Reaching a Settlement Agreement - The

Legal Framework
By Sally Cowen, Barrister at Cloisters

1. Disciplinary and grievance procedures take up time, diverting those involved

from their main work. An easy exit with a compromise sounds inviting but
getting something wrong could result in expending even more effort in
litigation.
2. A settlement agreement is a legally binding contract which can be used to
end the employment relationship on agreed terms. The agreement waives the
employees right to make a claim to a court or employment tribunal. The
agreement is entirely voluntary and usually is the result of a process of
negotiation.
3. Good practice includes;
3.1.setting out the reasons for the proposal at the time when it is made.
3.2.Giving a reasonable period of time to consider the proposal (generally 10
days minimum)
3.3.Allowing the employee to be accompanied at any meeting.
3.4.With or without payment in lieu of notice.
Settlement agreements
4. According to the ACAS Code of Practice which was brought into effect in July
2013, a settlement agreement will be legally valid if;
4.1.The agreement must be in writing,
4.2.The agreement must be about a particular complaint/proceedings
4.3.The employee received independent legal advice on the consequence of
the agreement,
4.4.The independent legal advice must have insurance covering any claim
arising,
4.5.The agreement must name the adviser
4.6.The agreement must state the statutory conditions have been satisfied
and state which matters are covered.

Protected conversations
5.

How to make the first move? An invitation to resign, however softly

expressed, amounts to a vote of no confidence. That is to behave in a manner
calculated or likely to destroy or seriously damage the employment
relationship. Unless the employer has reasonable and proper cause for
behaving that way, constructive dismissal would be made out see Billington
v Michael Hunter & Sons Ltd EAT/578/03. Why shouldnt the employee be able
to rely on evidence of this conversation?

6. Legislation has introduced one particular way in which employers can take
this first step without fear of breach of trust and confidence. The key effect of
s111A ERA is that it can put pre-termination negotiations under the shelter of
the without prejudice rule, even though there was no dispute in existence at
the time of the negotiations. As such, if s111A is satisfied, evidence of what
was said or done during the negotiations is inadmissible in ordinary unfair
dismissal claims.
7. Crucially, s111A relates only to unfair dismissal claims. If there was no prior
dispute between the parties, evidence of what was said and done would be
admissible in breach of contract, wrongful dismissal and discrimination claims
and in claims of automatically unfair dismissal. That raises practical questions
about how best to case manage such mixed claims
8. Section 111A can apply where there is no current dispute or where one or
more of the parties is unaware that there is an employment problem (para
6). Thus if an employee is invited to a meeting out of the blue then this
provision will apply.
9. Section 111A is subject to there being no improper behavior. Where such
behavior occurs, what is said or done in pre-termination negotiations will only
be inadmissible to the extent the tribunal considers just. Note that it doesnt
necessarily remove the protection completely. The responses to the
consultation exercise in Autumn 2012 had expressed a need for clarity and
certainty, particularly over what might count as improper behaviour. ACAS
Code of Practice Settlement Agreements falls short:
What constitutes improper behavior is ultimately for a tribunal to
decide on the facts and circumstances of each case. Improper behavior
will, however, include (but not be limited to) behavior that would be
regarded as unambiguous impropriety under the without prejudice
rule (para 17)
10.The Code gives a non-exhaustive list of examples of improper behavior:
a. All forms of harassment bullying and intimidation, including through
the use of offensive words or aggressive behaviour;
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b. Physical assault or the threat of physical assault and other criminal

