The concept of a compromise agreement was created in 1993. It is a document that records an employee’s agreement not to pursue an employment related claim, such as unfair dismissal or breach of contract. This agreement is usually in exchange for a sum of money.
In employment law, there are various requirements that are necessary for the agreement to be valid:-
- The agreement must be in writing.
- The agreement must relate to a particular complaint raised by the employee
- The employee must have received legal advice from a relevant independent adviser, such as a solicitor, on the terms and effect of the proposed agreement and its effect on the employee's ability to pursue any rights before an employment tribunal.
- The adviser must have a current contract of insurance, or professional indemnity insurance, covering the risk of a claim by the employee in respect of the advice.
- The agreement must identify the adviser – usually the adviser signs to confirm that the advice has been given
- The agreement must state that the conditions regulating compromise agreements have been satisfied.
Your solicitor will need to make sure that your compromise agreement fulfils all of these requirements.
Your compromise agreement should be tailored to your own individual circumstances. However, there are some features that are common to most compromise agreements.
The purpose of this booklet is to explain succinctly some of the more common clauses that are found in compromise agreements. It is not intended to be a replacement for formal legal advice.
Reasons for termination
Your compromise agreement does not have to give a reason for the termination of employment. If a reason is given, it will have to be consistent with any reference that your employer provides.
The reason for termination may be relevant if you have Income Protection Insurance, for example as part of a house insurance policy. Some such insurance policies only pay out if the reason for termination is redundancy.
Please contact us to discuss your compromise agreement in more detail.
Without prejudice and subject to contract
Many compromise agreements are marked ‘Without prejudice and subject to contract’.
A ‘without prejudice’ document cannot usually be used in evidence in court or employment tribunal proceedings. The phrase indicates that the compromise agreement is a genuine attempt to reach a settlement.
‘Subject to contract’ means that the document will not be binding on either party until it is properly signed.
Your compromise agreement usually includes a clause towards the end providing that the agreement is without prejudice and subject to contract until it has been signed. In other words, neither you nor your employer are under any obligation until all the formalities have been completed.
Parties to the Agreement
Usually the only parties to a compromise agreement are the employer and the employee.
If you have worked for more than one group company, it may be appropriate for all the relevant group companies to be parties to the agreement as well.
It is common for the compromise agreement to include a clause stating that the group companies are also parties to the agreement.
Background
It is often helpful to set out a brief summary of the circumstances which led to the parties entering into the compromise agreement, including details of the individual's employment (such as start date, position, any complaints raised, reason for termination).
Interpretation or Definitions
Many compromise agreements begin with a clause defining the meaning of various terms throughout the agreement. This may include what types of information are considered confidential, the termination date and the identity of the legal advisor.
Arrangements prior to termination
Unless your employment has already ended, your compromise agreement should deal with the arrangements in the period prior to termination. In particular, it should confirm the payments that will be made to you over that period. These payments usually include salary, holiday pay and expenses. Since these arise under the contract, they will be subject to tax in the usual way.
If you are going to receive any bonus or commission payment then this should be specified in the agreement, and the employer may also wish to specify what payments you will not be receiving.
Garden leave
Your compromise agreement may provide that you will be on ‘garden leave’ until the end of your employment.
If you are placed on garden leave, you will not be required to attend the office. You are free to stay at home (or in the garden)! You do however remain an employee and subject to your employer’s authority. For example, you will not be allowed to go on holiday without properly booking time off work.
The aim of garden leave is to protect the employer’s business interests, such as confidential information.
Most employees are more than happy to be on garden leave because they continue to get paid without having to attend work.
Payment in Lieu of Notice
If you are not working your notice period, you are likely to be entitled to a payment in lieu of notice (PILON). The length of notice period is usually determined by any relevant provisions in the employment contract.
Accrued but untaken Holiday Entitlement
You have the right to a payment in lieu of statutory holiday entitlement that has accrued but not been taken at the date of termination. Usually this is extended to any contractual holiday in excess of the statutory minimum, however, this is not required by law.
If you are receiving a PILON, you are not entitled to compensation for the holiday that would have accrued during the notice period.
The payment due in relation to accrued but unused holiday pay is usually calculated on the basis of the annual salary divided by the number of working days for each day’s holiday entitlement. It should be based on working days and not calendar days. The relevant calculation for a full-time worker is 1/260.
The law does not allow employers to deduct money from the employee's final salary where the employee has taken holiday in excess of his entitlement. The employer will only be able to do this, if there is a right to do so in the employment contract.
Termination payment
Employees usually receive a termination payment by way of compensation for loss of employment. This will be paid tax free up to £30,000.
If the termination payment is made after the employer has issued the employee's P45, the employer may choose to deduct income tax at the basic rate only, in which case the employee will be responsible for any further tax due.
References
There is no legal obligation on an employer to provide a reference for an employee or ex-employee and employers are therefore entitled to refuse to provide a reference.
