Compromise Agreement
What is a compromise agreement?
A compromise agreement is a legally binding employment termination contract between employer and employee. As with any contract, it can only be entered into with the consent of both parties. The essence of a compromise agreement is that the employee agrees to waive any rights to sue the employer for employment related claims in a tribunal or a court, usually in return for a severance payment. Compromise agreements tend to be fairly standardised since, in order to be legally binding, they must incorporate a number of clauses required by statutes
Benefits for employers
The main benefits of a compromise agreement for employers are that they provide certainty and confidentiality. This is particularly the case because Employment Tribunal claims are inherently time consuming and expensive, and the general rule is that regardless of who wins at Tribunal each side pays their own legal costs. 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.
Appropriate use of a compromise agreement
Compromise agreements are not appropriate for all employment termination situations, but they have become more commonly used. They are useful when :-
- there is a risk of the employee making a claim against the employer.
- to avoid a potentially long drawn out process leading to termination such as capability process, sickness absence or redundancy.
Importance of negotiations being expressly “without prejudice”
It is not unusual for an employee to suggest a compromise agreement but regardless of who instigates discussions, employers need to tread carefully with 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.
Employee independent legal advice
Under the statutory rules, for a compromise agreement to be legally binding, an employee must take advice from their own solicitor or recognised trade union advisor who also signs the compromise agreement. It is general practice for the employer to contribute to the employee’s legal fees for taking advice and the going rate for this is typically £250.00 plus VAT.
Severance payment
An acceptable financial settlement depends on the specific circumstances of each case, but it is common our experience, for the ex gratia payment (see below), over and above contractual entitlements such as notice pay, holiday pay and other benefits, to be in the range of the equivalent of 2-4 months salary. The reason for this tend to be :-
- Such an amount gives the employee breathing space in looking for a new job
- The employee must face the risk and substantial delay associated with a possible Employment Tribunal claim
- Whilst all Tribunal claims area different, awards are generally fairly low and based on loss and not compensation. There is a duty on the employee, if fit to work, to actively seek alternative employment following unfair dismissal. Depending on the job market, many employees will secure another job fairly
Salary to the date of termination of employment, accrued holiday pay and any other contractual entitlements are taxable in the normal way.
Typically, under Inland Revenue rules the ex gratia compensation for ‘loss of office’ can be paid without tax being deducted for the first £30,000. This includes statutory and contractual redundancy payments. There should be a clause insisting that the employee be responsible for any tax that may be payable.
Restrictive covenants
Many employment contracts, particularly for senior and/or sales employees, include post termination restrictions on working for a competitor or approaching customers. It is vital to re-state any contractual restrictive covenants in a compromise agreement. It is also possible to include restrictions in a compromise agreement even if these were not in the underlying employment contract but, in either case, it is necessary to make an additional payment (over and above contractual entitlements and ex gratia amount described above)as legal consideration for what represents a new contract. 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.
Reference
There is no legal obligation on an employer to provide a reference. It is common for employees to request a reference as part of the terms of any compromise agreement. Care should be taken with any reference, which should be factual and should generally avoid “recommending” the employee.