Smart Exits: Protected Conversations and Termination Payments

Reaching a settlement is a common way of managing an employee’s exit from a company, especially in the case of a dismissal or redundancy. The employee receives a termination payment, which may include a payment in lieu of notice and/or redundancy payment, in return for waiving any claims it may have against its employer. However, it is important that this process is managed carefully to ensure employers benefit from the protection anticipated and avoid any unforeseen consequences. 

Protected conversations

The ‘Without Prejudice’ principle is used to prevent statements made by parties in a genuine attempt to settle an ‘existing dispute’ being disclosed before a court or tribunal. However, when an employer has an ‘out of the blue’ discussion with an employee about the termination of their employment, there will be no existing dispute so the without prejudice rule will not apply.

Therefore, section 111A of the Employment Rights Act 1996 (ERA 1996) gives employers the ability to have an ‘off the record’ conversation with employees in respect of the termination of their employment in certain circumstances even where there is no existing dispute. This is known as a ‘Protected Conversation’.

Section 111A only applies to pre-termination negotiations if both of the following apply:

1. A claim is brought in the Employment Tribunal for ordinary unfair dismissal only (including constructive unfair dismissal); and
2. There has been no ‘improper behaviour’ on the part of the employer in relation to anything said or done during the protected conversation or the settlement negotiation process.

Steps to follow:

Before the meeting

1. Consider whether the employee has any protected characteristics or may have a claim for anything else (such as breach of contract). If so, consider whether having a protected conversation would be appropriate.
2. Arrange a face to face meeting with the employee, and give them reasonable notice of the meeting. Whilst not a requirement, it may be good practice to give the employee the option to be accompanied by a colleague or TU representative.

At the meeting

1. Explain in neutral terms why termination discussions are being raised. If you are concerned about the employee’s conduct/performance, explain you are giving the employee the option to accept a settlement agreement and leave on good terms before the formal disciplinary/performance procedure is commenced.
2. Explain that the pre-termination discussions are ‘protected conversations’ covered by s111A ERA 1996.
3. Set out the factual alternatives if the settlement agreement is not accepted (which may be disciplinary proceedings/formal performance management). You may say that the conclusion of the proceedings may result in the employee’s dismissal, however you must not say the employee will be dismissed if they do not accept the settlement agreement.
4. You must not behave improperly (examples of which are above).
5. You should take comprehensive notes of the meeting.

After the meeting

1. Follow up the meeting with a letter setting out the main points of discussion and a copy of the Settlement Agreement.
2. Mark all correspondence ‘Without Prejudice and Subject to s111A Employment Rights Act 1996’.
3. Give the employee a reasonable amount of time to seek advice and consider the agreement - 10 days is considered reasonable. If the employee is given insufficient time to respond this may be an example of improper behaviour.

Whilst following the above procedure should protect you from falling foul of s111A, each employment situation is different, and the above approach may not be the best one for you. As such, it is prudent to seek legal advice to guide you through each stage of the process.

Termination Payments

Those clauses within a settlement agreement relating to termination payments and payments in lieu of notice (PILONs) must be given careful consideration since an important change in the way that PILONs are treated for tax purposes was introduced in April 2018.

Previously, PILONs could be made to an employee as part of an ex-gratia termination payment on a tax-free basis. However, new legislation requires that all PILONs are subject to income tax and class 1 NICs, and a failure to accurately reflect this within a Settlement Agreement could lead to allegations of fraud by HMRC.

Tips:

• Keep notice pay and termination payment clauses separate. Failure to do so could see HMRC pursuing you for the tax due on a proportion of the termination payment equal to that of the employee’s notice pay entitlement (known as post-employment notice pay or PENP).
• Calculate the amount of taxable pay based on the statutory formula to ensure tax is dealt with correctly.
• If an employee will have worked their notice period as at their termination date (and therefore there is no PILON), state this within the Settlement Agreement so that it is clear to HMRC that no part of the termination payment constitutes PENP.
• Include provision to make a PILON within employment contracts. A PILON will be taxable whether contractual or non-contractual and to pay one where there is no contractual right to do so will be a breach of contract. This breach will render all post-termination restrictions unenforceable against an employee. Depending on the nature of the employee’s role, this could have unforeseen and serious consequences.
• Bear in mind that tax indemnities within Settlement Agreements can be problematic so structure termination payments legitimately from the outset and if in doubt, seek professional advice.