Employment settlement agreements: the basics

EMPLOYMENT SETTLEMENT AGREEMENTS: THE BASICS

What is an employment settlement agreement?

An employment settlement agreement is a legally binding contract between an employer and employee. Depending on the circumstances, settlement agreements may – and usually do – involve a payment by the employer in exchange for the employee waiving any actual or potential legal claims they may have e.g. unfair or wrongful dismissal, discrimination, redundancy or pay claims.

When is an employment settlement agreement used?

An employment settlement agreement can be helpful to an employer when they are faced with a difficult employee or undertaking a re-structure of their business. They are commonly used in redundancy situations or to settle actual or threatened employment tribunal proceedings from an employee.

From an employer’s perspective, taking an employee through a lengthy disciplinary and appeals procedure, or faced with defending a claim being pursued by an employee (whether rightly or wrongly), can involve significant management time and expense. Offering the employee a settlement agreement is a speedy and cost-effective way to resolve the matter conclusively.

An employer will usually initiate a settlement agreement discussion via a “protected conversation” which allows an employer (subject to some exceptions) to enter into a “without prejudice” or “off-the-record” conversation with the employee about a proposed exit or termination. However, there is no reason why an employee may not themselves request a settlement agreement.

Are settlement payments tax free?

It depends.

Employers used to be able to combine the value of an employee’s notice pay with their settlement payment on a tax free basis (up to £30,000), but this is no longer allowed.

If the employee does not work their full notice period or received a payment in lieu of their notice period, any settlement payment will be taxed up to the value of the employee’s wages or salary during that notice period (this is known as post-employment notice pay (PENP)). For example, if the employee’s notice period is three months but the termination is to be immediate, then it means that the first three months’ worth of the settlement payment is PENP and will be taxed. On the other hand, if the employee is paid for and works their full notice period, then the settlement payment will not be taxed at all as PENP.

The balance of a settlement payment, over and above the PENP, will usually (but not always) be free of tax up to £30,000.

Why would you need a solicitor for an employment settlement agreement?

Well, an employment settlement agreement is not legally binding unless the employee has received independent legal advice on its terms and effect before signing it. A solicitor is a relevant independent advisor who can provide this advice and sign off on the advisor’s certificate, which is required to finalise the agreement before it is returned to the employer.

Birdi & Co advises employers and employees on settlement agreements. We understand the need to comply with tight deadlines and will normally be able to act at short notice.

For more information, please call us on 020 4571 8631 or email us at hello@birdilaw.co.uk. Alternatively, please take a moment to complete our free enquiry form.

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