behaviour
c. All forms of victimization
d. Discrimination because of age, sex, race, disability, sexual
orientation, religion or belief, transgender, pregnancy and maternity
and marriage or civil partnership
e. Putting undue pressure on a party. For instance:
i. Not giving at least 10 calendar days to consider the formal
proposed written terms of the settlement and to get legal
advice
ii. Saying that if a settlement proposal is rejected then the
employee will be dismissed
iii. An employee threatening to undermine an organisations
public reputation if they do not sign the agreement (unless
PIDA applies).
11.ACAS point out that these examples are not intended to prevent a party
setting out in a neutral manner the reasons that have led to the proposed
settlement agreement, or factually stating the likely alternatives if an
agreement is not reached, including the possibility of starting a disciplinary
process if relevant. (para 19]
12.There is no legal requirement to permit employees to be accompanied at
discussions of potential settlement agreements under s111A, but the ACAS
Code recommends this as good practice (para 13).
13.Employment Tribunals will take account of the ACAS Code when considering
pre-termination negotiations.
14.The ACAS Guide does not really go on to develop the scope of improper
behaviour with the hoped-for clarity. Half of the Guide is devoted to useful
templates, prefaced by a Checklist referenced to pages in the Guide.
However, read as a whole the Guide supports a view that it would not take
very much for behaviour to be seen as improper. For example, it suggests
that undue pressure might include the tactic of reducing progressively the
amount offered (page 8).
15.In the ACAS Guides sixth example, the offer of a settlement agreement is
prefaced by a fit note recommending minor adaptations of the work
environment and the comment you know you cant carry on working here
now that youve got a bad hip. Its just not going to work. ACAS suggest that
these comments may amount to disability discrimination and may therefore
be regarded as improper behaviour or unambiguous impropriety.

16.ACAS also suggest that there was no pre-existing dispute in this example, so
the comments would be admissible in a disability discrimination claim. While
the employer might have foreseen a dispute, the employee having just
presented a fit note, could anticipate nothing apart from compliance with
legal requirements.
17.The Guide also cautions against adopting a one size fits all approach to
discussions, warning that this could lead to inadvertently discriminating
against employees with some protected characteristics.
18.Where there is an existing dispute, then without prejudice negotiation can
occur. This protection will not apply where there is fraud, undue influence or
unambiguous impropriety. This is a narrower test than that of improper
behaviour in s111A. That of course is subject to any of the other exceptions
being established (see below).

Without prejudice is there a dispute?

19.The core of the common law without prejudice rule is the public policy of
encouraging litigants to settle their differences rather than litigate them to
the finish Rush & Tompkins Ltd v GLC [1989] AC 1280. The other limb is the
express or implied agreement of the parties themselves that communications
in the course of their negotiations should not be admissible in evidence if,
despite the negotiations, a contested hearing ensues Unilever plc v Proctor
& Gamble Co [2000] 1 WLR 2436, CA @ 2448H.
20.Parties should be free to fully and frankly put their cards on the table. At an
unscripted meeting the discussions between the parties representatives
may contain a mixture of admissions and half-admissions against a partys
interest, more or less confident assertions of a partys case, offers, counteroffers, and statements (which might be characterized as threats or thinking
aloud) about future plans and possibilities. @ 2444B per Robert Walker LJ.
21. This is the context in which the question of whether or not a dispute is in
existence should be considered. The issue is not a matter of labelling
marking a letter without prejudice or stating that a meeting is without
prejudice does not act as a magic wand; all depends on whether the factual
matrix engages the doctrine. Bare assertions, or statements of fact, are
insufficient. A dispute must already be in existence which, if not resolved,
each of the parties actually contemplated, or might reasonably have
contemplated, would end in litigation. As Lord Griffiths put it in Rush &
Tompkins there must as a matter of law be a real dispute capable of
settlement in the sense of compromise (rather than in the sense of simple
payment or satisfaction).

22. In BNP Paribas v Mezzotero [2004] IRLR 508, EAT (Cox J) had held that the
mere raising of a grievance about discrimination did not put the parties in
dispute. Although there are some question marks over Mezzotero the point
was that the ET was entitled to conclude on the facts that when the employer
had suggested it would be better all round if her employment was
terminated, there was no extant dispute about termination.
23. The EAT in Portnykh v Nomura International plc [2014] IRLR 251 raised the
possibility that the parties might agree to apply the without prejudice rule to
negotiations unconnected with litigation that, in effect, there is no need for
there to be an underlying dispute. It is suggested that a dispute, with each
party understanding that there is a dispute, is central to the doctrine. In
Portnykh in any event, the matter began with the company proposing to
dismiss him for misconduct the start of a dispute on any view.
24. During the resulting negotiations, Portnykh suggested that the reason for
dismissal should be given as redundancy; the company agreed. After
negotiations broke down, he claimed automatically unfair dismissal because
of having made protected disclosures. The EAT excluded the without
prejudice material because the ET had misdirected itself as it had excluded
the factual context of the documentary material in deciding there was no
dispute. The alternative finding that the case came within the category of
unambiguous impropriety was also overruled: the ET had not appreciated
how limited the concept actually is.

