What Is a Compromise Agreement? Essential Facts You Need to Know

In the current economic climate, compromise agreements are a familiar feature of the employment landscape, yet many people still ask us ´what is a compromise agreement and how does it work in practice?´

Thomas Mansfield Employment Law Solicitors regularly advise both employers and employees as to the terms and effect of these agreements, so we decided to share our knowledge with both companies and individuals here.

What Is a Compromise Agreement?

Compromise agreements are written agreements that provide an effective means of drawing a line under employment disputes and preventing employment tribunal proceedings and other legal action.

Why employers and employees use compromise agreements

For employers this can be attractive because it avoids costly litigation and exposure to potentially sizeable awards of compensation.

For an employee, it provides an incentive not to pursue claims against their employer in return for an up-front payment of compensation.

What are the legal requirements for a valid compromise agreement?

It is not enough for the employer and the employee to agree between themselves in exchange for money that the employee will not pursue legal action against the employer. Unless the compromise agreement meets specific statutory requirements it is not binding and more importantly, will not be effective in preventing legal action. If an employer is to avoid claims, compromise agreements must satisfy the relevant conditions of the applicable employment statute. A compromise agreement must be in writing. It must relate to specific proceedings that are live at the point in time at which the parties enter into the agreement and the employee must have received advice from a relevant independent adviser be it a solicitor or a trade union representative. From an employer’s perspective it is very important that the agreement is drafted correctly.

Risks of poorly drafted compromise agreements

The case of Palihakkara v British Telecommunications PLC is a salutary lesson to employers who do not instruct the services of specialist employment law advisers to draft their compromise agreements for them. In this case the employee entered into a compromise agreement to settle “all claims past or future arising out of her termination of employment”. The agreement focused solely upon claims arising on termination and not those claims that could have arisen during the course of the employee’s employment such as harassment on the grounds of race or sex discrimination. As such, the employee was free to pursue those claims notwithstanding the existence of a compromise agreement.

Common terms and payouts in compromise agreements

Common terms and conditions that one might see in a compromise agreement include the settlement package which is of course the all important aspect of the agreement for the employee.

One of the difficult things for an employer is deciding how much to offer the employee. This is ultimately a commercial decision based upon the potential liability that the employer faces and the potential loss to the employee.

Tax-free limit

Compromise agreements are often presented as a means of making a payment to an employee on a tax-free basis and this can be an attractive proposition, particularly given the fact that in certain circumstances, up to £30,000 is capable of being paid without deduction of income tax. A very important provision of compromise agreements, particularly from the employer’s perspective, is the requirement for confidentiality surrounding the terms of settlement. The last thing the employer wants is to create a precedent that it makes payments to all employees on termination. In addition, the employer and the employee will want to ensure that neither makes derogatory comments about the other.

All of these provisions are routinely incorporated into compromise agreements. From the employers perspective a word to the wise is that compromise agreements must be correctly drafted and encompass all possible legal claims that the employee may bring if future headaches are to be avoided. Read more about compromise agreements