Settlement agreements: 10 things to think about to ensure you receive a fair deal

settle_your_differencesIt can be a daunting prospect to be faced with being offered a settlement agreement by your employer. There are a number of considerations you need to think about with your lawyer to ensure the best possible deal.

A settlement agreement is a legally binding document setting out the terms and conditions surrounding the termination of your employment. By signing such a document you are agreeing to effectively waive any claims you may have arising out of your employment and the termination thereof. Given the legal effect of a settlement agreement, is important therefore to try to negotiate the best deal possible for you.

At iLaw we have over 20 years of experience negotiating settlement agreements (previously known as compromise agreements) on behalf of clients.

Here are our top 10 considerations we identify to clients to ensure they get a fair deal:

1.THE COMPENSATION AMOUNT

You should try as far as possible to maximise the financial terms of the settlement. With this in mind, the amount of money you are being offered under the settlement agreement as an ex gratia sum as compensation for loss of employment ought to reflect the likely value of the potential legal claims you may have arising out of your employment and its termination.

As part of the advice your independent adviser ought to give when taking you through the terms and effect of your settlement agreement they ought to identify any claims you may have against your employer arising out of your employment and their (respective) value(s).

Since you will be effectively be waiving any such claims by signing a settlement agreement, it is important to ensure you are adequately compensated for doing so.

If you are unhappy with the ex gratia amount being offered compared to the value of your potential claims arising out of your employment and the termination thereof you can seek to try and negotiate a higher figure. Your independent adviser can assist in carrying out this negotiation on your behalf and pass on the cost by seeking a higher cost contribution from your employer for advising under the agreement.

Your employer though is not obliged to agree this request and indeed it may not be in their interests to do so. In such circumstances you would remain responsible for any additional legal costs.

2. TAX LIABILITY

 Where a payment is made on termination of employment (including any redundancy payment) and expressed as compensation for loss of employment, the first £30,000 will be treated as exempt from tax up to £30,000. Any excess will be subject to income tax deductions in the normal way.

If the termination date is close to the end of the tax year you may find it tax efficient to move the termination date into the next tax year or to stagger payments under the settlement agreement into the next tax year.

3. PAYMENT IN LIEU OF NOTICE

 Where your employer does not require you to work your notice period, then you ought to be entitled to receive payment in lieu of notice (commonly referred to as ‘PILON’).

You ought to refer to your contract of employment in the first instance for the length of your notice entitlement. Where your contractual notice entitlement is relatively short and you have been working for your employer for a number of years it may be that statute will intervene to provide you with a longer notice entitlement. Legal advice ought to be obtained in this regard.

Where there is no PILON clause in your contract of employment and your employer does not typically pay its employees PILON on termination of employment, a sum representing the equivalent of the notice period can often be paid tax free up to £30,000.

Where your contract of employment contains specific PILON provisions though whereby your employer reserves the right to pay you money in lieu of notice rather than making you work your notice period then payment of your PILON is regarded as contractual. Even where there is no PILON clause in your contract of employment itself, where your employer typically pays its employees PILON on termination as a matter of custom and practice then HMRC may regard this entitlement as an implied contractual PILON (or auto PILON as it is often referred to) and therefore taxable. In both circumstances, HMRC will expect your employer to specifically refer to this payment being made in the settlement agreement and to make appropriate deductions for tax.

Sometimes employers attempt to include PILON as part of the ex gratia lump sum under a settlement agreement. Where there is a PILON clause in your contract of employment or an auto PILON situation arises in your case, if HMRC investigates the payment as they are entitled to do, you may find yourself personally liable to pay the necessary deductions yourself whether under any tax indemnity contained in your settlement agreement or otherwise.

4. HOLIDAY PAY

 We always insist that the number of days untaken paid holiday entitlement which you have accrued up to and including the date of termination of employment is specified in the settlement agreement to avoid any misunderstandings or disputes later on.

It is particularly important to specify the amount of untaken holiday entitlement you have accrued in the agreement itself as you will be unable to take any action to claim additional untaken paid holiday entitlement after signing the settlement agreement because you will have waived your right to do so under the agreement.

If you are receiving payment in lieu of having to work your notice period, then, strictly speaking, you are not entitled to compensation for any period of paid holiday entitlement that would have accrued to you during your notice period.

5. BONUS

 Some contracts of employment specify that entitlement to bonus is discretionary and where employment ends or where notice is served before bonus is due to be paid out, entitlement to bonus is lost. This does not prevent you though from still seeking to argue that you ought to be entitled to bonus.

Where you would ordinarily be entitled to receive a bonus, have worked for a significant proportion of your bonus year and the bonus amounts are readily quantifiable you can ask your employer to pay a pro-rata sum in respect of bonus under your settlement agreement.

As with all payments you consider you ought to be entitled to on termination of employment, you must ensure your settlement agreement expressly provides for bonus entitlement including the amount due. Unless your settlement agreement does so you are unlikely to receive any bonus payment you will be unable to take any action to claim bonus after signing the settlement agreement because you will have waived your right to do so under the agreement.

