Guide to our Settlement Agreement template

Posted by David Cammack on 27th May 2016

Our Settlement Agreement Template constitutes a formal contract for use by an employer to set out the terms of either:

(a) the settlement of a dispute with an ex-employee; or

(b) the terms under which a current employee will leave the employer’s employ and agree to waive or settle any all possible claims he might have against the employer in return for a payment.

This settlement agreement template satisfies the legal requirements for this to be a valid “settlement agreement” under the various employment statutes and regulations that apply. See further below.

Settlement agreements were known as “compromise agreements” until the law changed in July 2013.

Confidentiality and restrictive covenants

This template assumes that the employee’s employment contract already contains clauses on confidentiality and non-competition restrictive covenants (if desired by the employer), and provides that those obligations will remain in force.

If these were missing, then it is possible to add them into this template now. If you do not have suitable wording, then you can separately purchase the template Legalo has for the Director’s Service Agreement, which includes them. However, to avoid disputes with HM Revenue & Customs over their value, it is advisable to specify the amount that the employer is to pay the employee to sign up to these new covenants in the agreement, and then apply PAYE tax deductions to that amount. You should consult with your accountant on what value should be apportioned to these covenants. You will need to adapt this template accordingly. See also the note on tax issues below.

Legal requirements

Certain employment rights and discrimination claims can only be waived or settled by way of either (a) ACAS conciliation or (b) a settlement agreement that meets the statutory criteria. The requirements for a valid settlement agreement are the same as they were for compromise agreements. This means:

1. the agreement must be in writing;
2. the agreement must relate to a “particular complaint” or “particular proceedings”;
3. the employee must receive legal advice from a relevant independent adviser (a) on the terms and effect of the proposed agreement and (b) that the employee will be foregoing his right to an employment tribunal;
4. the independent adviser must have current professional indemnity insurance;
5. the agreement must identify the independent adviser; and
6. the agreement must state that the conditions regulating settlement agreements have been satisfied.

If these conditions are not satisfied, the agreement will not be binding on the employee, which means the employee could later bring an employment tribunal claim, so it is important to follow the correct process – ensuring the employee does receive independent legal advice.

Tax issues

Where a payment is made to an employee on the termination of employment (other than for signing up to new confidentiality and restrictive covenants, as noted above), it is either subject to PAYE tax deductions in the normal way or treated as a termination payment under sections 401 to 416 of the Income Tax (Earnings and Pensions) Act 2003. If the latter, then up to the first £30,000 is exempt from tax, but any excess will still be subject to tax.

The employer should operate PAYE deductions for any excess over the £30,000 tax-free amount. Should HMRC argue that the £30,000 tax exemption does not apply, it will generally pursue the employer not the employee, as it is the employer’s duty to operate the PAYE system. For this reason in the template we have included an indemnity from the employee for any unpredicted tax, so the employer has a right to recover the extra tax it has had to pay to HMRC from the employee. See clause 3.2 for this indemnity.

In our template, in clause 3.3, we have stated that the termination payment and the issue of the P45 to the employee will be made at the same time, so the P45 can take account of the termination payment (and relevant tax due on it, if any). If the termination payment is less than £30,000 (and therefore not taxable) it makes little practical difference for tax purposes whether it is paid before or after the issue of the P45 by the employer. However if the payment is to be made after issue of the P45, then for higher rate taxpayers this causes a problem. The “0T” tax code that now applies to post-P45 termination payments will in many cases make the higher-rate taxpayer worse off, because the employer will have to deduct even more higher rate tax than it would normally under PAYE (the employee may get this back later when he files his income tax return with HMRC, but it will tie up his money until he can reclaim it from HMRC). Following our wording in clause 3.3 should avoid this problem.

This is just a brief note on tax, designed to highlight some issues, but not to provide tax advice. In all cases you should consult your accountant for a definitive position.

Clauses in this Settlement Agreement

If the termination of employment arises from a transfer of a business that is subject to the Transfer of Undertakings (Protection of Employment) Regulations 2006, then both the transferor and transferee should be made a party to the settlement agreement. To do this, firstly replace the party clause for the Employer with the following and fill in the details of both the transferor and transferee in it:

“1. [COMPANY NAME] incorporated and registered in [COUNTRY OF INCORPORATION] with company number [NUMBER] whose registered office is at [REGISTERED OFFICE ADDRESS] and [COMPANY NAME] incorporated and registered in [COUNTRY OF INCORPORATION] with company number [NUMBER] whose registered office is at [REGISTERED OFFICE ADDRESS] (together “the Employer”); and”

Secondly, replace Background clauses “A” and “B” with the following ones:

“(A) The Employee’s employment has recently transferred pursuant to the Transfer of Undertakings (Protection of Employment) Regulations 2006 between the two parties comprising the Employer. Under the terms of this agreement, all the parties have agreed to deal with the termination of that employment and any related claims.

