Part 2: Taking a Principled Approach to Employment Settlements

2.1
In this Part, we identify six key principles which we think should underlie a public sector employer’s approach to resolving employment disputes.

• Principle 1 – Minimise the Potential for Terminating Employment
• Principle 2 – Reach a Soundly Based Decision to Settle
• Principle 3 – Observe Appropriate Standards of Probity and Integrity
• Principle 4 – Ensure That Terms of Settlement Are Appropriate
• Principle 5 – Preserve Maximum Transparency
• Principle 6 – Avoid Exposure to Public or Political Embarrassment

Principle 1 – Minimise the Potential for Terminating Employment

Any dispute with an employee arises in the context of an employment relationship. A good employer should manage the relationship in such a way as to minimise the potential for an emerging dispute to develop into one where termination of the employment becomes the only feasible option for either party.

2.2
The parties to an employment relationship have mutual duties of good faith, trust, and confidence. As well, most public sector employers are required by law to be “good employers”. (Appendix B on page 32 describes the duties of a public sector employer in more detail.)

2.3
Any employment dispute should be seen in the context of the overall employment relationship. A “good employer” should manage the employment relationship constructively to deal with emerging problems and prevent them from escalating into full disputes. This may include:

• ensuring that the terms and conditions of employment – especially those in respect of termination – are clear and appropriate to the needs of the position;
• establishing clear expectations about the employee’s performance, and having adequate systems for performance appraisal;
• managing the employment relationship constructively, to enable the employee to perform to his or her full potential; and
• having clear procedures to deal with disputes.

2.4
In other words, the employer’s objective should be to deal with problems in an employment relationship so as to preclude the problems escalating to the point where termination of employment is the only feasible option. Termination of employment leading to a settlement and severance payment such as we discuss in this report should be a truly exceptional occurrence.

2.5
In the following example, the employer chose to terminate the employment relationship and make a substantial severance payment – rather than manage the relationship in a way which enabled the employee to meet the changing requirements of the position.

Entity A, a local authority subsidiary, engaged a chief executive for a role which was primarily managerial. No formal employment agreement or written performance criteria were prepared. Over time, it became apparent that the managerial focus of the chief executive’s role was not compatible with the entity’s strategic requirements.

The governing body decided that it needed a chief executive with strategic vision, and that the existing chief executive did not have the appropriate skills. It rejected the option of developing a new job description and performance criteria, and giving the chief executive an opportunity to meet the new expectations. Instead, it decided to terminate the employment relationship.

Anticipating that the chief executive would respond by raising a personal grievance, the governing body initiated negotiations for an employment settlement. The negotiations resulted in a severance payment of over $80,000.

2.6
A public sector employer can reduce the risk of public criticism arising from an employment settlement if it can show that it managed the changing employment relationship in a way which:

• was fair to the employee; and
• made termination of the relationship the last resort.

Principle 2 – Reach a Soundly Based Decision to Settle

If termination of employment becomes the only feasible option for resolving a dispute, a public sector employer’s decision to settle (rather than pursue a dismissal and/or defend a personal grievance raised by the employee) should be one which:

• is properly authorised;
• is based on specialist advice that assesses all options for resolving the dispute and appreciates the wider public sector dimension; and
• is reasonable and appropriate – having regard to the interests of the organisation and the wider public interest.

Authorisation

2.7
Questions of authorisation may arise under legislation, an external administrative direction, or an internal delegation.⁵ These should be considered at the time that a decision is made to enter negotiations for an employment settlement. In the case of an internal delegation, it is common for a governing body to designate one or more members or officers to undertake or oversee negotiations, within identified parameters.

2.8
The following example shows how a failure to involve the governing body can result in unauthorised payments.

Entity B, a Crown entity, was undergoing restructuring. It was in financial difficulty, and as a condition of additional funding the Crown had appointed a Manager (“the Crown Manager”) who had financial oversight powers.

The chief executive was the “employer” for the purposes of dealing with any personal grievance or other employment dispute, and had a delegation to spend up to $70,000 on personnel matters. All items beyond the chief executive’s delegation were to be approved by a committee of the governing body.

The Crown Manager made it clear to the chief executive that he expected the chief executive to consult him on any unusual or large expenditure items – even those within the chief executive’s delegation. The chief executive entered into employment settlements, following mediation, with four senior managers who had raised grievances about the restructuring.

