Compromise agreements are an important tool for employers in limiting the risk of successful Employment Tribunal claims against them. Daryl Cowan demonstrates how they work.
Compromise agreements are an important tool for employers in limiting the risk of successful Employment Tribunal claims against them. Daryl Cowan demonstrates how they work.
The downturn in the economy, and the inevitable dismissals (whether by redundancy or otherwise), has led to compromise agreements rising to the fore again; they are the only way in which an employer can prevent an employee from legitimately bringing employment claims against it.
While, on the face of it, compromise agreements appear to be a fairly straight forward option for employers, care must be taken so as to ensure they are valid and binding, and to make sure that there are no inadvertent tax liabilities incurred. They have also been the subject of considerable litigation in the past, more of which below.
What are compromise agreements?
Compromise agreements are often referred to as ‘severance agreements’. They record in writing the terms of any settlement reached between employer and employee.
The effect of the employee signing such an agreement is that, in exchange for receiving a settlement payment and any other benefits which you agree to give the employee, the employee will be prevented from bringing or continuing with a claim before the Employment Tribunal in respect of the employment or its termination (e.g. unfair dismissal or discrimination claims).
In short, compromise agreements are used to achieve a clean break between employer and employee – a full and final settlement between the parties.
What are the legal requirements?
To be legally binding, compromise agreements must comply with the following requirements:
• they must be in writing;
• they must relate to the particular complaint or particular proceedings about which there is a dispute. An employer cannot use a compromise agreement to seek to exclude all potential future claims;
• the employee must have received independent legal advice from a solicitor or other appropriately qualified advisor, as to the terms and effect of the proposed agreement;
• the advisor must be identified in the agreement and must have in force a professional indemnity policy to cover the risk of giving negligent advice; and
•the agreement must state that the above conditions relating to compromise agreements have been satisfied.
What do they cover?
The compromise agreement will set out the financial and other terms upon which the employment relationship will end. It can be tailored precisely to the particular circumstances in question and will typically cover such key matters as:
• The amount of settlement payment and when it is payable. In return, the employee will refrain from instituting or continuing a complaint before the Employment Tribunal and accept the payment ‘in full and final settlement’ of any claims.
• Personal injury claims or claims relating to future pension entitlement are likely to be expressly excluded.
• The range of claims the agreement is seeking to compromise.
• What reference (if any) will be provided by the employer.
• Whether the employee is bound to observe confidentiality regarding the fact that a compromise agreement has been offered and the terms of such an agreement.
• Whether the employee must observe any other restrictions after the employment has terminated. For example, a restriction preventing the employee from setting up in competition with the employer.
Tax
In many cases it will be possible to treat up to £30,000 of any settlement payment made under a compromise agreement as exempt from tax. However, for sums over this amount, or in cases where the relief is not available, the agreement will state who will be liable for any tax due.
It is often assumed that the first £30,000 of any severance payment will be automatically treated as exempt from tax. However, HM Revenue and Customs tend to take a different view. If HMRC were to inspect an agreement it will first look to see whether the severance payment is in any way a contractual payment. For example, if the employer is making a payment in lieu of notice HMRC will check whether there is a contractual right for such a payment to be made. So, if the contract of employment contains the right for the employer to make a payment in lieu, then such a payment will be taxable and will not come within the £30,000 exemption.
Secondly, HMRC will look at the clauses within the compromise agreement itself and consider whether any may give rise to a tax liability. It will look for what it considers being new contractual terms and for which it can claim that some or all of the severance payment is being made. For example, clauses within the agreement which introduce new confidentiality terms or restrictive covenants are likely to attract attention and unless they are drafted carefully they could leave the severance payment vulnerable to taxation. Quite often this issue can be dealt with by allotting a payment (subject to deductions for tax) in return for, for example, the new restrictive covenant. This way, the consideration is taxed and not the severance payment itself.
For these reasons, it is always sensible for the employer to ensure that the employee provides an indemnity with regard to tax within the agreement.
Compromise agreements and litigation
Ordinarily, a carefully drafted compromise agreement will do what it says on the tin – it will compromise all and any claims an employee may have against an employer. Likewise, the (ex) employee would ordinarily expect, once the agreement is signed, to receive payment and draw a line under the matter. However, there have been some high profile cases illustrating how the employer can claim breach of contract by the employee and either refuse payment or recoup payments made. These are summarised below.
Misrepresentation by the employee: Crystal Palace FC vs. Dowie[i]
Iain Dowie was manager of Crystal Palace Football Club, under a contract running from December 2003 until June 2008. After failing to achieve promotion to the Premier League, Dowie announced his early departure from Palace at a press conference. He agreed terms for his departure in a compromise agreement shortly before his announcement.
Palace alleged that Dowie made representations, during telephone conversations between himself and club, that he intended to leave Palace to move to the North of England for family reasons. It was alleged that Dowie made it clear that he had had no contact with Charlton football club, had not been invited to attend an interview with Charlton, and had no present intention to join Charlton. Dowie joined Charlton the following week. Palace arranged for Court proceedings to be served on Dowie, at a Charlton press conference announcing his arrival.
The High Court ruled in Palace's favour, finding that the Club entered into the compromise agreement on the basis of fraudulent representations by Dowie about his future plans. The decision enabled Palace to seek compensation. Dowie appealed, but the matter was settled prior to a further hearing.
The important point for employers here is that, where the severance sum being offered would be influenced by whether the employee may have already have found alternative work (thereby limiting any damages that may be awarded to them if they were to take employment tribunal proceedings), the compromise agreement should cover this, so that you don't have to rely on verbal representations made. The agreement can have a simple clause whereby the employee warrants that they have neither been offered nor accepted alternative work at the time of signing the agreement.
Breach of warranty by the employee: Freeport v Collidge[ii]
Following on from the Dowie case, the recent Freeport v Collidge case deals with the issue of breach of a warranty contained in a compromise agreement. Mr Collidge was a director and chief executive of Freeport plc, involved in the management of out of town shopping precincts. In March 2006, allegations of financial irregularities by Mr Collidge came to light. He denied the allegations but was suspended pending further investigations.
While suspended, he made it clear that he would sooner resign and negotiate a compromise agreement than go through the disciplinary process. Mr Collidge agreed a sum and other benefits in exchange for his resignation. However, in signing the agreement, Mr Collidge provided a warranty that there were no circumstances of which he was aware which would have entitled the employer to terminate his employment without notice.
Shortly before payment was due, Freeport refused to pay because the investigation had revealed circumstances which, in the absence of explanation by Mr Collidge, were a breach of the warranty. The Court of Appeal found against Mr Collidge, on the basis that there were numerous circumstances of which Mr Collidge was aware, when he signed the agreement, which constituted repudiatory breaches of his contract of employment and which would have entitled Freeport to terminate his employment without notice. Having breached the warranty, he was not entitled to payment.
All in the drafting
Clearly, compromise agreements are very useful for employers in ensuring that claims are not made against them after agreement has been reached. But, they must ensure that the agreements are properly drafted so as to ensure that they are valid and binding. In addition, careful drafting can provide employers with additional protection against discovering at a later date that the employee made misrepresentations or had been involved in conduct that would have amounted to a breach of the employment contract (to the extent that the employer would never have entered into an agreement had it known about it).
[i] www.bailii.org/ew/cases/EWHC/QB/2007/1392.html
[ii] www.bailii.org/ew/cases/EWCA/Civ/2008/485.html