Compromise Agreements

Under the provisions of the Employment Rights Act 1996, it is unlawful to make any contract that is intended to limit an employee’s rights under the Act or to prevent an employee making a claim to an employment tribunal. However, those restrictions can be avoided by “compromise agreements” between employee and employer in conjunction with an ACAS conciliation officer.
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The effect in connection with termination of employment is that the employee agrees not to start any legal proceedings against the employer in return for a payment. It is therefore a restrictive covenant, as it restricts the conduct or activities of the employee after termination.

Financial settlements in respect of restrictive covenants generally give rise to a charge to income tax and NICs however this type of arrangement is exempted from tax and NICs by the provisions of the Inland Revenue’s Statement of Practice 3/96. Such payments made to the employee are liable to tax only to the extent that, together with other non-contractual termination payments, they do not exceed £30,000.

The basis for the exemption is that payments made are normally made to settle any claims that the employee may otherwise have against the employer due to the termination of employment. As a result, none of the payment is attributable to the restrictive covenant.

Most of these arrangements include a “repayment clause”, whereby the settlement sum has to be repaid if the employee decides to ignore the terms and start litigation. It has been argued that, because the settlement sum is lost if the employee starts litigation, the payment must, at least in part, be attributable to the restrictive covenant.

Responding to this argument, the Inland Revenue states that, following legal advice, a tax charge would arise only in exceptional circumstances. Where it can be shown that the arrangement deals with genuine claims and the payment properly reflects the value of those claims, the settlement sum is fully attributable to the termination. The Revenue would only query the nature of the arrangement if the amount of the settlement is clearly in excess of a reasonable sum for settlement of the claims.

We are able to assist in drafting compromise agreements for employees who are leaving the employ of the employer. It is a legally binding contract, in written form, to accept compensation from an employer instead of the employee pursuing the case through an Employment Tribunal.

Increasingly employers are now using these arrangements to prevent future claims in numerous situations as the written contract makes sure that any agreement reached between the parties is clear to both parties and ensures that specified claims in the employment tribunal can no longer be brought against the employer. Employers who want to prevent employees complaining to tribunal after they have been made redundant may make use of these arrangements in such situations.

The effect of signing in these circumstances is that the employee, in effect, signs away their right to complain to the Employment Tribunal. The contract will contain all payment details and can also deal with matters relating to confidentiality, returning of documents and so on. It is a confidential document and can be specifically stated to be so.

If the matters relate to a payment for compensation i.e. discrimination, the agreement will contain the details of any payment and an acceptance of the terms not to pursue any claim.

If the matters relate to redundancy, the package for redundancy will be spelt out clearly and the employee will sign away their legal rights to make any claim against the employer.

The law requires that the employee must seek independent legal advice. The employee must understand the implications of the document he or she is signing. The professional adviser must sign a declaration to confirm the advice has been given.

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