Knowledge Base

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Some issues relating to settlement agreements

This is a note about some of the issues involved in Settlement Agreements. It is not a substitute for individual advice that, of course, we will give you, but it is a pre-prepared advice on some of the issues that will arise in your Settlement Agreement. It is designed for us to advise you on these issues economically so that you are prepared for some of the points that may arise.

The Tax Indemnity

Nearly all Settlement Agreements rely in some way on the £30,000 tax free allowance for termination of employment or loss of office payments. New law means companies have to pay tax on notice periods so the ability to get tax free ‘damages for breach of contract’ has stopped. There is still sometimes scope for legitimately moving money into the tax-free allowance.

If the £30,000 allowance is used companies invariably want a contractual right to claim back any tax that should have been deducted. This is in case HMRC ever challenge the tax treatment. Such a contractual right is called a tax indemnity and you will find such a clause in most Settlement Agreements. An example is as follows:-

The payments under Clause 2 (“the Termination Payment”) are made in consideration of this agreement. The parties believe that the termination payment and benefits provided to the Employee pursuant to Clause 2 of this Agreement are exempt from tax and national insurance liability. Save for any tax and national insurance contributions deducted by the company, the Employee undertakes to indemnify and hold the company harmless against all other taxes and national insurance contributions in respect of the payments and benefits provided, or to be provided, pursuant to this Agreement, and all costs, claims, expenses or proceedings, penalties and interest incurred by the company which arise out of or in connection with any liability to pay (or deduct) tax or national insurance contributions in respect of such payments and benefits.

There is a range of such tax indemnities ranging from favourable to the employee to completely and utterly one-sided and against the employee. This range can be summarised as follows:-

  1. No tax indemnity;
  2. Just a requirement to pay back the tax not deducted on the first £30,000 and only if HMRC challenge the tax treatment and also only after the employee has had an opportunity to argue the point with HMRC;
  3. Tax and Employee’s National Insurance only - no opportunity to take issue with the HMRC;
  4. Tax, National Insurance, penalties and interest; and
  5. Tax, National Insurance, possibly including Employer’s National Insurance, costs, penalties, interest - no opportunity to take issue with the Revenue and the costs to include all costs of taking issue with HMRC’s investigation, possibly costs of any criminal sanctions and costs of making any of the payments to the Agreement!

When dealing with a Settlement Agreement for the employee we could try to delete the tax indemnity entirely. However, such an argument has almost never been successful. We could try to make the company’s proposed tax indemnity completely useless, which we do occasionally succeed in doing. If there are solicitors on the other side or the company’s advisers are aware of the situation, they won’t allow this. We could accept the company’s tax indemnity but make slight amendments such as removing the requirement to repay penalties, costs and interest. We can also ensure that only Employee’s National Insurance is covered by the indemnity or try to we can use our own tax indemnity clause which only relates to tax and Employee’s National Insurance. It also prevents the company admitting it owes tax before you have had an opportunity to take it up with HMRC or a Court.

The issue of costs and penalties arise as a result of tax law. A company is required to complete its own tax returns and account properly for tax and national insurance. If it does not the Revenue could claim interest on the tax that has not been paid. In addition, it could impose penalties. Costs may also be incurred in dealing with HMRC’s investigation or prosecution. These can be significant liabilities. Employers try, via the ‘tax indemity’ to impose a requirement on the ex-employee that he or she pays all such costs that arise from the settlement agreement. As a minimum, we will always seek to ensure that no costs, penalties and interest are included within the indemnity.

When negotiating any aspect of the Settlement agreement and in particular the tax indemnity much will depend on your negotiating strength. Sometimes we find that the parties have already negotiated a lot before we get involved. If this is the case and if negotiations have already been exhaustive then there is likely to be little room for further negotiation. Therefore, sometimes, with the best will in the world, we can’t get anywhere; other times, when we explain why the proposed tax indemnity is totally one sided, a realistic version is accepted. We also know that our success in this depends on the other side’s attitude to sensible negotiation. Our ability to negotiate also depends on a number of other factors, not only your negotiating strength, as mentioned above, but also the amount of costs involved. If we are on a tight budget, we may not be able to negotiate for considerable periods. Usually at the first instance we will seek to include our standard tax indemnity (on the basis that removing an indemnity entirely has always proved to be unsuccessful) but if we can’t do that we will have to, as lawyers say, “take a view” and discuss the issue with you.

