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A compromise agreement is a formal, legally binding agreement made between an employer and employee (or ex-employee) in which the employee agrees not to pursue particular claims that they might have in relation to their employment or its termination, in return for a financial settlement. Thus, the primary function of a compromise agreement is to stop an employee from making any statutory or contractual claim in connection with their employment.
Compromise agreements are often used in situations where employer and employee want to part company without resorting to redundancy, firing or resigning. They can also be used as a way of settling serious employee grievances, such as claims of constructive dismissal or unlawful discrimination. Generally, compromise agreements are used by employers in order to remove employees from employment quickly and easily, avoiding the possible adverse publicity and uncertain outcome of an Employment Tribunal or court case.
This article considers the overall legal requirements of compromise agreements, but legal advice should always be sought when drafting such an agreement.
Compromise agreements are complex legal documents and they must be specifically drafted according to the facts and circumstances of each particular case. The Legal Stop offers a fixed fee compromise agreement drafting service in addition to our compromise agreement templates. For further details please contact us using our request form.
In order for a compromise agreement to be legally binding, the following conditions must be satisfied:
• The agreement must be in writing.
• It must relate to the ‘particular proceedings’.
• The employee must have received independent legal advice from a qualified adviser as to the terms and effect of the agreement.
• There must be in force, when the adviser gives the legal advice, a contract of insurance or professional indemnity insurance covering the risk of a claim by the employee in respect of loss arising as a result of the advice.
• The agreement must identify the relevant adviser.
• The agreement must state that the conditions regulating compromise agreements are satisfied.
A compromise agreement can be used to settle one or more employee complaints. It must clearly state each of the specific complaints being settled and refer to the relevant statutory provisions because, as identified above, the compromise agreement must relate to the ‘particular proceedings’. Please note that a ‘blanket agreement’ simply signing away all of an employee’s employment rights, or one which lists every form of employment right known to the law, will not be a valid compromise agreement.
Contractual and Statutory Claims
Compromise Agreements are an exception to the general principle set out in all employment legislation that an individual cannot contract out of their statutory employment rights. Thus, a compromise agreement is necessary to obtain a valid waiver of an employee's statutory claims. Please note that there is no need for a compromise agreement in order to settle only contractual claims. This is because an agreement to refrain from instituting proceedings in a contract claim is binding without the need for any special requirements to be satisfied. A simple waiver and release of claims will be effective. On the other hand, with statutory claims, any agreement by an employee to waive their statutory rights that is not in the form of a compromise agreement will be invalid and unenforceable. This means that the employee would still be eligible to lodge a claim in the Employment Tribunal, even though they might have already accepted a sum of money from the employer in apparent 'full and final settlement'.
Open discussions with employees in relation to compromise agreements are very risky. This is because such conduct, if not protected by the veil of without prejudice privilege, is likely to be enough to constitute a fundamental breach of the implied term of mutual trust and confidence, enabling the employee to resign and claim constructive dismissal. Thus, never invite an employee to resign in return for an exit package on an open basis. The employee might resign anyway and then issue a constructive dismissal claim.
For the ‘without prejudice’ rule to apply, the employee must have genuinely consented to the meeting being held on a ‘without prejudice’ basis, there must be a pre-existing dispute between the parties and the discussion must be a genuine attempt to settle the dispute.
Compromise Agreement Clauses
Common clauses found in a compromise agreement include:
• An agreement by both parties to keep the details of the settlement confidential and not to make detrimental statements about one another.
• A requirement for the employee to return the employer's property.
• The provision of an agreed form reference for the employee.
• A requirement for the employee to resign as a director or as company secretary.
• A requirement for the employee to transfer their shares in the company.
• An agreement by the employer to contribute towards the employee's legal costs.
• A tax indemnity from the employee.
• Post-termination restrictive covenants (if these are new, there should be a separate
monetary payment, called ‘consideration’, given to the employee for agreeing to them).
• Confirmation that the employee has not knowingly committed any breach of their employment contract or breach of duty owed to the employer.
Generally accrued pension rights cannot be waived under a Compromise Agreement (as the trustees of the pension fund are not party to the agreement).
If the terms of the Compromise Agreement are breached by the employer, the employee could pursue a claim for breach of contract.
Employers often wrongly believe that all payments made on the termination of employment
are subject to a tax exemption of £30,000. Not all sums payable under a compromise agreement are tax-free. In determining what tax is payable in respect of termination payments, the key is to identify each element of the termination package and then consider the tax provisions applicable to the individual elements.
Outstanding wages, bonuses, commission and holiday pay are fully taxable, being payments
made under the employee's contract of employment. Ex gratia (non-contractual) sums paid as compensation for loss of employment under the terms of the compromise agreement are taxable, but subject to the £30,000 tax-free exemption.
Where an employee receives a contractual payment in lieu of notice, the payment is chargeable to tax as earnings from employment. However, where there is no contractual entitlement to a payment in lieu of notice, a non-contractual payment will be regarded as compensation for loss of employment, making it subject to the £30,000 tax-free exemption.