6. TERMINATION DATE

 The termination date contained in the settlement agreement ought to be reasonably contemporaneous with the date you and your employer both signed it.

If the settlement agreement is entered into a number of months before the termination date then this may put in jeopardy the tax free status of any ex gratia payment.

In such circumstances, HMRC may seek to argue that part or all of the termination payment represents an inducement for the employee to continue to perform services for the employer for the interim period between the date of signing the agreement and termination date and will treat it as taxable.

7. REASON FOR TERMINATION

 Often employers include wording that termination is ‘by mutual consent’. Such wording though may once again jeopardise the tax free status of any ex gratia settlement payment.

 The reason for termination specified in the settlement agreement may be relevant also if you have income protection insurance, for example as part of a house insurance policy. Some insurance policies only pay out if the reason for termination of employment is redundancy and will ask documentary evidence to be provided of this.

8. REFERENCE

 It is important that you are provided with a reference on termination of your employment to assist you with obtaining new employment and that you are satisfied with the content.

There is no legal obligation on an employer to provide a reference and employers are therefore entitled to refuse to provide references.

For this reason your settlement agreement ought to contain a term providing that your employer will respond to any request for a reference from a prospective employer in writing in accordance with the agreed form of reference attached and further that any verbal reference provided will be in no less favourable terms.

It is common practice for employers to provide short form references, which give little more information beyond your dates of employment and job title.

It may be possible to agree an improved form of reference which includes additional information about your duties and responsibilities, skills and capabilities and any milestones/ achievements in performing your role which casts you in a more positive light.

Be warned though that sometimes a more detailed reference can lead a prospective new employer to suspect that an agreed settlement was negotiated by lawyers in relation to your previous employment and lead to them asking questions regarding the precise circumstances surrounding termination thereof.

9. NON BAD MOUTHING PROVISIONS

 Your settlement agreement will typically include a restriction preventing you from making any adverse or derogatory remarks about your employer or do anything to bring them into disrepute

We always recommend ensuring the agreement includes reciprocal non bad mouthing provisions on your employer that it will use reasonable endeavors to ensure that its employees and officers do not make any adverse or derogatory remark about you or do anything to bring you into disrepute also.

10. RESTRICTIVE COVENANTS AND GARDEN LEAVE

 Restrictive covenants (or post-termination restrictions as they are sometimes called) are often included in a settlement agreement. These provisions are either specifically drafted for the purposes of the settlement agreement or reference is included that you will continue to be bound by your existing restrictions contained in your contract of employment.

Such post termination restrictions are only ever enforceable to the extent that they are necessary to protect the legitimate business interests of the employer.

Post termination restrictions also need to be closely defined in terms of duration and scope if they are to be enforceable.

Typical restrictions include:

  • Non-competition;
  • Non solicitation of clients/ customers;
  • Non dealing with clients/customers;
  • Non solicitation of key employees; and
  • Non-interference with suppliers

No compete restrictions are particularly draconian preventing you from working for a competitor for a period of time post termination of your current employment, effectively therefore amounting as a fetter on your ability to obtain alternative employment. In this context you need to look at the amount of compensation on offer under the settlement agreement compared with any period of time during which you will be constrained.

As part of a negotiation on a settlement agreement we always endeavor on our clients’ behalf to get any problematic post termination restrictions removed if at all possible or if not the ambit of the restriction in terms of time and scope reduced.

Also the settlement agreement should state that any post termination restrictions your employer wants to hold you to should be reduced by any period for which you are on garden leave as such a period will effectively already constrain you from working/ dealing with customers, employees and suppliers. See below for more on garden leave.

Where you employer has acted towards you in a manner which could be said to be in breach of contract it may be possible to argue,  by virtue of this breach, that any post termination restrictions fall away and are no longer effective.

 Your settlement agreement may provide that you are placed on a period of what is commonly referred to as ‘garden leave’ until the end of your employment.

This effectively means you are not being required to attend your employer’s offices and you may be restricted in the contact that you can have with clients/other staff.

Most employees are perfectly content to be put on garden leave (subject to the length of garden leave required of them) as they will continue to receive full salary and accrue paid holiday entitlement for this period without having to work.

In such circumstances, you still need to remember that whilst you are not required to attend work you remain an employee and are still subject to your employer’s authority, instructions, policies and procedures. So for example, if you are asked to cooperate with them on providing information as part of a work handover you are still obliged to do so. Also if you decide you want to go on holiday you should book time off in the normal way and obtain approval first.

NEXT STEPS

If you have been offered a settlement agreement you need to take independent legal advice on the agreement before it can be considered legally binding. Your employer normally agrees to contribute a fixed amount towards your legal fees for obtaining that advice under the terms of the settlement agreement.

At iLaw we do not charge more than the cost contribution provided by your employer for obtaining this advice. Call us today on 0207 489 2059 OR 07525618363 for a FREE initial consultation or to make an appointment. Also check out our specialist settlement agreement page .

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