There are some solicitors out there who we consider ‘good’ in that they draft sensible agreements from the outset. By sensible we mean realistic, fair and sensible. Other solicitors take a different approach and draft utterly one-sided agreements that no sensible solicitor on the other side could ever agree to. What happens in that later case is that no one benefits but the solicitors who record much more chargeable time than they would otherwise have done.

At the same time as looking at the indemnity we will, of course, be looking at the tax treatment of the payments under the Settlement Agreement. We have great experience in dealing with the tax treatment of Settlement Agreement payments. It is quite often the case that companies are proposing not to tax something that should clearly be taxed. Our view is that it is best to get the tax treatment right than to store up potential problems for the employee under a tax indemnity in the future. Occasionally we are asked by companies to take part in, what is tantamount, to a fraud and, of course, we will not entertain that whatsoever. Sometimes companies can be a little bit upset that we state that the proposed method of payment is actually wrong and, of course, we would discuss with you at the appropriate time. The new law on ‘post employment notice pay’ for example, is often overlooked by companies this could give the employee problems later. As a minimum we would want to see something like the following to deal with tax on the notice money:

The parties agree that, following this payment, the amount given by the formula in section 402D(1) Income Tax (Earnings and Pensions) Act 2003 (ITEPA) will be nil and that accordingly the Employee’s Post-Employment Notice Pay is nil where that phrase has the meaning given in s402D of ITEPA.

Return of company Property

Clauses about company property appear in all settlement agreements and are not normally an issue. We have had one experience, however, of an ex-employee who signed a Settlement Agreement but did not return some of the company property. The company refused to make the payment under the Settlement Agreement. There is usually a link between getting the money and returning of company property so the company in that case was right not to pay. If there might be an issue with the company’s attitude towards return of its property make a list and discuss it with company when returning it and try and get a receipt for the property.

Another point to note is that often these agreements require you to warrant that you have ‘irretrievably deleted’ all company information on your home computer. We know that is almost impossible to do without destroying the hard drive. Sometimes we can amend the clause to say ‘in a way technically possible’ or similar. However, this is a smallish issue and it would be extremely unlikely that a company would argue that an employee who has deleted the information and emptied the ‘deleted items’ folder had not in fact ‘irretrievably deleted’ the information. We are increasingly seeing agreements drafted more sensibly in the first place. We had one client who wiped his company laptop before returning it and therefore was not in a position to ‘return all property belonging to the company’ as its software on his laptop could not be returned.

“No Bad Mouthing”

This is a slang way of describing a requirement not to say or do anything that brings the company into disrepute or to be rude about it. We generally want such clauses to apply to both sides. There will also be a requirement to keep things confidential and not to refer to the settlement agreement or the amounts paid. It is not sensible to require a company to agree that no employee will ever ‘bad mouth’ a departed employee. This is because the settlement agreement can’t bind all the employees and the last thing you want is for your ex-employer to have to write to all the staff saying ‘don’t whatever you do be rude about so and so who left last month’. It is sensible to ask that certain named staff won’t bad mouth you and that the company won’t authorise anyone else to do so.

References and Reason for Leaving

We have a standard reference clause which provides that the company will only provide the agreed reference and say anything outside the terms of the reference. You don’t want the company providing the agreed reference to a prospective employer but also saying ‘this is the reference we agreed to provide pursuant to a Settlement Agreement when the employee threatened to sue us’ or similar.

If you want an agreed reference, we advise that you start writing it as soon as possible because often the terms of the reference can slow down the completion of the rest of the Agreement. However, we understand that most companies now simply give a standard reference so it might be sensible to only have this.

We see Settlement Agreements that claim the employee cannot say anything about the reason for leaving. You have to explain why you left as saying “I can’t tell you why I left” sounds like you were stealing! We will seek an agreed reason for leaving. This might be resignation or redundancy but sometimes we can only get ‘mutual agreement’. We will try to ensure that you can discuss the reason for leaving and also your job and experience in any later interview.
Our worse experience of silly clauses was in 2020 when an HR officer drafted a clause requiring our client to answer any question about why he left with the words ‘no comment’. We will never agree such a ridiculous requirement.

