Legal Insight: Compromise agreements

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On Friday 6 April, changes to The Equality Act 2010 (Amendment) Order 2012 confirmed that an employee’s lawyer could act as an independent adviser for the purposes of preparing a compromise agreement.

But while this is all very well and good, what actually is a compromise agreement and why do employers use them so frequently to settle potential employment disputes or deal with redundancy situations?  What is a compromise agreement?   Legislation granting employment rights prevents employees from ‘contracting out’ of their entitlement to bring claims to an employment tribunal, except in limited circumstances. One such circumstance is if they take a compromise agreement to an independent solicitor in order to obtain advice on its terms and effect.   A compromise agreement sets out the terms under which staff members will leave their current employment. By its very nature, it usually involves paying them to settle any claims that they might have taken to an employment tribunal.   Non-financial considerations are also sometimes settled upon such as providing a reference or outplacement services.   It is common for employers to request that the employee concerned agrees to various warranties (or promises). Common warranties include an agreement to return company property; to keep the terms of the settlement confidential and not to make any disparaging comments about their former employer.   Employers typically agree to pay the staff member’s legal costs incurred in seeking advice about the compromise agreement in order to ensure that it is binding. Costs here usually range from £250-£500+VAT.   While this is a tax-free benefit for the employee, to obtain a tax concession, the solicitor’s invoice must be addressed to the staff member but expressed in such a way as to be payable by the employer.   When should they be used?   Compromise agreements are essential if agreement has been reached with an employee to end their employment because of an ongoing dispute or one that could arise.   This scenario could amount to an agreed parting of the ways following a dispute or it could simply be a redundancy situation. Common situations settled by compromise agreements include allegations of underperformance, unresolved grievances or even conduct problems.   In these scenarios, a compromise agreement is the only way to ensure that employees cannot bring an employment tribunal claim and so employers use them to manage risk. Disputes settled by compromise agreements remove the cost, management time and adverse publicity associated with such claims.   But it is also important to remember that an employee’s solicitor will advise them in respect of any claims that they may have taken to an employment tribunal or elsewhere. Therefore, offering a compromise agreement might prompt negotiations for a higher compensation payment or even lead to a claim.   In contentious situations, therefore, it is sensible to reach an agreement in principle with the staff member concerned before asking them to seek independent legal advice. If this is not possible and the employee has unrealistic expectations, the advice of a solicitor might lead to a sensible settlement. However, this is a high risk strategy.   Before beginning any negotiations with a staff member, employers should make sure that they agree to talk ‘without prejudice’, which essentially means off-the-record.   Negotiations that are genuinely entered into to resolve a potential legal claim cannot be referred to in proceedings that follow if they break down. To obtain this protection, ask the employee if they are prepared to talk ‘off-the-record’, say that any conversations will be ‘without prejudice’ and ensure that any emails or letters have a ‘without prejudice’ heading.   But remember that solicitors are unlikely to advise a staff member to sign a compromise agreement if they are receiving no more than their statutory entitlements. Conversely, it makes little sense for employers to make a payment not required by law without asking the employee concerned to sign a compromise agreement.   Common issues   It is always worth anticipating issues that solicitors are likely to raise in order to minimise the work and delay involved in dealing with their correspondence.   An agreement that deals with the following issues is more likely to be signed without the need for significant amendments, which could lead to delays and even requests for a higher contribution towards legal costs.   1. References   If an employer agrees to provide a reference, it should be attached to the agreement, along with a clause to confirm that it will be provided if a reference request is made to a specific person or role (for example, an HR manager).   Solicitors might ask that the clause referring to the reference include a warranty by the employer that they will not depart from the spirit of the written reference in any verbal communications with a prospective employer or employment agency.   2. Tax   Payments of up to £30,000 made in compensation for loss of employment can be made tax-free. However, any payments that are due under the contract such as pay for work done-to-date or accrued holiday pay are taxable and subject to National Insurance in the usual way.   Furthermore, if the contract of employment refers to a power to make a payment in lieu of notice (known as a ‘PILON’ clause), any notice pay would likewise be subject to income tax and National Insurance.   Payments should be broken down in the agreement to avoid any suggestion that compensation payments are, in fact, taxable.   Payments in consideration for warranties (such as confidentiality) are also taxable. To avoid any suggestion that the compensation payment is a consideration for warranties, they should be made in the form of mutual or nominal payments (for example, £100 less tax).   A clause should also be added to the compromise agreement requiring that the employee concerned indemnify their employer against any demands from HM Revenue & Customs in relation to the compensation payments.   This is because HMRC has the power to require employers to pay any tax that is found to be due, even if the employee has left and received the money on a tax-free basis. Solicitors might ask that the staff member in question be given the right to challenge HMRC before the employer pays the tax demand.   The benefits   A key advantage of a compromise agreement is that, once signed, it prevents employees from bringing the particular proceedings to which the agreement refers.   Most compromise agreements attempt to prevent any possible claim that the staff member might have, including future claims. For example, solicitors usually seek an exemption for any personal injury claims of which the employee is not yet aware and in respect to accrued pension rights.  Adrian Hoggarth and Louise Taft are both lawyers in the employment team at law firm, Prolegal.

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