Settlement agreements: practical tips on making them work

One year on from the introduction of “pre-termination negotiations” and the change from compromise agreements to “settlement agreements”, how can you make sure that you are using these potentially useful tools effectively in seeking to avoid costly litigation?

Pre-termination negotiations were introduced on 29 July 2013. These enable an employer and employee to speak about exit terms without the fear of these discussions becoming admissible in future proceedings, albeit subject to some important conditions. Pre-termination negotiations co-exist alongside the existing “without prejudice” rule with one major difference – in order to hold pre-termination negotiations with an employee there does not need to be an existing dispute.

In the past, if employers commenced such discussions but settlement could not be reached, then their position was likely to be undermined because the details of such discussions would normally be admissible as evidence, which could adversely affect the employer’s position. The introduction of such pre-termination negotiations were heralded by the Government as a means for employers to have exit discussions with employees without the fear of costly litigation, thereby removing some of the red tape and enabling employers to hire and fire with greater ease. However, employers should not be lulled into a false sense of security and instead should use them with caution, taking note of the following:

• A pre-termination negotiation will be protected (and therefore inadmissible in any subsequent proceedings, assuming settlement terms are not agreed) only if the employee claims for unfair dismissal. If the employee asserts other claims, such as discrimination or breach of contract, the discussion will not be protected. It is important to note that an employee only has to assert claims other than unfair dismissal to potentially rely upon these discussions; they do not have to be successful with those claims.
• Even if the employee only has a potential claim for unfair dismissal, employers need to ensure that they do not engage in “improper behaviour” (for example, bullying) or place “undue pressure” on the employee (for example, threatening the employee with immediate dismissal if he/she does not accept the settlement offer) because this will result in the discussions becoming admissible.
• Acas have published a Code of Practice (the “code”), which should be followed in all cases where pre-termination negotiations or a settlement agreement are anticipated. Although the following are not legal requirements, the Code makes it clear that the employer ideally should: offer the employee the right to be accompanied to such discussions, which may help to avoid arguments of “improper behaviour” or “undue pressure”, albeit that, in the light of the nature of the discussions, the employee may choose not to be accompanied; and put the final agreement in writing (although an initial offer can be made verbally) and give the employee at least 10 days to consider and seek advice on the terms of a settlement agreement.

 Settlement agreements and the Acas Code

Settlement agreements replaced compromise agreements from 29 July 2013. Although this is little more than a name change (all of the legal requirements for a compromise agreement still have to be met, including independent legal advice for the employee), the process for offering such agreements generally should be reconsidered in the light of the Code.

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When discussing settlement agreements, employers should:

• adhere to the Code, even if the employer is not seeking to rely on “pre-termination negotiations”;
• only give factually correct references to avoid potential litigation (for example, not stating that an employee’s performance was strong when the reason for the employee’s departure was because of capability issues);
• make sure to take advice regarding the correct tax position on each type of payment. Many employers assume that all payments made pursuant to a settlement agreement fall within the £30,000 tax exemption and can be paid tax free. That is not correct; contractual payments, including holiday pay, bonus or commission payments and, potentially (depending on the employee’s contract), pay in lieu of notice must be subject to tax and national insurance contributions; and
• consider paying the employee any sums due under the settlement agreement in instalments if the employer has concerns regarding the employee’s compliance with the agreed terms, for example adhering to restrictive covenants and non-derogatory clauses.

Pre-termination negotiations must not be seen as a “get out of jail free” card when dealing with disgruntled employees, whether their potential claims are genuine or vexatious. Nevertheless, used properly, the new regime may, in the right circumstances, prove a useful tool for employers to agree a severance deal and settle potential claims without the need to follow lengthy internal procedures.