Compromise Agreements

A compromise agreement is an agreement between an employer and employee in settlement of claims arising from the employee’s employment and/or its termination. In simple terms, the employee agrees to give up most, if not all, of his/her employment-related legal rights and any outstanding claims against the employer in return for an agreed termination payment and/or benefits.

What claims are normally waived by a compromise agreement?

Compromise agreements are commonly used to settle claims arising from legislation (such as unfair dismissal and discrimination) and contractual claims (such as notice pay or unpaid bonus). If claims arising from legislation are to be settled, certain legal formalities must be complied with. Usually compromise agreements will be drafted in such a way that once an employee has signed the agreement, he/she will not be able to bring any claim in respect of his/her employment or its termination. The only claims that are normally (although not always) excluded from the scope of a compromise agreement are claims in respect of personal injury and accrued pension rights.

Each compromise agreement will be drafted differently so it is very important that independent legal advice is sought to ensure the employee understands which claim(s) he or she is giving up, and so that a proper assessment can be made as to what the appropriate level of compensation should be.

What matters does a typical compromise agreement cover?

A compromise agreement will usually include terms covering key matters such as:

  • The date that the employment terminated or will terminate;
  • Arrangements for the return of any company property;
  • Details of the various claims the agreement is intended to compromise;
  • The sum of money to be paid to the employee and details of when it must be paid;
  • Who will be liable for any tax due on the termination payment;
  • What level of contribution to the employee’s legal fees will be met by the employer;
  • What happens if the employee does in fact bring an employment-related claim against the employer;
  • What staff, clients, customers and if appropriate the press, will be told about the employee’s departure;
  • Whether the employee must observe any restrictions upon his/her activities after the employment has terminated and if so, for how long those restrictions will last;
  • Whether certain matters must be kept confidential
  • What references (if any) the employer will give to future prospective employers.

In addition, employees who are also directors will typically be required to resign their directorship and if an employee holds shares in the company or a group company he or she may also be required to transfer these back to the company.

Tax treatment of termination payments

Special tax exemptions make it possible to treat up to £30,000 of a termination payment made under a compromise agreement as exempt from tax. Certain conditions must be met before that relief is available. In summary, this means that:

  • Any part of the termination payment that is made as compensation for the loss of the right to be employed in the future, should be capable of being paid free of tax and National Insurance assuming that it does not exceed £30,000.
  • If part of the termination payment is a payment in lieu of notice and/or of other benefits deriving from the employment relationship, this part of the payment is likely to be taxable.

Compromise Agreements: a guide for employees

Requirement for independent legal advice

If a compromise agreement intends to settle claims which arise from legislation (e.g. unfair dismissal, discrimination) it must comply with certain legal formalities if it is to be legally binding upon the parties. One such requirement is that the employee must obtain independent legal advice from a lawyer or other appropriately qualified adviser upon the terms of the compromise agreement and the implications for the employee of signing it.

The Law Department will take the employee through the agreement clause by clause explaining each term of the agreement to the employee. Usually, compromise agreements require that the adviser confirms that the employee has received the necessary advice by signing a certificate which is attached to the agreement.

Most employers will make a contribution towards the cost of the employee obtaining independent legal advice. The contribution is usually nominal (commonly £250 plus VAT) and may not cover the full cost incurred by the employee in obtaining the necessary advice. This is usually true where negotiations take place to improve the termination payment or to protect the employee’s position.

Additional legal formalities

In addition to the requirement that the employee take independent legal advice, to validly settle statutory claims the agreement must:

  • Be in writing
  • Properly and clearly identify the particular claims or proceedings which it attempts to settle
  • Confirm that the conditions relating to compromise agreements in the relevant legislation have been complied with;
  • Identify the name and status of the independent legal adviser
  • Confirm that the independent adviser has a policy of insurance or certificate of indemnity against claims arising from negligent advice.

Without prejudice discussions

An employer will often raise the question of a compromise agreement with the employee in the course of talks ‘off the record’ often called ‘without prejudice’ discussions, that is which cannot be referred to in subsequent legal proceedings. It is not unusual for such discussions to take place mid-way through a performance management, grievance or absence management procedure with the compromise agreement being offered as an alternative to continuing with the procedure in question.

Provided there is a genuine dispute between the employer and employee and the ‘without prejudice’ discussions are a genuine attempt to settle that dispute, neither the employer or employee can refer to them in future legal proceedings. This means that an employer can withdraw the offer of a compromise agreement at any time until it is signed. Likewise, an employee is free to choose whether or not to sign the agreement.

Binding nature of compromise agreements

Provided all of the necessary legal formalities are complied with, once it has been signed a compromise agreement will be binding against both employer and employee. This means that if, for example, the employer failed to pay the termination payment on time the employee could take enforcement action for the debt. In addition, if the employee were to breach a term of the agreement, for example by bringing a claim which had been settled, the employer would be able to recover the termination payment.

For a useful checklist on what statutory claims can and can't be settled by compromise agreements, please click here