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Termination of employment: What is a settlement agreement?
22nd Nov 2021
Termination of employment: What is a settlement agreement? - Linkilaw Solicitors
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Settlement agreements are used as a tool to resolve workplace problems and, most commonly, to end an employment relationship on terms mutually agreed by the two parties, usually an employer and an employee.

It is important to note that a settlement agreement may not substitute other methods such as managing disputes through honest conversations, workplace mediation, informal and formal disciplinary or grievance procedures.

This article explains what settlement agreements are, in which circumstances may be used, and how to negotiate the terms and settlement payments.

What is a settlement agreement?

A settlement agreement (formerly known as a compromise agreement) is a legally binding agreement between two parties, usually the employer and an employee, not to pursue any potential claims in the employment tribunal or other court proceedings in exchange for some form of monetary payment.

A settlement agreement may be offered by both parties involved, but it is the employer who will typically propose a settlement agreement to terminate a contract.

Settlement agreements are entirely voluntary, and they are reached through a process of discussion and negotiation. They include terms and conditions mutually agreed upon, and parties can reject the offer if they wish.

When may a settlement agreement be used?

There are different scenarios where settlement agreements are used. Usually, when the employer does not want to follow a longsome process before terminating, both parties agree that this is the best way forward and want to avoid the time, cost and stress that a tribunal claim would entail.

Settlement agreements can also be used to solve a workplace dispute that does not result in termination of employment. For instance, it may be used to resolve a dispute over holiday pay.

There is no legal requirement to go through a disciplinary process before suggesting a settlement agreement, and it can be offered at any stage of the employment relationship.

Can an employer threaten to dismiss the employee if they do not accept the settlement agreement?

No. Threatening to dismiss an employee for rejecting a settlement agreement may result in the employee resigning and claiming constructive unfair dismissal. Additionally, it constitutes improper behaviour and will be disclosable to a Tribunal.

As a general rule, a minimum of 10 days should be allowed to consider the proposed terms of a settlement agreement and receive independent advice, usually through an employment solicitor.

If no reasonable time is allowed, the settlement discussions may be accepted as evidence in an upcoming unfair dismissal claim before an employment tribunal.

Settlement agreement

Deciding the terms and the settlement payments  

Employers can start settlement discussions and make an offer either orally or in writing. We recommend putting an offer in writing and clearly stating why the proposal is being made to avoid misunderstandings.  

The settlement offer will depend on the particular circumstances of each case, but it usually outlines the proposed terms of the agreement, the financial payment to the employee, and often includes a reference. Once agreed, the agreement must be put in writing.  

Some of the terms of the agreement to negotiate and decide are the full breakdown of payments and how these payments will be taxed. There are different elements to bear in mind to decide the settlement payments:   

  • The facts to terminate the contract. 
  • The length of the employment relationship.   
  • Any notice payment.   
  • Outstanding holiday entitlement or any bonuses or commission owed.   
  • The difficulty to fill the current role or for the employee to find another job.  
  • The time and cost involved if an agreement is not reached, and a tribunal or court claim occurs.  

Payments of up to £30,000 compensation can often be paid without tax being deducted.   

The employee’s solicitor will compare the amount offered in the settlement agreement to what the employee could get if pursuing their claim in a tribunal and consequently advise if the amount is satisfactory or insufficient. The employee will then decide how to proceed.    

Other aspects to be decided in the settlement terms are the confidentiality of the agreement and any potential clauses preventing from making derogatory comments, and an agreed reference.   

Once the two parties have signed the settlement agreement, compensation should be paid within 7-21 days. However, certain payments such as outstanding salary, holidays and bonuses or commission payments will be made through the payroll. 

How can we help?

Our employment solicitors can help you draft and negotiate a settlement agreement that ensures all terms agreed are satisfactory for the two parties involved.

We can also advise on and manage disciplinary, grievance and discrimination issues identified.

Book a call with our legal team today

Our legal commentary is not intended to be a comprehensive review of all developments in the law and practice. Please seek legal advice before applying it to specific issues or transactions.

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