The chief executive did not involve the Crown Manager or the governing body in any of the decisions. The payments to two of the four employees exceeded the chief executive’s delegation and were therefore unauthorised.

Assessing the available options

2.9
The statutory framework for resolving employment disputes⁶ gives an employer several options where a dispute involves both performance concerns and a threatened or actual personal grievance.

2.10
There can be good reasons to settle, rather than litigate, an employment dispute. Employment advisers typically weigh up the likely economic costs of settling against the cost of the worst-case scenario – defending, and losing, a personal grievance in the Employment Relations Authority. This analysis forms the basis of the decision whether to defend or settle and, where settlement is chosen, determines the limits of the employer’s negotiating position.

2.11
Other non-cash costs – such as opportunity costs and the cost of management time and effort – are often included in this analysis.

2.12
Settling can be beneficial for other reasons, because it:

• avoids the unpleasant and emotionally damaging aspects of litigation;
• achieves finality; and
• enables the parties to move on.

2.13
However, a public sector employer should also be alert to factors and risks that may make an employment settlement undesirable. For example, paying compensation to a poorly performing employee in return for the employee’s resignation may result in a public perception that the employer has rushed needlessly into settlement and effectively rewarded the employee for poor performance. Alternatively, if the employer has agreed to settle in response to a threatened or actual personal grievance, it may be perceived as having given an undeserved windfall to someone whose entitlement has not been independently determined by the Employment Relations Authority.

2.14
This could encourage other employees to raise personal grievances instead of working through issues with the employer.

2.15 Ultimately, a public sector employer needs to ensure that it can justify a decision to settle as reasonable and appropriate. It should take comprehensive, specialist advice that assesses:

• all the options for settlement; and
• the benefits, as well as the cost, of litigating the dispute.

2.16
We use the term “specialist advice” to mean advice which covers not only the ‘employment law’ context but also the ‘public interest’ factor (see paragraph 1.23).

2.17
The following example shows the risks in not obtaining comprehensive specialist advice about the options for resolving a dispute.

The chief executive of Entity C developed concerns about a manager’s performance, and sought legal advice about how to address them. The chief executive then became aware of potentially serious misconduct by the manager.

The chief executive told the manager that addressing the more general performance concerns would be postponed until completion of the investigation into the alleged misconduct. The manager responded by initiating a dispute over the interpretation of documents relevant to the alleged misconduct. The chief executive denied there was a genuine issue of interpretation.

The manager then:

• applied to the Employment Tribunal⁷ for mediation assistance on the interpretation issue; and
• raised a personal grievance, alleging (among other things) unfair treatment during the performance review process.

The entity took advice from a human resources specialist (which was not in writing) and canvassed:

• the remedies available to employees in the event of a successful personal grievance claim; and
• the potential monetary liability should the entity wish to proceed with dismissal.

The entity denied any liability under the personal grievance, but decided to enter negotiations with the employee. These resulted in a settlement, under which the cost to the entity (excluding its legal fees and management time) was over $40,000. It included a tax-free payment for hurt and humiliation of $25,000.

2.18
The entity did not obtain written legal advice on the options open to it. The oral advice which it got did not cover any implications of structuring a settlement primarily on a payment for hurt and humiliation.

2.19
The example also illustrates how the ground can shift in favour of the employee during settlement negotiations. The entity went from a position of concern about an employee’s performance and potential serious misconduct, to making a significant payment to the employee for hurt and humiliation (albeit with no admission of liability).

2.20
On the other hand, there may have been some benefit for the parties in reaching a full and final settlement, and avoiding the expense and other disadvantages associated with defending a personal grievance in litigation.

Principle 3 – Observe Appropriate Standards of Probity and Integrity

When negotiating an employment settlement, a public sector employer should conduct itself in a manner that reflects appropriate standards of probity and integrity.

2.21
The law requires all employers, whether in the public or private sector, to observe a fair process when dealing with employees. A failure to do so can result in the employer’s actions being held to be unjustified by the Employment Relations Authority – even if the employer had substantive grounds for taking them.

2.22
The requirement to follow a fair process is consistent with an employer’s duties of good faith, trust, and confidence, and a public sector employer’s obligation to be a “good employer”.⁸

2.23
One aspect of these duties is the need to identify conflicts of interest, and take necessary steps to remove affected persons from the process. The following example illustrates how this can be done.

