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Drafting settlement agreements - required terms

In this article, our second of three guides to drafting settlement agreements, we focus on the terms and clauses that are an absolute necessity for inclusion in a settlement agreement.

Why is it important to include these terms?

It is necessary to include certain terms within a settlement agreement because failing to do so would mean that the agreement is not legally binding, and so leaving your business open to potentially costly employment claims).  It also is necessary because not including the terms would mean the agreement does not cover the outcomes you are envisaging, potentially making it ripe for exploitation by a well-advised former employee.

Statutory requirements

There are six statutory requirements for a settlement agreement in order for it to be a legally binding settlement. They are as follows:

  • It must be in writing
  • It must relate to ‘particular proceedings’ (see below!)
  • It must state that the conditions relating to settlement agreements under the relevant statute have been satisfied
  • The employee must have received legal advice on the agreement from an independent legal adviser
  • The adviser must be insured
  • The agreement must identify the adviser

All six of these must be fulfilled in any settlement agreement in order for it to be valid.

The requirements fit into two broad categories – the agreement must specify the claims it is settling, and the employee must receive legal advice on their ability to bring a claim before a court or tribunal in respect of those claims.

Claims

It is a common occurrence to see settlement agreements drafted by employers which include a very long list of potential employment claims, in an effort to cover all bases and provide maximum protection for the business. It is also a way around the established legal position that it is not enough for parties to simply agree a blanket exclusion of all employment claims, without specifying which claims the parties have in mind.

It is good practice, however, to tailor settlement agreements to the particular circumstances of the situation. As an example, if drafting a settlement agreement for a senior director on a six-figure salary, it is clearly not necessary to ask them to waive their right to bring a claim under the National Minimum Wage Act 1998. Similarly, someone who works 40 hours per week will not be able to bring a claim for unfavourable treatment against part time workers.

Employers should be wary of being overly reliant on precedents, and ensure that each agreement is appropriate for the situation. However, properly drafted precedents will include a clause that states that the conditions relating to settlement agreements has been complied with. Although in the agreement itself this is often predominantly a rather long list of employment legislation, it is absolutely crucial that this paragraph is included, otherwise it will not be legally valid, and could prejudice both parties.

Legal advice

A second crucial requirement for settlement agreements is that the employee must receive legal advice on the agreement from an independent legal adviser, who should sign a certificate to confirm that they have done so. They must be named in the agreement itself and be covered by appropriate insurance.

The crux of a settlement agreement will be that the employee receives a payment as compensation for their employment coming to an end and in return the employee gives up their right to bring an employment claim at a tribunal or court. However, employees must be fully informed of what they are giving up in order to make the agreement fair. An employer could put what appears to be a tempting offer to an employee as part of a settlement agreement (for example £10,000), but if the employee has a watertight claim worth more than £50,000, it is absolutely not in their interests to sign the agreement.

It is therefore critical that the employee has an independent lawyer (i.e. not one that is also acting on behalf of the employer!) to establish whether the employee has a potential claim, and what exactly they would be giving up by signing the agreement.

Other important clauses

As well as setting out the claims that are being waived, the key details that need to be included in a settlement agreement are as follows:

  • When is the employment relationship ending?
  • How much will the employee be paid, and when will they receive it?
  • Is the employee working their notice, or receiving a payment in lieu (PILON)?

It is necessary to define exactly when the employment is ending (or has ended) as this is usually when all salary payments and other benefits will cease.

Similarly, the employee will be most concerned about the amount that they will be paid and, crucially, when they will get it. Agreements usually state that it will be within a number of days following the end of employment, or receipt of a signed settlement agreement, whichever is later. Care should be taken that enough time is given to make the payment, and so payroll teams should be kept in the loop to ensure payment goes ahead smoothly.

The final point is particularly important from a tax perspective -which was explored in more detail in February’s drafting masterclass article - as new rules came into effect in 2018 which tightened up the way severance payments are taxed.

Conclusion

The clauses above are absolutely vital to include in a settlement agreement, so that the employee has clarity on how their employment will be brought to an end.

There are a host of other clauses which should be included, ranging from the most standard of boilerplate clauses to some potentially tricky clauses which are most often the subject of negotiation. We will consider these further in April’s drafting masterclass article.

Disclaimer

This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.

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