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Settlement and Termination Discussions

Settlement and Termination Discussions Overview

As any employer will know, handling potential claims by employees can be extremely disruptive, time-consuming and costly to an employer. An employee may have claims against their employer under the contract of employment, under statute or in accordance with other common law rights. In addition, claims against employers or prospective employers can arise at any time during employment, on termination or even during a recruitment process.

In many cases, an employer may want to consider making a settlement payment to an employee or prospective employee, in return for them waiving the potential claims. Such a decision is generally governed by commercial factors such as management time, costs, reputation issues and even the risk of adverse publicity.

The form of the waiver will depend on the type of claims that need to be waived, it is possible to waive contractual and common law claims by contractual waiver. As a general rule statutory claims can be waived only in more limited situations and would be void unless they are either (i) agreed through Acas; (ii) recorded in a valid Settlement Agreement; or (iii) covered by the Acas Arbitration Scheme.

Settlement can be reached with employees where the employment is continuing but it is more common where the employment has terminated or is to terminate as part of the settlement arrangements.

1. Settlement Agreements

Prior to 2013 Settlement Agreements were known as “compromise agreements” and employers may find these still being referred to as such.

A Settlement Agreement is a binding agreement between an employee and employer (and sometimes other parties to a statutory claim) to settle an existing case or refrain from commencing or continuing with legal proceedings against the employer.

A number of important legal formalities must be met in order for the Settlement Agreement to be valid and binding, perhaps the most important of these is that the employee must have received appropriate independent legal advice on the Settlement Agreement.

Not all claims can be waived by Settlement Agreement. It is not possible to waive claims for accrued pension rights, future personal injury and certain specific statutory claims.

For full information on this topic, see Settlement Agreements [FS30.02].

2. Acas Settlements

The Advisory Conciliation and Arbitration Service (Acas) conciliation officers have the power to settle a number of specified claims that are (or could be) the subject of tribunal proceedings. Acas settlements cannot cover personal injury claims as these are expressly excluded from the specified claims. However, certain claims which cannot be settled under a settlement agreement may be settled through Acas.

Acas early conciliation has been mandatory for most claims since 2014.

Conciliation officers commonly use a form COT3 to record a settlement. The agreed terms will be recorded and signed by or on behalf of the parties. However, the Acas facilitated settlement will be valid and binding once reached, even if not recorded in writing.

3. Termination Discussions

Approaching an employee to hold a discussion regarding the potential termination of their employment always carries some level of risk. However, the ability to hold a grown up conversation with an employee, where the employment relationship is not working out, can be very beneficial to a business.

The risk versus benefit analysis will need to be carried out and factors that the employer should take into account include the savings of management time, legal costs and other commercial considerations involved in avoiding a lengthy performance management/redundancy/disciplinary/ill health capability procedure. If there is a risk of a claim being brought then a financial settlement can be attractive to avoid subsequent litigation, associated costs and in some cases the risk of negative publicity or damage to employee relations.

Once the termination discussion has taken place the employer has shown their hand and this could mean that they have reached a point of no return with that employee, making any settlement potentially more urgent and higher cost. A failed termination discussion followed by a performance management procedure, for example, could leave an employer exposed to an allegation that the employer had already made up their mind to dismiss, that the subsequent process was a sham and therefore the resultant dismissal was unfair. However, there are ways that a termination discussion can be held that minimise those risks or at least reduce them to an acceptable level when considering the risk versus benefit analysis.

Employers may be able to take advantage of the without prejudice rule where there is an existing dispute and the termination discussion represents a genuine attempt to settle and avoid litigation.

In the employment context the without prejudice rule may have limited use because often it would be beneficial to hold a termination discussion at a point before an actual dispute has arisen, for example to allow the employer and employee to air their issues and explore options. To tackle this issue the government introduced a new statutory framework of “protected conversations” in 2013, this makes it easier for employers to initiate termination discussions and put forward settlement offers with less risk of those conversations being admissible in evidence against the employer in subsequent unfair dismissal proceedings.

For full information on this topic, see Protected Conversations and Without Prejudice [FS30.03].

4. Taxation of Termination Payments

The income tax treatment of various payments made to employees in connection with the termination of their employment is a highly complex matter, legal advice is always recommended.

The key question is always whether the payments being made are to be regarded as earnings (such as salary, notice pay, bonus payments, commission, holiday pay) which are subject to deductions for tax and National Insurance Contributions, or compensation for loss of office. Where a payment is compensation for loss of office (the “termination payment” or “ex gratia payment”) special rules apply which allow the first £30,000 of any such sum to benefit from a tax exemption and therefore be paid without deductions for tax and NICs. Any balance over £30,000 is subject to deductions for tax as well as both employer and employee NICs.

HMRC have the ability to analyse the reality of the situation where the parties have taken advantage of the tax exemption and may decide that tax was in fact payable, such interest from HMRC can be costly and highly problematic for an employer, even if the employee receiving the payment provided a tax indemnity to the employer. HMRC scrutiny may occur years after a payment has been made, in the course of a routine PAYE audit, by which time an employer may have made numerous other payments which were dealt with on the same (possibly faulty) basis.

Particular issues with the tax treatment of termination payments can occur in relation to:

  • arrangements where termination occurs and payments are paid a significant period after settlement agreement has been reached;
  • golden handshakes and payments under change of control provisions;
  • Non-contractual customary termination payments (other than contractual enhanced redundancy payments).

We recommend that employers obtain legal advice in relation to how to structure the termination payments package.

This document has been created by, or on behalf of ESP Ltd, as a general document and as a guide in relation to its subject matter and has not been bespoke drafted for you or the specific circumstances in which you are looking to use it. Prior to using this document and undertaking any HR process you must consult your organisation’s own policies and procedures to ensure that you do not do anything in conflict with your own policies and procedures.  If in any doubt as to how to use this document or, if you require any legal advice, please feel free to contact ESP Ltd on 0333 006 2929 and our legal team will be more than happy to assist.  ESP Ltd will not be liable in any way for any actions undertaken by you or your use of this document unless we have been consulted regarding your use of this document as legal advisor to your business or have bespoke drafted any documentation in response to a specific support request.

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