursue a tribunal case, or take the matter to court.

As well as involving current employees, there may also be cases whereby a settlement agreement is reached between an employer and an unsuccessful candidate, who feels that they were discriminated against during the recruitment process.

As part of our efforts to help both employers and employees understand what a settlement agreement is – and what you should know about proceeding with one – we’ve outlined two scenarios in which the deployment of a settlement agreement is appropriate. We have also answered several frequently asked questions with the intention of providing greater clarity.

Settlement Agreement Scenario #1

James has worked successfully for five years as a sales executive at a double-glazing company. As part of corporate restructuring, the company reduced its sales personnel, and James was moved into the marketing department. Despite the best efforts of his employer to accommodate the change, James feels unhappy in his role, and his performance has taken a significant dip as a result. 

Recognising that he is in danger of disciplinary proceedings if his performance continues to fall short of expectations, James decides that a clean break is required, one that will put him in a favourable position both from a financial and recruitment point of view. He approaches his employer to raise the prospect of a settlement agreement. His employer recognises that an agreement will save time (which might otherwise be taken up with lengthy disciplinary proceedings), and they agree to begin negotiations. 

In light of James’s previous five years of success within the sales department, an agreement is reached whereby James receives a financial severance package, as well as an agreed-upon employment reference. In return, James agrees not to take the matter forwards in the form of a tribunal or other court proceedings.

Settlement Agreement Scenario #2

Holly and Jessica do not get on well with each other. In the office, colleagues have noticed that their tumultuous relationship is having an impact on the morale of the team, and have raised the issue with manager Rafiq. In an effort to improve the situation, Rafiq has held mediation sessions with both Holly and Jessica, with little success. 

The three have reached an impasse and Holly has raised a grievance about Jessica and the way the Company have dealt with this matter.  While Rafiq does not want to lose either Holly or Jessica, he recognises that it is a tricky situation – one that could devolve into lengthy disciplinary and/or grievance proceedings, and even an employment tribunal.

HR get involved and have a without prejudice conversation with Holly, making her an offer of a favourable financial severance package and an agreed-upon reference. Holly is happy with the offer and agrees not to raise the matter with a tribunal or take it to court. Holly also agrees to work a notice period that allows her employer to find and train her replacement.

We hope that both scenarios have suitably illustrated the purpose of a settlement agreement. Employers should, however, use a settlement agreement only as one of the many tools at their disposal. It should not be their first and only method of resolution.

Why Would an Employer Offer a Settlement Agreement?

The three main reasons for an employer to offer a settlement agreement are reducing time, costs, and reputational risk. Firstly, the employer can – where appropriate – save time by not undertaking lengthy disciplinary proceedings or mediation sessions that are proving fruitless. 

Secondly, a settlement agreement can reduce – and often eliminate – the risk that the employer will be taken to an employment tribunal or to court, an expensive undertaking that could result in reputational damage.

Who can Sign a Settlement Agreement?

A settlement agreement is signed by the parties to the agreement, usually a representative of Employer and the Employee. In addition to this, the Employee will need to seek the advice of an independent solicitor who will also need to sign the agreement.

Is a Settlement Agreement Legally Binding?

Yes. A settlement agreement becomes legally binding once the employee has taken independent legal advice on the terms. To do so, the employee is required to take a copy of the agreement to a solicitor who specialises in employment law.

Does a Settlement Agreement Need to be Witnessed?

A settlement agreement does not usually need to be witnessed, however some that are signed off as ‘deeds’ will need to be witnessed.

Are Settlement Agreements Confidential?

Confidentiality clauses (sometimes referred to as non-disclosure agreements or NDAs) are often, but not always, found in a settlement agreement. They might include a requirement for the employee to continue adhering to the confidentiality clause detailed in their original employment contract, or specifically prohibit the employee from discussing the settlement terms with anyone other than specifically named individuals.

What is a Reasonable Settlement Agreement?

