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If you need to terminate the contract of an employee, a properly drafted settlement agreement can bring things to a swift conclusion with no possibility of tribunal claims.
Formerly known as a compromise agreement, a settlement agreement sets out the terms for a full and final payment. However, there are many aspects to consider and it is essential to make sure that the agreement is watertight.
Below we examine some of the most common considerations and what you may want to include in any settlement agreement.
Why Create a Settlement Agreement?
A settlement agreement is often the most efficient, cheapest and quickest way to end an employment contract. The agreement sets out the full terms that apply for the termination of the employment contract and explicitly specifies that it represents full and final settlement.
A settlement agreement is not something one side can force on the other; it has to contain mutually agreeable terms.
When the employee signs a settlement agreement they are providing confirmation that they will not seek to take further action against the employer through a tribunal. In return, the employer provides a payment and/or other terms which are beneficial to the employee. There are a wide range of terms which can be included in the agreement, providing both parties are happy to do so.
What Are the Common Terms Included?
Although you can include whatever terms you choose in a settlement agreement, there are some areas which are commonly covered. These include:
- Outstanding salary
- Other outstanding monetary payments including bonuses, holiday pay and commission
- The termination amount which is being paid
- A non-disclosure clause to prevent details of the settlement agreement being publicly discussed
- A non-derogatory clause to prevent denigration by either side
- Agreement that the employee will waive any further rights against the employer
- Rights regarding shares or share options
- Agreement over the employment providing a reference (this may be more difficult when the contract is being terminated due to poor performance)
- Whether the employer will contribute to the payment of legal fees
It is common for the settlement agreement to also recommend that the employee seeks professional advice before signing.
Factors to Consider
In the settlement agreement some factors are more complicated than others. It is important that each section is clear and comprehensive to ensure it fulfils its purpose.
As a settlement agreement may include different types of payment which may have different tax liabilities with HMRC. Some types of payment may be subject to income tax while other types will be liable to Capital Gains Tax.
HMRC can pursue either the employer or employee for cases where they believe more tax should have been paid so it is vital that the structure of the settlement is made clear. If there are elements which are to be taxed differently, or some elements which are exempt from tax, they should be separated within the agreement.
As an additional layer of protection, it is advisable to state within the agreement that the employee will be liable for all tax which becomes due on their final taxable remuneration. The employer should ensure they are complying with any known PAYE obligations but if HMRC carry out further checks and believe that further tax is due, this clause allows the employer to recover the sum from the employee if HMRC disagrees with how that income was initially taxed at source.
Timing of payments
In some cases it is simply a matter of making payment once the settlement agreement has been signed and witnessed. If the agreement allows for the payment to be made in instalments, the timing of each instalment should be specified and agreed.
As described above, it is typical for an agreement to stipulate that by signing the employee agrees not to pursue any further action against the employer, and that the payment is full, final and binding.
However, it is good practice to be explicit that the agreement not only covers the company but also the directors and other officers individually.
Covenants can cover a wide range of subjects which include many different types of behaviour such as:
- Being employed by a competitor
- Use of confidential information
- Poaching clients, staff or contracts
- Confidentiality over trade secrets
The agreement should specify the length of time the covenants apply for and must be reasonable in order to be enforceable in the courts.
It is normal for consideration to be paid in the settlement for the inclusion of covenants. The amount is usually only nominal but will be subject to PAYE and should be clearly specified in the payment breakdown.
Denigration of reputation
The requirement to protect reputation is often a key part of a settlement agreement. Both the employer and the employee undertake not to damage the others’ reputation.
One of the more modern inclusions in this type of clause is reference to social media accounts. It is not unusual for the employee to be required to remove all references to the employer from all/any social media platforms by their termination date.
Provision of references
While both parties are usually obligated not to damage each other’s reputation, the provision of a reference is also a common element. This can be a controversial point if there have been unsatisfactory elements to the employee’s performance, but provides the employer with a strong negotiating position.
Regardless of what the terms of the agreement set out, the employer must provide an employment reference which is not misleading, and is truthful. Therefore, to meet the terms of the settlement while also protecting themselves from claims, it is common for an employer to agree to provide simple references only.
A simple reference may only include the employee’s title and their length of service with no further comment regarding performance or achievements.
Although it is easy to secure the return of company property such as laptops, the inclusion of company information on devices owned by the employee is more challenging.
Including a clause which specifies that all company property should be permanently wiped from employee devices is recommended. This provides stronger grounds to ensure that the employee is unable to use any residual information to breach the agreement over reputational damage.
Get the Agreement Checked
Each settlement agreement should be specific to the employee whose contract you are terminating so you should always seek professional advice before offering terms.