In Entity C, the chief executive took steps to address a concern about an employee’s performance and alleged misconduct. The employee then raised a personal grievance alleging inappropriate personal conduct by the chief executive and unfair treatment. The chief executive had a conflict of interest, but acted appropriately by involving the chairperson of the entity’s governing body, who took steps to enable the dispute to be resolved.

Principle 4 – Ensure That Terms of Settlement Are Appropriate

A public sector employer which enters an employment settlement should ensure that the terms of the settlement are consistent with:

• the employer’s contractual obligations to the employee; and
• the employee’s legal entitlement to, and acceptable levels of payment for, tax-free compensation.

2.24
This principle recognises the high standards which public sector entities are expected to meet, consistent with their stewardship of public funds or publiclyowned assets.

Consistency with contractual obligations

2.25
We said in Part 1 that an employment settlement usually involves the employee agreeing to resign in return for a payment for any lost remuneration, as well as payment for hurt and humiliation. ⁹ At the termination of employment, the employee will also receive payment for any other entitlements (such as holiday pay).

2.26
Payments other than payments for hurt and humiliation should be:

• consistent with the provisions in the employment agreement as to termination, notice, and redundancy; and
• taxed at source.

2.27
Neither of these requirements was satisfied in the following example.

In Entity B’s restructuring process, several employees who were to be made redundant raised personal grievances about the way the restructuring process had been conducted. The chief executive settled all the personal grievances following mediation.

Under the settlements, the employees received payments which were equivalent to their contractual entitlements had they been made redundant. However, none of the payments were expressed as redundancy payments. In some of the cases, an additional amount was added which was not provided for in the employee's employment agreement.

All the employees received their settlement payments on a tax-free basis. Had the employees been made redundant and paid in accordance with their contractual entitlements, the payments would have been taxable as income. A review of the substance of the employee's personal grievances raised doubt as to whether any of the grievances were genuine.

2.28
An employer should ensure that the employment agreement contains adequate protections in the event of termination. This is especially important in the case of a fixed-term employment agreement,¹⁰ where early termination can expose the employer to a substantial payment of lost remuneration for the remainder of the fixed term. The following example illustrates this point.

Entity D, a Crown entity, appointed its chief executive for a period of three years, subject to good performance. The agreement provided for termination on three months’ written notice, or on a date agreed by both parties. There was also provision for payment of remuneration in lieu of notice.

Half-way into the term of employment, the entity’s governing body resolved to extend the appointment to a term of four-and-a-half years. The termination provision was amended to provide that, should the entity terminate the contract (except in the case of serious misconduct), the amount due under the remainder of the contract would be paid to the chief executive in full.

Soon afterwards, the employment relationship broke down – following the resignation of the chairperson and several board members and the appointment of a new chairperson. Under the ensuing employment settlement, the chief executive received a gross sum of more than $500,000, which represented the amount payable for the remainder of the contracted term.

2.29
Most Crown entities are obliged to consult with the State Services Commissioner about (or, in some cases, obtain the Commissioner’s concurrence to) the terms and conditions of employment of their chief executive or other employees. The State Services Commissioner plays a valuable role in helping Crown entities to ensure that their employment agreements contain adequate protections in respect of termination and redundancy. In the example of Entity D, the entity failed to consult the Commissioner (as it was required to do) on the variation of the termination provision.

2.30
We are aware that some fixed-term employment agreements contain an “irreconcilable breakdown” clause to limit an employer’s liability if the employment relationship breaks down during the term. Clauses of this type:

• recognise that a good working relationship between the employer and the employee is fundamental;
• acknowledge that the employee is entitled to a payment if the relationship breaks down irrevocably through no fault of the employee;
• establish a formula to calculate the payment; and
• enable the employer to terminate the agreement after giving notice to the employee.

2.31
A clause of this type was formerly included in the standard-form agreement for government department chief executives. It is now considered to be inconsistent with the Government’s policy in respect of severance payments, because it would require a payment in the event of early termination.

Payments for hurt and humiliation

2.32
Payments for hurt and humiliation are made under section 123(c)(i) of the Employment Relations Act. Section 123(c)(i) concerns damages that may be awarded where the Employment Relations Authority determines that an employee has a personal grievance and has suffered humiliation, loss of dignity, and injury to feelings.

2.33
If an employee takes a personal grievance to the Employment Relations Authority, the Authority must be satisfied that there is a valid grievance – which has caused humiliation, loss of dignity, and injury to feelings – before the employee is entitled to any payment under section 123(c)(i). In contrast, the focus in an employment settlement involving a personal grievance is on resolving the dispute between the parties.