(B) Until it is signed by all parties and dated, the draft of this agreement shall be deemed to be without prejudice and subject to contract.”

Thirdly, at the end of the agreement, add in an extra signature clause for the transferee to sign in the same format as the one already there for the Employer, and put the transferee’s name in that new one. Put the transferor’s name in the existing one for “the Employer”. Finally, you need a separate agreement between the transferor and transferee setting out which of them is paying the various payments due to the employee under the agreement – this can take the form of a simple letter, but is best evidenced in writing rather than being left as only a verbal agreement, so it is easily enforceable.

Background

(A) – Select which option applies regarding whether the employee is still employed or not as at the date the settlement agreement is signed.

(B) – This clause could be deleted from the final version (but this is not necessary), but should be included in any preliminary drafts that are circulated for approval or negotiation. It means that if there is any on-going dispute, e.g. an employment tribunal claim has been brought, the draft cannot be mentioned to the tribunal in evidence and that the fact an offer to settle any dispute has been made is not an admission of guilt by the employer.

Numbered clauses

1. Interpretation – This clause defines the main terms used in the agreement. We have used “he/him/his” throughout to include “she/her”, on the basis that putting “he/she” in every case looks clumsy. No sexism is intended by this and with the “Find/Replace” function in Word you would be able to alter this fairly easily throughout the template if that is your preference.

  • Employment – This definition is self-explanatory.
  • Employment Contract – This definition is self-explanatory.
  • Termination Date – This definition refers to the agreed date of termination if the employee has not yet left the employer’s employ or the actual date of termination of the employment if he is now an ex-employee. Fill in the date in clause 2.1 -see below.
  • Termination Payment – This definition refers to the amount payable for the settlement of the employee’s claims – see clause 3.1.

2. Termination of employment – In clause 2.1 select the option that reflects if the employee is currently employed or is already an ex-employee. This should be correct as at the date the agreement is signed. In clause 2.2 select the options that reflect if the payments and other benefits (“perquisites”) have been paid or are yet to be paid – this probably depends on whether the employee is currently employed or is already an ex-employee. In clause 2.2 fill in the number of days for which holiday pay is being paid (if any) and the amount payable in total for the holidays. If there were no holidays left, then you can put “£0 in respect of 0 days’ outstanding holiday …”. If too many holidays have been taken you can amend the wording to reflect a deduction being made for excess holidays taken by the employee.

Clause 2.3 is included in case the employer is paying in lieu of notice. If this is not the case and the employee has worked his notice period in full then delete the whole of clause 2.3. If the contract of employment included a clause that permitted the employer to pay in lieu of notice, then keep the words in square brackets at the start of clause 2.3 (if not, delete them). Select the options in clause 2.3 that reflect if the payment has been paid or is yet to be paid, the gross amount of the pay in lieu of notice and how many weeks or months notice are required to be paid for (this might be the balance of a notice period that has been served in part and, if so, the amount should reflect just that balance due). If there was not a clause in the employment contract permitting payment in lieu then the amount might be paid tax-free (up to the first £30,000) – if so, delete the words in square brackets at the end of this clause. If there was such a clause in the employment contract, then the amount will be subject to PAYE deduction.

Clause 2.4 preserves the effect of any clauses in the employment contract that were intended to last after its termination, such as provisions on confidentiality and non-competition restrictive covenants. Otherwise clause 10 might negate them. If you did not include suitable provisions on confidentiality and non-competition restrictive covenants in the employment contract, but you want to include them now, their value will be subject to tax, as noted above.

3. Other payments – This clause sets out the payment being made by the employer for the termination and waiver of any claims by the employee. Fill in the amount in clause 3.1. If a redundancy payment is included in it, then set the apportionment of the total in clauses 3.1.1 and 3.1.2. Also fill in the calculation of the redundancy payment in schedule 1. If not, then just keep the first sentence of clause 3.1 and delete the rest of it (including clauses 3.1.1 and 3.1.2). Clause 3.2 refers to the understanding that up to £30,000 of the payment in clause 3.1 may be free of tax, as noted above. Clause 3.3 refers to the timing of the payment and the issue of a P45 (see the note above).

4. Benefits – Perks of the job should be provided for the term of the notice period. If a payment is being made in lieu of notice, then either (a) it will include payment in lieu of such a perk or (b) the perk will be provided for what would have been the notice period. The employer should choose and then complete clause 4.1 accordingly. The sentence in clause 4.1 can be repeated (but it is better to keep them all within clause 4.1) as many times as necessary with details of other perks to be provided, which may have the same or different end dates. If there is no pension scheme that applies, then delete clause 4.2. If there is, keep clause 4.2, and, regarding the last sentence, either fill it in (if it applies) or delete it.

