How to negotiate an employment exit package with an employee

What is involved in an employee managed exit and severance package?

An offer of a exit or severance package is usually made to the employee on the condition that they enter into a settlement agreement.  This requires the employee to give up all their legal rights to pursue their employer for any claims in the employment tribunal, including any claim for notice pay, unfair dismissal or discrimination.  The idea is to achieve a clean break for both sides.

This article considers what items will typically be included and negotiated in an exit package. Employers who consider how all liabilities and benefits will be dealt, with before putting an offer to an employee, stand more chance of concluding negotiations on terms acceptable to them and achieving the sought after clean break.

What does an employee need to know before agreeing to an exit or severance package?

Notice, holiday and benefits

You will need to check whether their contract of employment has a notice of termination clause and whether the notice is less or more than the statutory notice entitlement.

It may be the case that the employee has a “payment in lieu of notice” (PILON) clause in their contract of employment. If they do, this may enable you to terminate the employment contract without notice, instead paying a basic salary and (depending on how it is written) the value of any benefits as well.

If the contract does not contain a PILON clause, you can still terminate their employment, but you must pay the equivalent of what they have earned and received in benefits during the notice period.  If you do not, you risk facing a breach of contract claim. This is known as a wrongful dismissal claim.

You may also be able to place the employee on garden leave.  Here, they remain employed but serve their notice at home, in a non-working capacity.  This keeps a soon to be departing employee out of your systems and away from your staff and customers.

What about bonus payments?

They may have accrued a bonus that has not been paid yet or bonus payment season may be just around the corner.  Whether a departing employee is entitled to receive all or part of any bonus as part of the severance package will depend upon the terms upon which the bonus was offered.  Many contracts and bonus schemes will exclude departing employees, even if they have worked the whole of the bonus year or hit the required bonus targets.

Even if the bonus is described as a discretionary bonus arrangement, if  bonuses have been paid out consistently in preceding years to people who have left but who have met bonus targets, there is a very good argument to say that the bonus should be paid.

What about shares and options?

If they have been awarded shares or options, or participated in a share save scheme, then how these are treated on the termination of employment will be determined by the scheme rules or any grant documents.

It is important to establish whether they are to be treated as a ‘good leaver’ as frequently there will be beneficial provisions connected to this status, such as the market value of the shares as opposed to the nominal or awarded value. Good leavers are usually those who have to retire due to ill-health or are made redundant.

A bad leaver typically receives nominal value for shares or loses unexercised share options. Bad leaver scenarios will include resignation and misconduct dismissals.

Do you have to pay compensation for loss of employment?

After establishing what an employee is entitled to by law, many exit packages will include an additional element, often described as a ‘compensation’ or an ‘ex-gratia’ payment.  Employers do not have to offer this.  But to incentivise the employee to agree to a settlement agreement, there needs to be some benefit to them that they would not otherwise be entitled to on termination.

When considering how much to offer, compensation is often based on a period of loss of salary for a number of weeks or months.  How much to offer requires an assessment of the job market for the departing employee, how strong the employer’s case is for dismissal if terms cannot be agreed and whether the employee has legitimate grounds for complaint.

On the latter point, compensation for loss of earnings for an unfair dismissal claim is currently capped at the lower of one year’s gross pay or £123,543.  So, if the employee’s annual salary is £65,000, the maximum they could hope to recover if they were to pursue a claim for unfair dismissal, would be £65,000 for loss of employment.  This will feed into the employer’s assessment of how much to offer.

Could the compensation payment be higher?

Yes, if they have been subjected to unlawful detriment for: asserting a statutory right e.g. health and safety right or for whistleblowing or discrimination for a protected characteristic such as age, sex, disability, race or other protected characteristics then the cap on compensation would not apply.

As employee with grounds to bring such a claim will seek, or be advised to seek, a higher payment to settle any potential claim.

Crucially, employees have a responsibility to mitigate their losses once their employment ends. Accordingly, this may strengthen your position in negotiations where the employee concerned has secured alternate employment.

How do I conduct a managed exit?

The best way to proceed is with a “protected conversation”. Here, the employer has a confidential discussion with the employee to suggest a managed exit on financial terms that would include notice and some form of reasonable compensation inducement to leave the organisation under a settlement agreement.

The reason why it is protected is that, if it is intended to settle the employee’s rights and there is no duress or improper pressure, then the employee cannot refer to the offer in any subsequent employment tribunal from unfair dismissal.  So if the settlement negotiations break down, and they refer to the settlement offer, the employment tribunal will disregard it.

But specialist advice is required if these conversations are to be conducted where the employee could bring a discrimination or whistleblowing claim, whether credible or not. As the conversation is not protected from disclosure in such a claim.

Importantly, the law is changing and from 1 January 2027 the cap on compensation for unfair dismissal claims will be removed.  We expect this will lead to employees negotiating, and employers offering, larger exit packages due to the risk of higher value claims if terms cannot be agreed.

If you would like to further discuss any of the information detailed above or have further questions about severance packages, please contact our Employment team.