Restrictive Covenants

These are clauses that stop you dealing with former customers or working for certain companies. The can be valid and enforceable. They are usually found in contracts of employment. They may become unenforceable depending on the circumstances of the termination. In some cases, particularly if the restrictions have become unenforceable, the company seeks to reinstate them or introduce new ones within the Settlement Agreement. This has tax implications, as a payment for entering into a restrictive covenant is taxable. If the company is seeking to introduce new restrictive covenants, we will seek a separate payment to protect the tax treatment of the other payments within the Settlement Agreement. You must discuss with us what your views are any restrictive covenants and we will need a copy of your Service Agreement or Contract of Employment. Quite often we have success in getting rid of covenants that simply seek to prevent competition, of the form, ‘the employee will not work for a competing business for 6 months after termination’. We will need to see your contract of employment to check these clauses.

Claims by the company against you

This is an unusual point that shouldn’t necessarily arise in a Settlement Agreement. The purpose of a Settlement Agreement is to deal with all of the employee’s claims against the company. It is, therefore, unusual for it to deal with claims by the company against the employee. Occasionally, however, we are asked to include a statement that the company has no claims against the employee. However, the company will usually say that they will only deal with claims that they know about. This reflects the general English common law position that claims that are unknown at the time of the settling cannot be settled by either party.

Asking a company to include a claim in a Settlement Agreement that it is in full and final settlement of all claims the company may have against the employee may hint at some unknown problem. If you have any concerns whatsoever that the company may have claims against you please raise them with us as soon as possible during the negotiation period.

Exclusion of all claims

Settlement Agreements try and settle every possible claim but should not settle personal injury claims, pension claims and claims to enforce the terms of the agreement. We try to ensure that the agreement only settles claims arising out of the employment and its termination and not ‘or otherwise’. In other words, if we see the words ‘or otherwise’ we delete it.
There is usually an ‘entire agreement’ clause at the end of a settlement agreement. It will say that the agreement replaces all previous understandings and arrangements. This is an important clause as if, for example, you have separately agreed that you will get next quarter’s bonus – signing the agreement makes that agreement void.

Being asked to sign the agreement twice

Do not be surprised if the settlement agreement requires you to re-sign the agreement again in the future if the termination of your employment is not for a while. This happens when someone is asked to sign an agreement before garden leave starts or when they are expected to work on for a while before getting notice and leaving. This is not sinister as it simply reflects the legal position that a settlement agreement is only effective to settle claims that are known about or exist at the time of the agreement. Thus, in theory if today you sign away your rights to unfair dismissal but are still employed tomorrow you have another claim for unfair dismissal. Of course, the law isn’t that silly – if the agreement is deals with a known termination soon thereafter then even if it is signed before the termination it is still valid. However, if it is signed a long time before the termination then it is normal to be asked to sign it again or to ‘re-affirm’ the agreement closer to the eventual termination date.

Warranty that you haven’t got another job

Be aware of this sort of clause. An example would be:
1) The Employee hereby warrants represents and agrees, and further acknowledges that the company has entered into this Agreement in reliance on her warranties representations and agreement that: ..
1.1) she has not accepted a position with another employer, nor has been offered such a position that she intends to accept; and
1.2) she will upon demand repay immediately any payment made under clause 3 of this Agreement if the Employee breaches any term, condition, warranty or undertaking of this Agreement.

These clauses are difficult to deal with. We can’t always get rid of them for you – after all what company wants to pay a lot of money for loss of earnings only to find that the employee has another job to go to immediately. We don’t want to be too clear either as to why we want to get rid of the clause as the company will assume you have got another job lined up. Please see the paragraph below on the effect of being in breach of a warranty.

Warranty that you are not in breach of contract.

This sort of clause is usually quite widely drafted. An example is

The Employee warrants that he has disclosed to the Employer any matter or matters that do or may constitute a breach by him of any of his obligations or duties to the Employer, including but not limited to a breach of trust.

Or

The Executive warrants that he has informed the company of any matter which could reasonably have caused the company to conclude that it could have dismissed him summarily for gross misconduct.

Or

Or even: “You warrant as a strict condition of this agreement that as at the date hereof…b) there are no circumstances of which you are aware or of which you ought reasonably to be aware which would constitute a repudiatory breach on your part of your contract of employment which would entitle or have entitled the company to terminate your employment without notice”.

