Settlement Agreements: looking to enter into a settlement agreement, here are 5 things you need to know
Most people understand that a settlement agreement can be used to resolve a dispute between an employer and an employee. However, there’s a lot more to settlement agreements than this general principle. Here, we set out 5 things you need to know about settlement agreements:
1. Tax free payments
In return for entering into a settlement agreement and waiving his/her contractual and statutory rights against the employer an employee may be offered a compensation package that includes various payments and other benefits.
Not all payments or benefits under a settlement agreement are eligible for the £30,000 exemption (i.e. can be treated as free from income tax and NICs).
It is important to consider the tax treatment of each element of the package separately, for example, why is the payment being made – is it contractual, compensation for loss of employment etc.?
Also, HMRC is planning to change the tax treatment of termination payments. https://www.crippspg.co.uk/employment/hmrcs-proposed-changes-termination-payments-mean-employers-employees/
2. ‘Without prejudice and subject to contract’
In settlement negotiations it is usual for all communications to be marked ‘without prejudice and subject to contract.’ Why?
If a statement (written or oral) is ‘without prejudice’(WP) or is part of ‘pre-termination negotiations’ (PTN) it may be inadmissible to a court or tribunal. The main benefit is that parties can talk freely without concern that anything said could be used in evidence if agreement is not reached, and in theory reach settlement as soon as possible. However, WP and PTN have their limitations:
a statement will only be WP if it is a genuine attempt to settle an existing dispute.
to instigate PTN there does not need to be a current issue, but PTN are restricted to normal unfair dismissal matters and there must not be any improper behaviour by the employer. Importantly, this means an employer cannot rely on PTN in other instances, such as discrimination.
The purpose of ‘subject to contract’ is to make it clear that no terms are agreed until the final written agreement is signed.
In any event, even if in doubt, to show your intentions it is sensible to mark all correspondence relating to a settlement agreement ‘without prejudice and subject to contract.’
3. Independent legal advice
Reflecting the substantial impact on an employee’s rights, for a settlement agreement to be binding the employee must have received independent legal advice on its terms.
The employee’s legal adviser does not need to sign the settlement agreement. However, they must be identified in the agreement and it is common practice for the agreement to require the execution of an adviser’s certificate.
4. Legal costs
Although not obliged to pay an employee’s legal fees, in light of the requirement for employee to obtain independent legal advice, employer’s often make a contribution towards the costs – ranging from £250 plus VAT to £1,000 plus VAT, depending on the complexity of the agreement.
The employer’s contribution to the employee’s legal costs can be free from income tax if they are:
- exclusively in connection with the termination of employment;
- the settlement agreement provides for the payment to be made by the employer; and
- the payment is made direct to the lawyer.
5. Entire Agreement
It may be last in our list, but this could be the most straight forward yet widely misunderstood issue.
Most settlement agreements will include an entire agreement clause. This means that irrespective of what has been discussed or agreed separately, if it is not included in the settlement agreement the parties are not bound by it!