What is a settlement agreement?

A settlement agreement (formerly known as a compromise agreement) is commonly used by an employer to seek an employee’s waiver of claim, normally in exchange for financial compensation. They are often used to terminate a contract of employment, although this isn’t always the case. Settlement agreements can also be reached in relation to a particular dispute even if employment were to continue.

What is a COT3 agreement?

A COT3 agreement is a legal alternative to a settlement agreement. They are negotiated through the Advisory Conciliation and Arbitration Service and the parties to a COT3 don’t need to be represented by solicitors.

COT3s are however limited in scope therefore employers often prefer to use settlement agreements and obtain bespoke legal advice from a solicitor.

When will an employer need to consider settlement agreements?

There are many circumstances in which a settlement agreement can be used. For example, redundancy will sadly be a common one in coming months in light of Covid-19’s economic effect and the tapering of the Coronavirus Job Retention Scheme.

Other circumstances include a dispute between the parties or dismissal of an underperforming employee without the need for a drawn out capability process.

When will an employee need to consider agreeing to a settlement agreement?

An employee needs to consider if it is in their interest to agree to settlement by weighing up the alternatives such as termination without settlement or likelihood of success in any prospective claim.

What is the outcome of a settlement agreement?

Normally, there will be compensatory payment (ex gratia payment) to the employee in return for their waiver of claim. Most settlement agreements waive an employee’s right to claim across a broad spectrum of issues meaning they cannot go to the court or tribunal further to settlement.

There will also be other financial settlements such as payment in lieu of contractual or statutory entitlements such as holiday, notice, pension etc.

There are other non-financial provisions that should be included such as an agreed form of reference, employee warranties, return of property and restrictive covenants such as confidentiality.

What are the requirements of a settlement agreement?

For a valid waiver of statutory employment rights, certain statutory conditions must be met:

  • The agreement must be in writing.
  • The agreement must relate to a particular complaint or particular proceedings.
  • The employee must have received independent legal advice on the agreement and in particular on its effect on their ability to pursue the statutory rights in question.
  • The independent legal adviser must meet certain criteria in terms of qualification and insurance.
  • The agreement must state that the conditions regulating settlement agreements in the relevant legislation have been met.

Who pays for an employee’s independent legal advice?

Although there is no legal requirement for an employer to pay for an employee’s legal fees in respect of independent legal advice, it is in the employer’s interests to pay all or most of the fee. Most employees will refuse to pay for the legal advice and as failure to seek this advice will deem the agreement invalid, the expense is small in comparison to the cost of an ineffective waiver.

What will an independent legal adviser advise on?

Even if an employer contributes to the employee’s legal fees, the independent legal adviser will act on the employee’s behalf in bringing to their attention the following:

  • Legal advice on the terms and effect of the agreement.
  • Legal advice on the employee’s ability to pursue the claims specified in the agreement.
  • Acting as a relevant independent adviser as defined by law.

It is normally outside of the scope of an independent legal adviser’s instruction to advise an employee on whether the settlement is a good or bad bargain for the employee or to negotiate terms of settlement on the employee’s behalf.  

Is a settlement agreement legally binding?

If the agreement is validly made (see above) and executed by the parties, yes, it is legally binding on the parties. Where either party breaches its terms, the other will have a right to sue for breach of contract.  

How much compensation should the employee receive?

This is very subjective and depends on the circumstances of the settlement and negotiations.

Factors for the employee will be the strength of their case and prospects of success, amount available if they are successful, costs of taking the matter to tribunal and the personal burden of litigation especially if starting a new job.

Factors for the employer will be the relative prospects of success for its defence, man-power and resources, what any likely award and/or costs would be if the matter was successful and the cost of bad publicity given the public nature of proceedings.

How are payments under a settlement agreement taxed?

Generally speaking, employers can pay the first £30,000 compensation for the settlement agreement tax free, but this will not apply to all payments. For example, amounts for payment in lieu of notice (known as PILON) and holiday will still be subject to tax and national insurance.

If I do not pay the employee their compensation, will the settlement agreement be void?

This depends on whether the waiver is conditional on payment under the agreement. If so, the agreement may be void. If it is not conditional, the employee will have a breach of contract claim.