2.34
However, the almost invariable practice is for employment settlements to include a payment for hurt and humiliation – described as having been made as if it were an award of damages under section 123(c)(i). This practice raises important probity and tax issues, because:

• No judicial institution has determined that the employee has a valid personal grievance and is entitled to a payment for hurt and humiliation.
• As we said in Part 1, there is an incentive for parties to structure a settlement primarily around a payment for hurt and humiliation (which is not taxable) instead of remuneration (which is). This often results in the payment for hurt and humiliation being higher than what would have been awarded if the employee’s entitlement had been determined judicially – which may bring the payment into question from a tax point of view.
• If the parties fail to ensure that the settlement is consistent with their respective tax obligations, they undermine the principle of voluntary compliance which lies at the heart of the tax system.

2.35
We believe that a public sector employer should ensure that its specialist advice about the settlement covers the following issues:

• what the employee is entitled to receive as a taxable payment under the employment agreement;
• whether there is also a legal basis for making a payment for hurt and humiliation;
• if so, what the employee would be likely to receive if the case was determined by the Employment Relations Authority; and
• what would be an acceptable level of a voluntary payment – in order to achieve a full and final settlement and recognise the employee foregoing the right to pursue a personal grievance by litigation, while genuinely compensating the employee for humiliation, loss of dignity, and injury to feelings.

2.36
Appendix C on pages 33-37 considers the tax question in more detail, with two illustrations. In general, we think that a payment made on the basis of advice on the issues listed in paragraph 2.35 ought also to be acceptable for tax purposes.

Principle 5 – Preserve Maximum Transparency

A public sector employer should ensure that any confidentiality agreement reached as part of an employment settlement:

• is genuinely necessary, and in the interests of both parties;
• is consistent with the employer’s obligations as to disclosure of information; and
• does not otherwise prevent the employer from being accountable for its use of public funds.

2.37
Most employment settlements require the parties to keep details of the settlement, and the events which led to it, confidential. Confidentiality clauses are a common feature in the employment settlements we see in the public sector.

Reasons for confidentiality clauses

2.38
There is no single reason for confidentiality clauses. For example, a clause may be designed to protect:

• the reputations of either or both of the parties;
• specific interests such as personal privacy or commercial confidentiality; or
• the process by which the agreement was reached.

2.39
These interests are recognised by the Employment Relations Act.¹¹ But it is also fair to say that many confidentiality clauses find their way into agreements by default.

Confidentiality in the public sector

2.40
Most employers in the public sector face significant limits on their ability to guarantee confidentiality to an employee under an employment settlement, because:

• Most public entities are subject to either the Official Information Act 1982 or the Local Government Official Information and Meetings Act 1987 (referred to collectively as “the OIA”). The OIA requires information to be made available on request unless there is a specified “good reason” to withhold it. The OIA overrides an employee’s entitlement to privacy under the Privacy Act 1993.¹²
• Other statutes (such as the Local Government Act 1974 and the New Zealand Public Health and Disability Act 2000¹³) require information relating to payments on termination of employment to be included in an entity’s annual report.
• Government departments, Crown entities, State-owned Enterprises, and some other public organisations are subject to Parliamentary scrutiny, through the doctrine of Ministerial responsibility and the financial review and inquiry powers of select committees. Select committees have extensive powers under Standing Orders to obtain evidence.
• A public entity may be required to make disclosure to an Ombudsman (under the Ombudsmen Act 1975) or the Auditor-General (under the Public Audit Act 2001). Both officers have extensive powers to report publicly on matters which come to their attention in the exercise of their functions.¹⁴

2.41
None of these provisions prevent an employer from accepting an obligation of confidentiality in respect of an employment settlement. Their significance lies in the potential for that obligation to be overridden in particular circumstances.¹⁵

2.42
A public sector employer should therefore turn its mind actively to the question of confidentiality, why it is needed, and to what extent the parties could meet any obligation they agree to. If necessary, the employer should take specialist advice. But, ultimately, the issue may turn on the employer’s judgement as to whether, and (if so) to what extent, it should either seek or agree to confidentiality in the wider public interest.