5. Waiver – This is the clause under which the employee acknowledges that this is a settlement agreement and in clause 5.2 it lists all the laws under which settlement agreements are permitted. In clause 5.1 it states that this settlement does not include 3 types of claim which should not or cannot be settled under a settlement agreement of this sort (i.e. any need for enforcement of this agreement by the Employee, any personal injury claims of which the employee is not aware at the date of this agreement and regarding any accrued rights in a pension) – see also the note on schedule 2 below. Given their nature, this exclusion should not pose an obstacle for the employer to use this settlement agreement.

6. Company property – This clause recites that the employee must return the employer’s property he has in good order and by a certain deadline. It also refers to the deletion of any computerised, etc copies of information belonging to the employer that cannot be returned. Depending on how they have been stored (e.g. “in the cloud”), ensuring permanent deletion has occurred may be impractical.

7. Warranty by the Employee – This clause provides the employer with an additional protection. If, having made the termination payment, the employer later discovers that the warranty in this clause (that the employee is not in serious breach of his employment contract) is not true, the employer should to be able to recoup the termination payment from the employee.

8. Confidentiality, etc – More specifically than clause 2.4, clause 8.1 refers to the confidentiality and post-termination restrictive covenants that were in the employment contract. If they were not in it, then delete the bits that do not apply. If they were included, fill in the relevant clause numbers. Clause 8.2 provides that the existence and terms of this agreement should be kept confidential. Clause 8.3 is a simple clause so that the parties do not make derogatory statements about each other after the agreement has been signed (whether in writing or verbally and whether slanderous or true).

The employee may want to go further than this and request that an agreed reference is included in the agreement (particularly for more senior employee’s terminations) and maybe also an agreed statement to be made the media and staff about the termination. If so, use clause 8.4 and schedule 4. If not, delete clause 8.4 and schedule 4. If only an agreed reference is needed, then keep the first sentence of clause 8.4 and delete the remainder of the clause.

9. Independent legal advice – As noted above independent legal advice to the employee is a fundamental requirement of a legally binding settlement agreement. The onus is on the employer to ensure this advice is given. Fill in the names in clause 2.1 – this should be the name of the individual lawyer who advised the employee and the name of his law firm. The lawyer should also complete the certificate in schedule 3 – see below. It is normal for the employer to make a payment towards the adviser’s fees. A contribution of around £250 to £300 plus VAT is common for straightforward situations. The adviser’s invoice should be made out to the employee but can state that it is “payable by the employer”. The VAT on it will not be recoverable by the employer.

Schedule 1 (Calculation of the statutory redundancy payment) – This fulfils the statutory obligation on the employer to provide the employee with a breakdown of the way in which any statutory redundancy payment has been calculated (if any). If there is no redundancy payment being paid under clause 3.1.1, then delete the whole of schedule 1, renumber schedules 2 and 3 and update any cross-references to schedules 2 and 3 in the agreement (in clauses 3.3, 5.1 and 9.1).

Schedule 2 (Types of claim) – This lists the types of claim that can be dealt with under a binding settlement agreement and a few that cannot. Regarding those that cannot, they have been included as a deterrent to the employee’s bring any such claim if any such genuine claim exists. The ones that cannot be dealt with under a settlement agreement are:

  • certain statutory employment rights claims that, by law, can only be settled through ACAS (e.g. claims such as the right to be informed and consulted under TUPE 2006, claims under regulations 5, 6 and 9 of the Employment Relations Act 1999 (Blacklists) Regulations 2010, claims under the Agency Workers Regulations 2010 and claims under paragraphs 11 and 12 of Schedule 6 to the Employment Equality (Age) Regulations 2006);
  • claims in relation to accrued pension rights; or
  • claims for personal injury that might be caused in the future.

Some old Acts are listed here where claims under them might be rather unlikely now, but still technically possible, e.g. claims under the Equal Pay Act 1970 could in theory still be brought as late as 30 September 2016.

Schedule 3 (Legal adviser’s certificate) – This is the certificate referred to in clause 9.1. It is not technically required, but it is for the employer’s comfort, so that it knows (a) the required independent legal advice has been given and (b) the agreement therefore can qualify as a binding settlement agreement. The employer can fill in the names in paragraphs 2 and 3, but the legal adviser should then fill in the remaining options. When the agreement is ready for signing on the counterpart being signed by the employee, the legal adviser should sign and date at the end of schedule 3. While he should sign his own personal signature (not the firm’s name) here, underneath his signature he can add “For and on behalf of” and then his firm’s name if he wishes.

Schedule 4 (Agreed form of reference) – If keeping clause 8.4, about an agreed form of reference, then insert the wording for the agreed reference here. If not, delete this schedule.