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This briefing is intended to give you an overview of the general duties set out in the Companies Act 2006 and to provide some practical guidance to help you comply with those duties.
Every director of a company owes a number of duties to the company they are appointed to. Compliance with each of the general duties is the personal responsibility of each director. The main directors' duties are set out in statute in sections 171 to 177 of the Companies Act 2006 (the CA 2006). The failure by a director to comply with any of the general duties has potentially serious consequences for that director.
Under the CA 2006 any person occupying the position of director, whether or not they are actually named 'director' and or have been validly appointed, will be a director of the company and will be subject to the general duties. In addition, shadow directors may also be subject to the general duties. A 'shadow director' is a person who has not been appointed as a director of the company but in accordance with whose directors or instructions the directors of the company are accustomed to act.
The general duties are:
• a duty to act in accordance with the company's constitution and only exercise powers for the purposes for which they are conferred;
• a duty to act in the way the director considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole and in doing so have regard to various specified matters;
• a duty to exercise independent judgment;
• a duty to exercise reasonable care, skill and diligence;
• a duty to avoid a situation in which the director has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company;
• a duty to not accept a benefit from a third party conferred by reason of the director being a director, or his doing (or not doing) anything as a director, and
• a duty for the director to declare if he is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company, and the nature and extent of that interest, to the directors.
It is important to note that any provision in a company's articles of association, a contract or otherwise, that purports to exempt the directors from compliance with the general duties is void.
A company may, through its articles of association, go further than the general duties by placing more onerous obligations on its directors. However, the articles of association may not 'dilute' the general duties.
Duty to act in accordance with the constitution and properly exercise powers
Each director must ensure that they:
• only exercises their powers for the purposes for which they are conferred, and
• acts in accordance with the company's constitution.
For these purposes, a company's constitution includes (but is not limited to):
• the company's articles of association, and
• any resolution or agreements affecting the company's constitution.
Every director should ensure that they are fully aware of the content of the company's constitution and all resolutions and agreements affecting it.
Duty to promote the success of the company
This duty requires that director acts in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. To be able to comply with this duty, the directors should first establish what 'success' means for the company.
Duty to exercise independent judgment
A director has a duty to exercise independent judgement, which means that he or she must not blindly follow the advice or instructions of a third party or fetter his or her discretion.
Duty to exercise reasonable care, skill and diligence
A director has a duty to exercise the same reasonable care, skill and diligence that would be exercised by a reasonably diligent person with:
• the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company, and
• the general knowledge, skill and experience that the director has.
This is a two part test, the first part of the test is objective and sets a minimum standard for a director based on their particular role and responsibilities. The second part of the test is subjective and takes into account the particular director's actual experience, knowledge, skills and specialism.
Duty to avoid conflicts of interest
A director must avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or may possibly conflict, with the interests of the company.
The prohibition relates to the situation rather than the actual conflict, thus, it appears that this duty applies whether or not the director has any influence over the situation and even if the conflict in question is trivial in nature.
The scope of this duty is therefore very wide!
This duty is not infringed:
• if the situation cannot reasonably be regarded as likely to give rise to a conflict of interest;
• if the matter has been authorised in advance by the directors in accordance with the CA 2006, or
• where a company's articles contain provisions for dealing with conflicts of interest, the directors have acted in accordance with those provisions.
Please note that authorisation cannot be given retrospectively and it applies to the conflict situation only and not other breaches of duty.
Duty not to accept a benefit from a third party
A director is under a duty not to accept a benefit from a third party that is conferred because:
• he is a director, or
• he has done (or not done) anything as a director.
This duty does not catch benefits accepted by a director from the company, an associated body corporate or a person acting on behalf of the company or an associated body corporate.
There is no definition of what constitutes a 'benefit', although it is thought to have a broad meaning that covers benefits of any description, including non-financial benefits.
Duty to declare an interest in a proposed transaction or arrangement
A director who is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company has a duty to declare the nature and extent of that interest to the other directors before the company enters into the transaction or arrangement, except where:
• the director is not aware of his interest or the transaction or arrangement in question (although for this purpose, the test is objective and director is treated as being aware of matters of which he ought reasonably to be aware);
• the interest cannot reasonably be regarded as being likely to give rise to a conflict of interest;
• the other directors are already aware of the interest (and for this purpose, the test is objective and the directors are treated as being aware of matters of which they ought reasonably to be aware), or
• it concerns the terms of his service contract that are to be considered by a meeting of the directors or a committee of the directors.
The declaration of interest must be made as soon as reasonably practicable after the director becomes aware of the interest.
Breach of a duty
The consequences of a breach of duties may, amongst other things, include:
• damages or compensation where the company has suffered loss;
• restoration of the company's property;
• an account of profits made by the director, and
• rescission of a contract.
It may be possible for a director to be protected from liability in the event of a breach of the general duties by:
• directors' insurance;
• an indemnity from the company;
• ratification by the members of the company, or
• relief from the court for the breach of duty.
The Legal Stop provides several legal documents and contracts aimed at helping you to comply with your legal duties as director!
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