Without prejudice unambiguous impropriety

25. Where the claim is about something other than unfair dismissal, s111A will
not apply. However, discussions may be without prejudice, giving the same
kind of protection, if the negotiations fail and the matter ends up in court.
26 The protection will not apply if there has been unambiguous impropriety by
one of the parties. This is a much narrower concept than improper behaviour.

27. Before considering unambiguous impropriety, one should first address

whether an estoppel is raised on the facts. This will occur where something
is clearly said during the communications which was intended to and did
cause a party to act in a particular way, but the other party was now
asserting something contrary - Hodgkinson & Corby Ltd v Wards Mobility
Services Ltd [1997] FSR 178, 191, a view that was not disapproved on
appeal.
28. If a party is seeking to show that an agreement should be set aside on the
ground of misrepresentation, fraud or undue influence, evidence of those
negotiations is admissible and WP does not apply.
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29. Other times when negotiations can be discussed in court/tribunal include

evidence of the bare facts that negotiations had taken place, letters written,
their dates etc. This can be used to explain delay, for example. As Robert
Walker LJ observed in Unilever, occasionally fuller evidence is needed in
order to give the court a fair picture of the rights and wrongs of the delay @
2445A

30. Similarly, if the issue is whether there is a concluded contract or compromise

agreement, the communications that resulted in that agreement are
admissible Tomlin v Standard Telephones & Cables Ltd [1969] 1 WLR 1378

31. Robert Walker LJ summarized the unambiguous impropriety exception thus:

Apart from any concluded contract or estoppel, one party may be allowed
to give evidence of what the other said or wrote if the exclusion of the
evidence would act as a cloak for perjury, blackmail or other
unambiguous impropriety
32. The exception should be applied only in the clearest cases of abuse of a
privileged occasion. In Woodward v Santander UK plc [2010] IRLR 834, the
EAT held that words which are unambiguously discriminatory fall (such as
we dont want you here because you are black) within the exception - @ 62,
but evidence from which an inference of discrimination could be drawn, does
not - @ 63. Discrimination cases, contra Mezzotero, do not fall into a
separate category of exception.
A tax on your settlements
33. An essential part of making a settlement agreement is addressing the tax
implications and packaging the agreement so as to maximize benefit and
minimize cost so far as possible.
34. Payment of salary up to the date that employment ends is subject to the
usual tax and NI deductions. Payment of any holidays outstanding at the
termination of employment will also be subject to tax.
35. A consultation exercise on the tax treatment of termination payments is
currently underway. A predictable outcome is that the distinction between
contractual and non-contractual PILONs is likely to go. Contractual PILONs are
part of the terms on which the employee serves, so attract tax & NICs.
Employers see them as useful as enabling a summary dismissal, yet
preserving existing restrictive covenants - EMI Group Electronics Ltd v
Coldicott [200] 1 WLR 540, CA

36. Non-contractual PILONs, in contrast, are damages for breach of contract, so

no tax or NICs are payable. Yet in each case payment is made by reference to
the amount of contractual notice. This amount will count towards the
30,000 tax free total.
37. Ex gratia payments for breach of contract are not subject to tax and
contribute to the 30,000 limit.
38 If a restrictive covenant is put into the settlement agreement which does not
exist in the original contract of employment, then consideration will need to
be paid to make it valid. This is usually a minimal amount (100-200) but is
subject to tax and NI.
Basic concepts
39. When considering whether or not a particular payment is taxable, the first
question to ask is whether it is taxable as general earnings under s.62 of
ITEPA or under some other specific provision. For example, if the benefit is
something that is specifically provided for in the contract of employment,
such as a bonus, then it would almost certainly be taxable as general
earnings, with tax & NI payable on that sum.
40. Other payments do not count as earnings - redundancy payments, for
example see s309 ITEPA.
41. Statutory payments, genuine compromise or compensation payments are
not earnings. A tribunal award for interim relief, even though it
compensates for missed earnings, is also a statutory payment so does not
come under s62 but instead is considered under s401 Turullois v HMRC
[2014] UKFTT 672
42. Clawback payments count as earnings, not damages. In HMRC v Martin
[2014] UKUT 0429, the employee had received a 250K signing bonus for
committing to work for five years. On early termination he had to repay
162.5K, yet he had already paid tax and NICs on that sum. At issue was
whether the repayment was liquidated damages (in which case he could not
recover the tax and NI already paid), or negative earnings. If the latter, he
could set the payment against positive earnings, or if in excess of his actual
earnings, offset the excess as an employment loss. The Upper Tribunal held
that on the facts, the clawback arose directly out of employment, so it was
earnings, not damages. But only tax was recoverable the regime for NICs
did not permit recovery.
Termination payment?
43.

