Negotiating a settlement agreement at the end of employment

A settlement agreement (previously called a compromise agreement) is mainly entered into by an employee and employer at the end of the employment relationship and involves the employee waiving their rights to make certain claims against the employer in return for (usually monetary) compensation.

Settlement agreements can be used in a variety of circumstances in order to tie up any ‘loose ends’ and ensure the parties’ positions are crystallised at the end of the employment relationship. For exiting senior employees, in addition to the monetary compensation, there are many other issues to consider when negotiating the terms of a settlement agreement.

Shares and share options

One of the primary considerations if you are a senior employee will be any share options and/or shares you have. Share options can be a tricky business; it is essential to review the scheme rules to understand how departure affects your share options. For example, share option rules often stipulate that departing employees are treated as ‘good leavers’ or ‘bad leavers’ at exit which affects how share options are dealt with. Some share option rules have discretion on how an exiting employee is treated, so if your options are particularly valuable ensuring you are classed as a ‘good leaver’ is crucial.

Likewise, if you are an employee shareholder your exit may affect how your shares are treated, and even their value. For example, there may be clauses in the company’s articles of association or in the shareholders’ agreement triggering the automatic sale of an employee’s shares upon departure, which would likely have a negative effect on the share price. Depending on each party’s position, negotiation may be possible to ensure you leave on the most favourable terms to you.

Post-termination restrictions

Post-termination restrictions (also called restrictive covenants) are important to ensure you are ready for your next role or appointment. As a first step, review the post-termination restrictions in your contract so you understand what they permit and what they prevent you from doing. Post-termination restrictions are a complex area of law; as a matter of public policy, post-termination restrictions are void unless the employer can show that they are necessary in order to protect a legitimate business interest and that they are proportionate, going no further than is necessary to protect that business interest.

It does not necessarily follow that because an employee is senior, onerous post-termination restrictions will always be enforceable. Whether such restrictions are enforceable involves analysis of a complex matrix of factors so it is important to seek specific legal advice to get a better understanding of your position. Likewise, your employer may ask that you re-affirm your existing post-termination restrictions as part of the settlement agreement, or even impose additional restrictions (for which they should provide an additional payment). If this is the case, it is advisable to seek legal advice specifically on the post-termination restrictions prior to entering in to the settlement agreement.

Taxation

Various parts of an exit package may be subject to tax depending on what they represent – contractual pay/bonuses; payments in respect of restrictive covenants; loans write offs; retention of a company car if you are not paying market value for it, and, since 6 April 2018, payments in lieu of notice (PILONs), even if there is no PILON clause in the employment contract. Certain elements of your package may be tax free up to a maximum of £30,000, but others will be taxable due to the nature of the payment.

Most settlement agreements contain an indemnity clause stating that you will cover the company’s tax liability if they have incorrectly taxed any payments, so it is in both parties’ interests to categorise the payments correctly. If the exit package is significant it can be structured in a tax efficient way (for example sometimes through payments into a pension scheme) so it is worth getting advice on this too.

Announcements and references

Upon departure, you will also be thinking about what is next for you. If you are retiring, maximising your exit package will be your priority. But if you are not lucky enough to retire just yet, you will want to ensure you are well prepared for your next move. References are often integral to securing future employment, so agreeing a form of reference with your employer which can be appended to the settlement agreement can ensure no problems arise moving forward. Similarly, external and/or internal announcements, which can also be appended to the settlement agreement, can be important to minimise any reputational impact and ensure that all parties are ‘singing from the same hymn sheet’. Although references and announcements do not technically cost the employer anything, they can sometimes become problematic so it is beneficial to address this early on during the exit negotiations.

Thinking of exiting?

These are just some of the main considerations a senior employee may have upon exiting, although of course each situation is fact-specific so any number of considerations may arise. If you are exiting or thinking about exiting and have any concerns you wish to discuss, please contact a member of our employment law team who would be happy to assist.