However, it is common to include a term in a compromise agreement that provides that the employer will respond to any requests for a reference in accordance with an agreed form that is usually annexed to the agreement.
Often this reference is very basic and provides minimal information such as start date, finish date and job title. Most employers these days are not surprised to receive such a simple reference.
Legal fees
Since one of the conditions of a compromise agreement is that the employee has received legal advice, it has become increasingly common for the employer to make a contribution to the employee's legal fees. However, it is not a legal requirement to do so.
Restrictive covenants and confidentiality
Restrictive covenants or post-termination restrictions are often included in compromise agreements to protect the employer from harm to its business. They are only enforceable to the extent that they are necessary to protect the legitimate business interests of the employer.
Typically, restrictive covenants can include restrictions against
- dealing with or soliciting customers and suppliers of the employer;
- poaching employees;
- disclosing confidential information.
It is usual for an employer to state that a specified amount of the termination payment is being paid in consideration for entering into the covenants. This is because payments for restrictive covenants are taxable in full and, if part of the payment is separated out in this way, the tax authorities may argue that the whole termination payment is payment for the covenants and should be taxable in full.
Employee’s Warranty
A compromise agreement often includes a warranty that the employee is not aware of any circumstances which would justify their summary dismissal.
The courts have held that a compromise agreement can be conditional upon such a clause. The employer could withhold the payment if it discovered circumstances that would have justified dismissing the employee without notice.
Repayment on breach
It is common to include in the compromise agreement a clause stating that an employee will repay the money if he breaches any of the terms of the compromise agreement.
There is a danger that such a clause may be unenforceable because ‘penalty clauses’ are not usually valid.
Nevertheless, the employer often includes the clause, as a deterrent against the employee starting a claim.
Tax Liability
The first £30,000 of a termination payment is exempt from tax and any excess will be subject to income tax in the normal way.
Any statutory redundancy payment or ex gratia payment will also be tax free.
The tax treatment of the payment in lieu of notice will depend on whether it is contractual, either expressly or impliedly. If so, it will be taxable as "earnings" in the normal way. However if there is no contractual right to the PILON then it will be exempt from tax, provided that the total termination payment does not exceed £30,000.
Any payments which are allocated to restrictive covenants or confidentiality obligations will be taxable in full.
If the termination date is close to the end of the tax year it may be more tax efficient to move the termination date into the next tax year. The termination payment will then be treated as taxable in that year, which will mean that the employee has longer to pay any additional tax due and may be able to make use of lower rate tax bands that would otherwise have not been used.
A compromise agreement usually includes a ‘tax indemnity’ clause. This provides that if additional tax is payable, it will be the liability of the employee rather than the employer. An employer can never make guarantees about the tax status of any payments.
Waiver of claims
When entering into a compromise agreement, the employer's aim will be for you to give up any rights to bring an employment related claim.
In recent years, the courts have clarified the law in this area. The following should be noted.
- A compromise agreement may cover more than one type of claim and may cover both claims that have been brought in a tribunal and those that have merely been raised by the employee.
- A compromise agreement must state that the conditions regulating compromise agreements under the law are satisfied
- A compromise agreement must clearly identify the claims being settled in order to be a binding waiver of those claims
- A "blanket agreement" simply signing away all an employee’s tribunal rights will not be effective. Compromise agreements should be tailored to the particular circumstances.
Only certain claims may be settled by a compromise agreement. A complete list is set out at Appendix 1.
It is not possible to waive any accrued pension rights. Often, any such rights are usually owed to the employee by the trustees of the pension scheme, who are not a party to the compromise agreement. The trustees would therefore not be bound by the terms of the compromise agreement and would be in breach of trust if they then failed to provide the employee with the benefits to which the employee is entitled under the pension scheme.
The employer may want to obtain a waiver in relation to all existing personal injury claims, and such a waiver may validly exclude claims of which the parties are unaware at the time of the agreement, provided the wording is sufficiently clear.
Confidentiality
Employers can protect confidential information while the employee is employed. However, unless there is an express term in the employment contract or compromise agreement, protection after termination will only extend to information which is so confidential as to amount to a trade secret.
Third party rights
The Contracts (Rights of Third Parties ) Act 1999 allows a third party to enforce contractual terms. If it is intended that a third party (for example, the employer's group companies or a buyer on a TUPE transfer) will have rights under the compromise agreement then this will be stated in the agreement.
Governing law and jurisdiction
A ‘jurisdiction clause’ enables the parties to agree which country's courts are to have jurisdiction to hear disputes. This will usually be England and Wales.
Adviser's certificate
Although it is not a legal requirement, it is good practice for the employee’s legal adviser to sign a certificate confirming that the advice has been given. Often, the employer will want this to be on the headed notepaper of the solicitor’s firm.
And finally . . .
We hope that the information in this booklet has helped you to understand your compromise agreement. However, you will need to obtain formal legal advice for your compromise agreement to be valid.
Call Advantage Employment Law on 0845 257 1075
