Five key questions about the use of settlement agreements

Jul 10, 2019 | Termination

Most employers will at some point at least consider using a settlement agreement (previously known as a compromise agreement) in the event of a dispute or other difficult employment situation.
If you find yourself wondering whether this would be an option for you, it’s important to understand the basics of how the agreements work.

What is a settlement agreement?

A settlement agreement is a legally binding agreement between an employer and an employee. The principle is that the employee gives up their right to bring specified legal claims, and usually receives an amount of money as compensation for doing so. The employment relationship is usually brought to an end as a result.
The terms of a settlement agreement are negotiated between the parties, however it will only have the desired effect of preventing the employee bringing legal claims if certain specific requirements are met.
One of these requirements is that the employee has had access to independent legal advice about the implications of the agreement, which in practice means that the employer will need to pay for that advice, from a solicitor or qualified legal adviser.

What goes in a settlement agreement?

As well as giving up the right to bring specific relevant claims, a settlement agreement usually contains clauses relating to confidentiality, references to be provided to future employers, details of any post-termination restrictions, return of company property, garden leave or payment in lieu of notice and other termination arrangements. Details of the employee’s legal adviser will also need to be included.

Who produces the settlement agreement?

The initial draft of the settlement agreement is usually provided by the employer (often drafted by the employer’s solicitor or other legal adviser.). The employee then takes independent advice on the terms, and there is often then a period of negotiation around these until agreement is reached.

How much financial compensation is involved?

It’s important to remember that the settlement agreement is basically a commercial negotiation. There are no specific amounts required, so the figure agreed will depend on a number of factors:

  • How much notice pay/redundancy pay would the employee normally be entitled to?
  • Is the employer anywhere near being in a position to lawfully and safely dismiss the employee without the need for a settlement agreement – ie if the employee is on a final warning for something, then dismissal in a short timeframe without a financial settlement is not an unlikely prospect, however if there are no formal proceedings commenced around capability, conduct or performance, then the employer would normally be looking at several months of stress and uncertainty, so a higher financial settlement would probably be necessary to incentivise the employee to accept the agreement.
  • How likely the employer thinks it is that the employee would pursue a legal claim
  • How strong a potential legal claim is
  • How important it is to the employer that the employee agrees to leave employment under the settlement.

What happens if the employee doesn’t accept the settlement agreement?

If the employee doesn’t accept a settlement offer, the employer has two options – either to increase the offer until they do, or withdraw from discussions, and either continue employment as before, or commence whichever termination process is most appropriate.
Settlement agreements can be very useful, but can also be expensive, so consider carefully whether one is actually necessary before commencing the process, and ensure you understand the implications for your business.
If you’d like some advice about using a settlement agreement to resolve a dispute in your business, do get in touch.