Section 403 ITEPA provides that if a payment is not taxable under other
provisions, the first 30K of a termination payment is tax free. The excess
counts as employment income. Payments are aggregated together if they
are from the same employment, or from associated employers or different
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employments with same employer. Similarly, payments made in different

tax years are aggregated together and subject to the same limit. Making a
payment in different tax years may, however, help the employees tax
planning for other reasons but it cannot lead to an increase in the 30K
threshold.
44.

An employee may want the payment to be split between tax years

(payments on 1st April and 30th April) in order to fully utilise the tax free
element of income, or to ensure tax at a lower tax band. There is nothing
inappropriate or unlawful about this. It really depends on whether the
employer wants to assist the employee and has the cash flow to do this.
Exceptions

45.

These are for:

a.Death or disability payments and benefits s406
b.Legal costs s413A
c. Where payment would have been exempt had employment continued,
for contributions to pension scheme s405(1), and the limited payment of
removal benefits and expenses s405(2)
d.Certain payments to or from pension schemes s407, s408; re employee
liabilities & indemnity insurance s409, s410
e.Foreign service relief s413, 414
In general, where exceptions are at issue, it is sensible to take advantage
of the ability to consult HMRC see below.
Legal costs

46.

If the employer pays the employee legal costs, the payment must meet
the whole or part of legal costs incurred by the employee exclusively in
connection with the termination of the employment.

47.

It must also be made under a court or tribunal order; or the Respondent

must pay the Claimants lawyers direct under a settlement agreement.

48.

There are exceptions to this rule - accountancy fees paid to an accountant

do not fall within the exception, although it would have done so if those
fees formed part of the solicitors bill to the client in respect of expert
witnesses.
Discrimination and termination payments

49.

The debate continues over whether or not a payment for injury to feelings
(or injured feelings if one reads s119 Equality Act 2010, rather than the
explanatory note put before Parliament to explain the meaning of the
provision) is taxable.
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50.

If it is paid in respect of pre-termination discrimination or detriments, it is

compensation and not taxable as earnings, nor as a termination payment
under s401.

51.

If it is paid in respect of termination, then the Upper Tribunal held in

Moorthy (see below) that it was taxable.

52.

In Oti-Obihara v Commissioners for HMRC [2011] IRLR 386, the FTT held
that a compensation payment made to an employee for discrimination is
taxable if the discrimination was the cause of the termination. However,
that was only to the extent that the compensation met the financial loss
caused by the termination.

53.

In Moorthy v Commissioners for HMRC [2015] IRLR 4, the claimant relied

on Oti-Obihara. He was an executive director in engineering firm.
Restructuring had led to redundancy. Although he claimed age
discrimination, that related only to his redundancy selection and dismissal.
His claim settled for 200K. It was not apportioned. HMRC demanded tax
on 140,023 (allowing a further 30,000 for damages to injury to feelings
for age discrimination).

54.

Moorthy argued that the sum was not taxable because it settled a
discrimination claim.
The FTT rejected that argument, as did the UTT
saying that it must be an injury to an employee and that must be a
medical condition akin to death or disability. Thus tax was payable as it
was connected to termination.

55.

In the next case, A v Commissioners for HMRC [2015] UKFTT 0189 (TC),
the FTT dealt with the issue of whether an undifferentiated lump sum
payment of 600,000 in settlement of claims of race discrimination was
taxable under s.62 ITEPA as earnings. HMRC pinned all on s62 and did not
make a separate argument that it would be taxable as a termination
payment.

56.

