Issues to consider when drafting a settlement …

1 Issues to consider when drafting a settlement agreement - checklist (employer)The employer (and its advisers) should consider the following Issues :Preparatory steps Obtain from the employer: a copy of the departing employee s latest contract of employment/other relevant documents containing contractual terms (NB these may be in a staff handbook) details of the contractual benefits enjoyed by the employee relevant information regarding the employee s pension benefits relevant information regarding any shares/share options, etc held by the employee? consider the Articles of Association/any relevant shareholder agreement , share scheme documentation, etc. See also Shares and share options belowStatus of negotiations Will negotiations take place between the parties, or their respective legal advisers?

2 How strong is the employer s negotiating position? How strong are the employee s claims or potential claims? In the case of dismissal, is there a fair reason and has the employer carried out a fair procedure? Is the employer in repudiatory breach? What is the employer prepared to offer initially, and is that a take it or leave it offer, or is it prepared to increase the offer during negotiations? Will the draft settlement agreement be provided to the employee once negotiations have taken place, or as the starting point for negotiations? See Precedent: Letter to employee enclosing settlement agreement The settlement agreement should be marked Without prejudice and subject to contract , and should cease to be so only when the signed agreement has been received by the employer or his adviser (and any other pre-conditions are met)Parties to the agreement consider whether companies/entities other than the employer may have an interest in the settlement agreement (See Practice Note: settlement agreements in employment: practical and tax Issues Parties to the agreement ): should other companies within the employer s group have the benefit of any of the provisions of the settlement , including the waiver of claims?

3 If the settlement agreement is entered into in the context of a TUPE transfer, does there need to be a tripartite settlement agreement ? See Precedent: settlement agreement additional clauses tripartite agreement (TUPE transfer) and drafting a tripartite settlement agreement checklist ) consider the Contracts (Rights of Third Parties) Act 1999 (see Practice Note: settlement agreements: practical and tax Issues Third party rights)Effectiveness of the agreement In order for the settlement agreement to validly settle statutory claims to which contracting-out provisions apply (see Practice Note: settlement agreements in employment: legal requirements): the agreement must be in writing it must relate to the particular proceedings the employee or worker must have received advice from a relevant independent adviser as to its terms and effect and, in particular, as to its effect on his ability to pursue his rights before a tribunal there must be in force, at the time the adviser gives that advice, relevant insurance covering the risk of a claim by the employee or worker in respect of loss arising as a result of the advice the agreement must identify the legal adviser it must state that the conditions regulating settlement agreements under the relevant statutory provisions (which should be identified) have been satisfied Avoid seeking to create a potential right of action against the employee s adviser (see Practice Note.

4 settlement agreements in employment: legal requirements Independent legal advice, under the heading Creating a right of action against the legal adviser ) by either: adding the employee s legal adviser as a party to the settlement agreement itself, or adding to the usual adviser s certificate a statement that the settlement agreement relates to the particular proceedings and/or that the conditions regulating settlement agreements contained in the various statutory provisions are satisfiedClaims being settled Ensure that the settlement agreement relates to the particular proceedings, ie the actual or potential statutory claims raised between the parties (whether identified by the employee or the employer). See Practice Note: settlement agreements in employment: legal requirements agreement must relate to particular proceedings If the employer is aware of pending claims in the employment tribunal/courts, these should be dealt with in the settlement agreement .

5 There should also be a warranty that no other claims have been made, or will be made There will usually be no charge to tax in respect of the employee s acceptance of the terms of the agreement in full and final settlement of his claims relating to the employment, and/or his agreement not to commence (or, if already commenced, to discontinue) legal proceedings in respect of those claims Are the statutory claims or potential claims in issue capable of being validly settled by a settlement agreement ? See: Statutory claims that may be validly settled by a settlement agreement checklist In addition to statutory claims, consider claims: for breach of contract for personal injury (see Practice Note: settlement agreements in employment: practical and tax Issues Personal injury claims) relating eg to pensions, bonus entitlement and share optionsTax Issues In relation to each payment or benefit made or provided under the settlement agreement , if it falls within the definition of earnings from an office or employment, income tax and NICs should deducted.

