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16 February 2010

Compromise agreements: 10 key points an employer should know

1. What is a compromise agreement?

It is a legally binding agreement between an employer and employee. The employee agrees to waive any rights to sue the employer for any employment related claims in a tribunal or a court, usually in return for a severance payment.

2. Why use a compromise agreement?

It provides the employer with certainty and security. Any severance payment is in full and final settlement of any claims that the employee may have arising from their employment or its termination. Once an agreement is reached the employee loses their right to pursue contractual and statutory claims against the employer in a tribunal or court. The existence and terms of any compromise agreement often remain confidential, including any payment that is made.

3. When should a compromise agreement be used?

It can be used when a clean break is needed where there is a risk of the employee making a claim against the employer.  It can also be used as a substitute for potentially long drawn out processes such as capability process or redundancy process.

It is often best deployed where the employee has suggested the compromise agreement. An employer should avoid putting any ultimatum to an employee. The compromise route should be one of a number of possible options. These other options, such as performance management, disciplinary action or redundancy process, should continue during any compromise negotiations.

4. The “off the record” discussion

Employers must proceed with great care before commencing any such discussions to avoid weakening their position or exposing themselves to possible claims such as constructive or unfair dismissal. As a general rule there must be a dispute between the employee and employer for such discussions to be deemed without prejudice. You should take legal advice before holding any off the record discussions.

5. Employee must take independent legal advice

For a compromise agreement to be legally binding, an employee must take advice from their own solicitor or recognised trade union advisor who then signs the compromise agreement. The advisor must have a current contract of insurance or professional indemnity insurance covering the risk of a claim against them being made by the employee in respect of the advice given.

6. References

There is no legal obligation on an employer to provide a reference. Employees often request a reference as part of the terms of any compromise reached. You are entitled to provide a simple factual reference merely confirming the dates the employee worked for you and job title.

7. The severance payment

What amounts to a reasonable and acceptable settlement will depend on the specific circumstances of each case, taking into account the wishes of each party, the terms in the employee’s contract of employment and the potential claims that could be pursued.

Wages to the date of termination of employment and accrued holiday pay are taxable in the normal way.

Usually any compensation for ‘loss of office’ can be paid without tax being deducted for the first £30,000. This includes statutory and contractual redundancy payments.

If there is a payment in lieu of notice (PILON) clause and the employer always pays notice pay in lieu as a matter of course then this payment will be subject to tax otherwise it can be paid gross.

If a gross payment is to be made then there should be a clause insisting that the employee be responsible for any tax that may be payable.

8. Non derogatory comments and confidentiality

It is accepted good practice for an employer to have a clause in any compromise agreement restricting what an employee can say about them. Such a clause usually prevents an employee from bad mouthing an employer, the people who work there or have worked there in the past. It is important to determine in the agreement what amounts to confidential information and ensure that all company property is returned to the employer.

9.  Restrictive covenants

Make sure that you re-state any contractual restrictive covenants in the compromise agreement. If you want to introduce new restrictive covenants as part of the agreement, additional consideration will be required. Such payment will be taxable and should be treated separately to avoid the whole termination payment becoming taxable even if it is less than £30,000.

10. Legal Costs

Generally it is expected that employers pay a contribution towards an employee’s legal fees. The reason for this is that the employer will want to ensure that there is a valid agreement to prevent the employee bringing any claims and the agreement will only be valid if the employee has had legal advice. Usually there will be a clause in the agreement reflecting this position.

For information and advice on all aspects of employment law, please contact Nick Phillips on 01782 205000 or email nick.phillips@beswicks.com.

Please note: we also advise employees who require independent legal advice on compromise agreements.

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