A settlement agreement is a legally binding contract between an employer and an employee that brings employment to an end on agreed terms. In return for a financial payment or other benefits, the employee agrees not to pursue certain legal claims against the employer, such as unfair dismissal or discrimination.
Settlement agreements are commonly used in the workplace, particularly when an employment relationship is ending or if an ongoing dispute exists. If you have been offered a settlement agreement, it is essential that you understand what it means, why it has been offered, and how it may affect your legal rights before you sign the agreement. If you would like to have a settlement agreement reviewed, please contact Laura Colebrook.
What Is a Settlement Agreement?
A settlement agreement (previously known as a compromise agreement) is used to resolve workplace disputes or end employment without the need for a formal process or Employment Tribunal claim.
In simple terms, your employer offers you compensation (and sometimes other benefits), and in return, you agree not to bring certain legal claims against them, usually connected to your employment or its termination.
Settlement agreements must meet strict legal requirements to be valid under the Employment Rights Act 1996, including that the employee receives independent legal advice before signing. Once validly signed, the agreement usually prevents the employee from bringing claims connected to their employment or its termination.
Under English law, a settlement agreement is only valid if:
- It is in writing
- It relates to specific employment claims
- You receive independent legal advice
- The agreement
Because of these requirements, you should never sign a settlement agreement without speaking to an independent solicitor first.
Why has my employer offered me a settlement agreement?
Being offered a settlement agreement can feel unsettling, but it does not automatically mean you have done anything wrong. Employers use settlement agreements in a wide range of situations, including:
- Redundancy Situations. Settlement agreements are often offered during redundancy processes, particularly where an employer is offering enhanced redundancy pay or wants certainty that no employment-related claims will be brought later.
- Performance or Capability Issues. If your employer has concerns about your performance or ability to carry out your role, they may offer a settlement agreement as an alternative to a formal performance or capability process. Depending on the circumstances, this may avoid a lengthy and stressful procedure for both sides.
- Workplace conflict or relationship breakdown. When working relationships have broken down and are not salvageable, a settlement agreement may be used to bring the relationship to an agreed end without assigning blame to either party.
- Grievances or Legal Disputes. If you have raised a grievance, or if there has been discussion of legal claims or ACAS Early Conciliation, a settlement agreement may be offered to resolve matters without the need for an Employment Tribunal claim.
What does a settlement agreement usually include?
A settlement agreement will often deal with:
- A termination date
- Compensation or severance pay
- Notice pay and outstanding holiday
- Waiver of legal claims
- Confidentiality and non-disparagement clauses
- References and announcements
- Tax treatment of payments
The precise terms will vary depending on the circumstances of each case.
What are you being asked to give up in a settlement agreement?
The most significant part of a settlement agreement is that you agree to waive your right to bring most employment-related claims. These often include:
- Unfair dismissal
- Discrimination claims
- Breach of contract
- Unlawful deduction from wages
What compensation can you expect?
There is no set monetary amount for settlement agreement compensation. The value depends on factors such as:
- Your length of service
- Your salary and benefits
- The circumstances of your exit
- The strength of any potential claims
- How long it may take you to find alternative work
Settlement payments often include:
- Notice pay (or pay in lieu of notice)
- Accrued but untaken holiday pay
- An additional ex gratia (compensation) payment
Some compensation for loss of employment may be paid tax-free up to £30,000, although tax treatment can be complex and should be checked carefully.
Can an employee negotiate the terms of a settlement agreement?
Yes. Settlement agreements are negotiable, and many employees improve the initial offer with legal support. Common areas of negotiation include:
- Increasing compensation
- Extending benefits (such as private medical insurance)
- Agreeing to provide a positive reference
- Clarifying confidentiality obligations
- Improving the wording of internal or external announcements
Why is legal advice required?
Independent legal advice is a legal requirement for a settlement agreement to be valid. This safeguard exists to ensure employees understand what they are agreeing to and the rights they are giving up.
A legal adviser will explain the agreement in plain English, assess whether the terms are lawful, and outline the potential risks of accepting or refusing the agreement.
Do you have to accept the settlement agreement?
No, an employee does not have to accept a settlement agreement, as it is voluntary. You are entitled to:
- Take legal advice
- Ask questions
- Negotiate the terms
- Decline the offer
You should never feel rushed or pressured into signing. If you do not accept, your employer may continue with internal procedures or take other steps, but you cannot be forced to sign.
Confidentiality and Reputation clauses in settlement agreements
Most settlement agreements contain confidentiality clauses covering:
- The existence of the agreement
- Its terms
- The circumstances surrounding your departure
These clauses cannot legally prevent you from whistleblowing, reporting criminal conduct, or cooperating with regulators. However, they may restrict what you can say publicly or to colleagues, so it is important to understand them fully before signing.
References and future employment
Many employees are concerned about references for future would-be employers. Settlement agreements often include an agreed reference, either attached to the agreement or described in it. This can provide reassurance and reduce anxiety about future job applications.
What happens after you sign a settlement agreement?
Once the agreement is signed:
- It becomes legally binding
- Your employment will usually end on the agreed date
- You will receive the agreed payments
- You will be bound by ongoing obligations such as confidentiality
You will generally not be able to bring employment claims covered by the agreement in the future.
Key things to remember before signing a settlement agreement
Before you sign a settlement agreement, you should:
- Take independent legal advice
- Understand what future employment claims you are giving up
- Check the financial compensation and tax position
- Ensure you are comfortable with confidentiality obligations
- Consider whether the agreement supports your future plans
How our specialist employment settlement agreement solicitors can help
Settlement agreements can provide clarity, financial security, and a clean break, but only if they are fair and properly understood. If you are an employee who has been asked to sign a settlement agreement, don’t just regard it as simply a formality, as it is a significant legal document that can affect your rights and future options.
Taking early legal advice ensures you understand your position, can negotiate effectively, and make an informed decision about whether a settlement agreement is right for you.
If you would like learn more or have a settlement agreement reviewed, please contact:
l.colebrook@thpsolicitors.co.uk
You can also listen to Laura’s podcast about Settlement Agreements.
FAQs on Settlement Agreements
What is a reasonable settlement agreement?
There is no fixed definition of what is “reasonable” in a settlement agreement. What is reasonable will depend on factors such as length of service, role, potential legal claims, and the risk to the employer if no agreement is reached. Each agreement needs to be assessed on its own facts.
How do you negotiate a settlement agreement with your employer?
Settlement agreement negotiations are usually handled through legal advisers, who raise points on compensation, notice pay, references and other terms. Employers are not obliged to improve an offer, but negotiation is often possible depending on the circumstances. Understanding the risks of refusal is an important part of the process.
What happens if a settlement agreement is not paid?
A settlement agreement is a legally binding contract. If an employer fails to pay sums due under the agreement, the employee may be able to enforce it through the courts. Legal advice should be taken before any enforcement action is started.
Can an employee request a settlement agreement?
An employee can suggest a settlement agreement, particularly where there is a dispute or breakdown in the working relationship. However, an employer is not required to agree and may choose to follow formal procedures instead. There is no automatic right to a settlement agreement.
What is the difference between a settlement agreement and redundancy?
Redundancy is a formal dismissal process with specific legal requirements. A settlement agreement is a contractual arrangement that can be used to end employment on agreed terms, sometimes alongside redundancy. The legal rights and protections involved are different.
Are settlement agreements taxable?
Some payments made under a settlement agreement may be paid tax-free up to certain limits, while others, such as notice pay, are usually taxable. Tax treatment depends on the nature of each payment rather than the label used. HMRC rules apply in all cases.