A reasonable settlement agreement could be defined as one in which both parties are satisfied with the outcome. This could depend upon many factors such as the financial terms, the working arrangements until the end date or the restrictions on who the Employee can work for after leaving. 

A reasonable settlement agreement is likely to differ considerably depending on the circumstances. For example, an employee who believes they have been discriminated against as part of redundancy proceedings will have different expectations than someone who believes that their holiday allowance is unfair.

How Long Does it Take to Negotiate a Settlement Agreement?

There is no set rule for how long negotiations should last. As a general rule of thumb, the employer will hold a meeting with the employee, outline the reason for proposing a settlement agreement, the potential consequences for the employee if a settlement agreement cannot be reached, and what the two parties’ priorities might be as part of an agreement. That first meeting is often followed by a written offer that the employee should take to a solicitor to explain the terms and their implications. 

The employee should then be given time to reflect on the terms of the settlement agreement. Acas, the Advisory, Conciliation and Arbitration Service, recommends giving employees 10 calendar days to consider the proposal, but this is not set in stone. The employer may allow for shorter or longer periods. Following time to reflect, the employee may respond with counter offers or requested amendments, which the employer may wish to consider, refuse, accept or negotiate further.

What Happens if a Settlement Agreement is Breached?

If a settlement agreement is breached, meaning a provision has not been adhered to, the solution is usually to claim a breach of contract, and seek compensation in the County Court or High Court (Sheriff Court in Scotland). Common examples of a breach of contract include an employer who has failed to pay the agreed-upon financial severance; or an employee who has communicated the final terms of the agreement publicly breaching the confidentiality clause that was agreed with their employer.

How Long Does a Settlement Agreement Last?

Often, there is no expiry date applicable to a settlement agreement. Things like the date of an employee’s final working day and when the settlement agreement will be signed will be on specified dates, but most terms in a settlement agreement run indefinitely unless otherwise specified.

Can You Cancel a Settlement Agreement?

Before the terms of a settlement agreement have been signed, either party can withdraw from negotiations, or change their minds on any part of the agreement. After all, the negotiation of a settlement agreement is entered into voluntarily. Once both parties have signed the agreement (following the employee’s consultation with an employment law solicitor), it becomes legally binding. Any breach of agreement – by either party – following the signing could lead to a pursuit of compensation in the County Court or High Court (Sheriff Court in Scotland).

Is a Settlement Agreement Subject to Tax?

Any payment relating to the pay and benefits that an employee usually receives or would have received remains subject to the usual rules on income tax and National Insurance. Included in that group are things like notice pay, holiday pay, bonuses, commission, and other salary/wages. 

Any part of a settlement payment that is paid as a compensation payment can generally be made tax-free up to the current threshold amount of £30,000.

Can You Claim Unemployment Benefits After Signing a Settlement Agreement?

Employees often claim unemployment benefits after signing a settlement agreement, and once their employment has ended. Their general statutory right to claim unemployment benefits is unaffected. Employees should be aware, however, that the amount they receive as part of their unemployment benefits could be impacted by the amount that they will receive as part of any settlement agreement.

Do Employers have to Pay Legal Fees for a Settlement Agreement?

There is no obligation for an employer to pay the legal fees for a settlement agreement. That being said, in the interest of goodwill, and due to the employer often being the party that proposes the agreement, most employers offer to contribute towards the fees charged by an employment law solicitor. After all, without the employee’s consultation with an employment law solicitor, the settlement agreement is not valid. If the employer decides not to help the employee pay the legal fees associated with an employment law solicitor and the employee cannot afford to do so, no settlement agreement can be reached.

Can Loch Associates Assist with Settlement Agreements?

Yes. The award-winning team at Loch Associates can help you with all facets of employment law, including settlement agreements.

We can ensure your agreement serves its intended purpose, is satisfactory to both parties, and is legally valid.
For further information, help and advice, speak to our experts.

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