Or

The Employee warrants and represents to the Employer that up to and as at the date this Agreement becomes binding in accordance with Clause 19 the Employee:

1.1) has not committed any material breach of any duty owed to the Employer or any Group company which in either case would, had the facts of such breach been known to the company prior to the Termination Date entitled it to terminate the Employee’s employment with the company summarily;
1.2) has not done or failed to do anything amounting to a repudiatory breach of the express or implied terms of his employment with the Employer or which, if it had been done or omitted after the execution of this Agreement, would have been in breach of any of its terms;
1.3) is not employed or self-employed in any capacity nor is he in discussions which are likely to lead to nor has he received such an offer of employment or self-employment; and
1.4) is not aware of any matters relating to any acts or omissions by him or any director, officer, employee or agent of the Employer (or any Group company) which if disclosed to the Employer would or might affect its decision to enter into this Agreement.

All such clauses need to be thought about carefully. If there are any skeletons in the closet, we need to know about them. In one case in May 2007 called Sean Mervyn Collidge v Freeport Plc ([2007] EWHC 1216 (QB)) and case number Case No: A2/2007/1280 A2/2007/1280(B) in the Court of Appeal, the ex-employee, Sean Collidge, got nothing even though he had signed a Settlement agreement providing for a large payment. What happened was that following a dispute with the company Mr Collidge agreed a leaving package in return for leaving the company. These terms were wrapped up in a settlement agreement which said that the money to be paid was subject to and conditional on terms which included a warranty by Mr Collidge that he wasn’t guilty of gross misconduct.
The company did not pay Mr Collidge the money as it was investigating certain matters. These included misuse of a company driver, misuse of a credit card, problems with expense and mileage claims and removal of company equipment. The company ensured that payment under the settlement agreement (£445,680!) was conditional on him stating that he had not been in breach of his contract of employment. The clause the company used was number 3 above in the list of examples.
The Court held that the obligation to pay was conditional on the warranty being true; i.e. that Mr Collidge was not aware of such facts. The Court decided that all the matters complained of, including expense fraud, would have justified summary dismissal (i.e. been gross misconduct, that Mr Collidge had been aware that there had been numerous circumstances that would have entitled the company to terminate his employment without notice and that he was not entitled to payment. This case is a good reminder of the importance of such a clause. In this particular case Mr Collidge may have thought that by signing the agreement he was home and dry but this was clearly not the case. There is not a lot that even experienced employment lawyers can do about such a clause. However, quite often company’s use settlement agreements as a way of avoiding having to dismiss someone. In such a case the reason for the proposed termination may, if not disclosed, be a breach of such a warranty. As such, those facts should be disclosed to the company before the agreement is signed so that the company couldn’t then use those facts as reason to avoid payment. However, telling the company you have been in breach of contract is a good way of ensuring that you are unlikely to get any money!

Outplacement

This is offered to many departing employees especially in large companies. Outplacement consists of the provision of support by a specialist company to help you find alternative employment. Section 310 of the 2003 Taxes Act (‘ITEPA’) provides that such assistance is only free of income tax if 4 conditions are met. One of those conditions is that the employee has 2 or more years’ service. This is a bit of an issue for those departing employees who haven’t got 2 years’ service and who are offered outplacement. If you accept it, it’s a taxabl benefit. You might think that you will just have the money instead. However, in our experience companies almost never agree to increase the settlement sum in return for not having the outplacement. This is because they have an overall contract with the outplacement company that allows the company to offer outplacement to ever departing employee without additional cost. Therefore, there is no individual payment in respect of any given employee that can be added to the settlement some. One of the other conditions that are required to be met before outplacement is tax free is that it is provided generally to departing employees or to employees of a particular class. Thus, if you do a special deal whereby the company pays the remaining costs of a training course that you are part way through, for example, the payment of those costs, even though they may come within the definition of ‘outplacement’ are not likely to be tax free.

Conclusion

The above advice does not deal with all the terms of the Settlement Agreement but deals with some of the issues we regularly see. However, it does deal with some typical clauses that we felt needed explaining in detail. Please do not hesitate to ask me about any of the points above but, of course, during the negotiation period when we discuss the Settlement Agreement, we will discuss all relevant points including, if appropriate, the points above.

Steen & Co Employment Solicitors