The FTT found that the payments were indeed made to compromise Mr As
race discrimination claims and were not made in return for his services as
an employee. As such the FTT held the payments could not be earnings
for the purposes of s.62 ITEPA.

57.

If in doubt get an Indemnity!

58.

In these circumstances an indemnity is essential. It is suggested that it

should cover the following agreements:
a. The employee to indemnify the respondent on a continuing basis in
respect of any income tax or employee NICs due in respect of the
payments and benefits itemized in clauses x-y; including

b. Any related interest, penalties, costs and expenses caused by the

employees own default or delay, but not sums arising from the
respondents default or delay
c. The Respondent to give the employee reasonable notice of any tax
demand which may lead to liabilities on the employee and provide
reasonable access to any documents the employee may reasonably
require to dispute a tax claim.
59.

And finally, add that nothing in this clause prevents the Respondent from
complying with its legal obligations to HMRC

Income Tax (PAYE) Regulationss 2003:

60.

An employer is legally obliged to deduct tax from a taxable sum in excess

of 30K and to account to HMRC in accordance with the PAYE Regulations.

61.

The key provision is Reg 37: if employment has ended, tax must be
deducted on the OT code. That means no allowances at all. If settlement
has been agreed at, say 70,000, the claimant will be taxed on the basis
that he or she earned all that in the month of payment and would continue
to earn at that rate in all subsequent months of the tax year. The excess
tax will be recovered eventually, but it amounts to a loan to HMRC in the
interim.

62.
Note that if settlement is achieved before a P45 is issued, the normal tax
allowances apply.
63.
Interest payments are not subject to PAYE, so are paid gross but will be
taxable.
COT3
64.

If you dont manage to settle before the employee starts ET proceedings,

then you can still settle, but you would be best advised to use the help of
ACAS.

65.

Early conciliation has meant that all potential ET claims have to be

referred to ACAS first. Over half of all claims which go through ACAS will
settle at that stage. Most cases will therefore never get anywhere near an
Employment Tribunal.

66.

When ACAS make a settlement agreement it is usually by way of a COT3

(the name of the form used). It is not essential to use this form, nor does it
actually have to be a written agreement, or signed by the parties, in order
to be binding. If an oral agreement is reached between the parties, using
an ACAS conciliation officer then it will be binding for the types of claims
listed. (Gilbert v Kembridge Fibres Ltd [1984] IRLR 52, EAT).

67.

COT3 will only apply to the types of cases set out in s.18(1) Employment
Tribunals Act 1996 (ETA) and only if expressly listed in the agreement. It
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can cover claims which have not yet arisen (such as victimisation based
on the complaints).
68.

A COT3 document is not privileged and indeed can be presented as

evidence before an ET. Conversations with an ACAS conciliator during
negotiation are privileged, unless privilege is waived by the party.

69.

If the ET make an order in the terms contained in the COT3, then the
payment must be made within 14 days. If not paid, then enforcement of a
judgment debt is the next step (not breach of contract).

70.

ACAS will remain involved until all aspects of liability and quantum and
settled.

71.

COT3 can be set aside as invalid, but only if misrepresentation, mistake,

undue influence, duress, incapacity or fraud are proved. This is a high
hurdle, which effectively involves showing an absence of choice.
Contracting Out Agreement

72.

It is possible to contract out of some statutory claims. These do not apply

to common law claims, except breach of contract claims. Mainly comes
from s.203 ERA and s.144 and s.147 Equality Act 2010.
The agreement must:
i.
ii.
iii.

iv.

v.

vi.

Be in writing
Relate to specific proceedings, ( or for Equality Act or Working Time
claims, must be a particular complaint).
Include reference to the employee having had independent advise from
a qualified lawyer, ILEX, TU representative who is appropriately trained,
or some other authorised person.
Identify the adviser, who must not be employed by or act for the
employer, but must be covered by an insurance or professional
indemnity.
State that the conditions for settlement of each statutory provision are
satisfied. Where a certain provision is missed off the list, that could still
be brought as a claim (Lunt v Merseyside TEC Ltd [1999] ICR 17)
The advice must include the ability to pursue a claim in the Tribunal,
but need not advise on whether it is a good deal.

Sally Cowen
Cloisters, Temple, London EC4Y 7AA
sc@cloisters.com
DD 0207 827 4061
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