2.43
There is evidence that many public sector employers recognise the value of transparency, and are conscious of the need to avoid committing themselves to unrealistic or undesirable levels of secrecy. Options for doing this include:

• making an undertaking of confidentiality subject to the OIA or any other statutory obligation;
• agreeing to observe confidentiality in respect of how the settlement was reached (consistent, for example, with the confidentiality of mediation proceedings), but not in relation to the outcome; and
• agreeing to a limited form of disclosure (such as in the form of an agreed statement) as a separate term of the agreement.

Principle 6 – Avoid Exposure to Public or Political Embarrassment

A public sector employer should not expose an external stakeholder to public or political embarrassment in relation to an employment settlement by failing to:

• address political or public interest risks; or
• keep the stakeholder adequately informed.

2.44
This principle recognises the ‘goldfish bowl’ factor – that public entities operate in an environment of political risk, in which their actions can be subjected to intense scrutiny.

2.45
A settlement involving a payment to a departing employee involves sensitive expenditure. Both the decision to settle and the payment of public funds under the settlement usually involve political as well as legal risk. The degree of political risk can increase with the seniority of the employee or the size of the payment. Addressing it may require specialist advice. Possible sources of advice are:

• the Crown Law Office or the State Services Commission (for departments and Crown entities);
• Local Government New Zealand or the Society of Local Government Managers (for entities in the local government sector); and
• lawyers with recognised expertise in public law.

2.46
Keeping external stakeholders informed is a critical part of political risk management. Each public entity has external stakeholders with a range of interests. Stakeholders may include:

• the governing body, in the case of a local authority or Crown entity whose chief executive has employer responsibilities;
• the State Services Commissioner and the responsible Minister, in the case of a government department;
• the overseeing department and the responsible Minister, in the case of any Crown entity;
• the shareholding Ministers and their advisers, in the case of a State-owned Enterprise; and
• the local authority, in the case of a local authority trading enterprise or other Council-controlled organisation.

2.47 Stakeholders such as these may not have any direct responsibility for employment matters.¹⁶ However, the public may hold them accountable or responsible in an indirect, or ultimate, sense for an employer’s decision to pay money under an employment settlement. Experience shows that there is considerable room for a stakeholder to be politically embarrassed if a settlement lacks transparency or is hard to justify on its terms.

2.48 The employer owes it to each relevant stakeholder to ensure that it keeps the stakeholder adequately informed about the settlement – consistent with the respective governance responsibilities and other interests (such as the privacy of the parties). The timing and content of the communication is a matter of judgement. It may, for example, be sensible to inform a stakeholder of an intention to enterstakeholder’s advice or concurrence – rather than simply informing the stakeholder of the settlement after it has happened.

2.49
Negotiating a confidentiality clause requires particular care, because of the potential for an obligation of confidentiality to limit the employer’s ability to defend the settlement to stakeholders and – if the settlement comes to public knowledge – the public.

5: See paragraph 1.28 for some examples.

6: See Appendix A on pages 29-31.

7: Under the Employment Contracts Act 1991, then in force.

8: See Appendix B (page 32) for more detail.

9: Both types of payment are made under section 123 of the Employment Relations Act (see Appendix A on pages 29-31).

10: Some public sector employment agreements – such as those for the chief executives of government departments and local authorities – must by statute have a fixed term. In other cases, an employer must have genuine reasons for a fixed term, and must specify them in the employment agreement: section 66(2) of the Employment Relations Act.

11: Section 148 extends confidentiality to all aspects of the mediation process under the Act. Clause 10 of Schedule 2 enables the Employment Relations Authority to prohibit publication of proceedings before it – including a consent order as to terms of settlement.

12: Section 7 of the Privacy Act.

13: Section 223E(12) of the Local Government Act, and section 42(3)(f) of the New Zealand Public Health and Disability Act.

14: The Auditor-General has twice reported publicly since 1999 on the amounts paid under employment settlements which were subject to confidentiality clauses: see Inquiry Into Certain Events Concerning the New Zealand Tourism Board (1999) and Airways Corporation Limited: Review of Certain Matters Concerning the National Air Traffic Services Consortium (2000).

15: For example, section 9 of the Official Information Act protects information on grounds such as privacy and prejudice to commercial interests. It also recognises the importance of confidentiality obligations. However, these interests must be weighed against any countervailing "public interest" favouring disclosure – for example, the accountability of officials.

16: Indeed, the public entity may be required by law to act independently of its stakeholders in employment matters: see, for example, section 33 of the State Sector Act 1988.