6 See Practice Notes: Taxation of settlement agreements (formerly compromise agreements), settlement agreements in employment: practical and tax Issues Taxation of settlement agreements: overview and Termination payments taxed as earnings. Examples include:References: ITEPA 2003, s 62 SSCBA 1992, s 3 contractual PILONs payments in respect of a period of garden leave If not, is it otherwise chargeable to tax? See Practice Notes: Termination payments and tax and Termination payments taxed as earnings Termination payments that are not taxed as earnings. Other taxing provisions apply to the following payments or benefits: benefits in kind benefits from an Employer-Financed Retirement Benefits Scheme employment-related securities disguised remuneration restrictive undertakings If not, the charging provision in ITEPA 2003, s 403 will apply (see Practice Note: Termination payments qualifying for 30,000 exemption): the first 30,000 will be free of tax there will be no class 1 (or class 1A) NICs liability Establish whether the employee has worked all or part of the employment period overseas, as the foreign service tax exemption may apply (see Practice Note: Foreign service exemption for termination payments) Establish whether any other exemption applies (see Practice Note.)

7 Non-taxable termination payments) The employer may decide to simply make PAYE deductions in respect of all payments and benefits and leave the employee to claim back from HMRC any income tax and NICs that were not in fact payable. Alternatively, the employer may take the view that it is in its interests to ascertain whether there are tax advantages for the employee in certain payments or benefits being made provided, with a view to encouraging the employee to take the settlement terms on offer While the employer will be primarily responsible for making deductions for income tax and NICs from payments or benefits under the settlement agreement , if it fails to do so and HMRC finds that income tax and NICs are payable on those sums, the resulting tax liabilities (apart from any employer NICs) will almost always be covered by a tax indemnity from the employeeTax indemnity The employer will want to ensure, so far as possible, that if HMRC takes a different view of the tax treatment of the payments under the settlement agreement (eg a purported redundancy payment or damages payment), it can recover any additional tax liability from the employee.

8 See Practice Note: settlement agreements in employment: practical and tax Issues Tax indemnity For sample wording, see clause 6 of Precedent: settlement agreement (employment) Liability for employer s secondary Class 1, Class 1A and Class 1B NICs cannot be recovered from the employee under the settlement agreementGarden leave Where employment has not yet been terminated, is there a contractual right to place the employee on garden leave? See Practice Note: Garden leave and the right to work Would it be preferable for the employer to exercise this right (or seek to negotiate an agreed period of garden leave now) rather than the employee leaving imminently and being paid in lieu of notice? Matters such as the perceived risk of the departing employee joining a competitor or the employee being key to completion of a particular transaction may be relevant If so, consider the tax implications and the need to protect the employer against claims that may arise between the date of the settlement agreement and the termination date (see Practice Note: settlement agreements in employment: practical and tax Issues Garden leave and reaffirmation (two-stage settlement ) and Precedents: settlement agreement additional clauses garden leave, settlement agreement additional clauses reaffirmation agreement and Reaffirmation agreement (two-stage settlement ))Payments to the departing employee consider the following types of payment.

9 Salary accruing up to the termination date payment in lieu of accrued but untaken holiday entitlement agreement and payment of outstanding expenses payment in lieu of notice, if the employee is not working his notice period (see Practice Notes: settlement agreements in employment: practical and tax Issues Payments in lieu of notice and Payment in lieu of notice (PILON)): is there a contractual right to make a payment in lieu of notice? if not, consider effect of repudiatory breach if one is made, eg existing post-termination restrictions may fall away and so, if the employer requires protection by such restrictions, the employee should be required to enter into fresh restrictions as a term of the settlement (see below) essentially, any PILON made under a term of the employment contract (implied or express) will be earnings under ITEPA 2003, s 62 and will therefore not qualify for the 30,000 exemption or exclusion from NIC-able earnings (see Practice Note: Taxation of payments in lieu of notice or PILONs) contractual and/or statutory redundancy payment (see Practice Notes: settlement agreements in employment.)

10 Practical and tax Issues Statutory and contractual redundancy payments, Entitlement to statutory redundancy payment and Definition of redundancy First definition: (a) entitlement to redundancy payment (b) reason for dismissal (unfair dismissal)): is the employee entitled to such a payment? if so, it will be taxable under ITEPA 2003, s 403, ie go towards using the 30,000 exemption, exempt from NICs compensation payment if it is a payment of damages or a genuine compensatory payment, it will be taxable under ITEPA 2003, s 403, ie go towards using the 30,000 exemption and be exempt from NICs (see Practice Note: Termination payments qualifying for 30,000 exemption) consider whether any deductions from the payments to be made to the employee are necessary, eg for holiday taken in excess of accrued entitlement or outstanding loan repayments Payment by instalments may be desirable (see Precedent: settlement agreement additional clauses instalment payments) where.