Comprehensive Guide to Employment Settlement Agreements
This comprehensive guide, prepared by experienced employment law specialists, provides detailed information about employment settlement agreements – what they are, when they’re offered, what you can expect to receive, how to negotiate them effectively, and the key legal considerations you should be aware of before signing. Whether you’re an employee who has been offered an agreement or you’re considering requesting one, this guide will help you navigate the process with confidence.
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What Is an Employment Settlement Agreement?
An employment settlement agreement (previously referred to as a “compromise agreement” until the terminology changed in 2013) is a legally binding contract formed between an employer and employee. Under this agreement, the employee accepts certain benefits—typically financial compensation—in exchange for waiving their right to pursue specific legal claims against their employer.
The fundamental purpose of a settlement agreement is to formally “settle” potential legal disputes without either party having to endure the time, expense, uncertainty, and stress associated with Employment Tribunal proceedings or civil litigation. By reaching a mutually acceptable resolution, both parties can move forward with certainty about their legal position.
Settlement agreements are distinct from other types of legal settlements (such as those in divorce proceedings or commercial disputes) because of specific statutory requirements that must be met for them to be valid in employment contexts.
Legal Requirements for a Valid Settlement Agreement
For an employment settlement agreement to be legally valid and enforceable in England and Wales, it must satisfy the specific statutory conditions set out in Section 203(3) of the Employment Rights Act 1996:
- Written format: The agreement must be in writing – verbal agreements are not sufficient.
- Specific complaints: The agreement must relate to “particular complaints” or “particular proceedings” – broad, general waivers of rights are not effective.
- Independent legal advice: The employee must receive advice from a relevant independent legal adviser (such as a qualified solicitor, barrister, or certified trade union representative) on the terms and effect of the proposed agreement, particularly regarding its impact on their ability to pursue claims before an Employment Tribunal.
- Professional insurance: The legal adviser must have a current contract of professional indemnity insurance covering the risk of a claim by the employee regarding the advice given.
- Adviser identification: The agreement must identify the legal adviser by name or firm.
- Statutory compliance statement: The agreement must explicitly state that the conditions regulating settlement agreements under the relevant statutory provisions have been satisfied.
If an agreement fails to meet all these requirements, it will not effectively waive statutory employment rights, potentially allowing the employee to accept payment under the agreement while still pursuing claims in an Employment Tribunal.
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Types of Employment Rights That Can Be Waived
Before considering a settlement agreement, it’s crucial to understand the different categories of employment rights you may be waiving:
Contractual Rights
These are rights established in your employment contract, including:
- Notice period entitlements
- Holiday allowance and pay
- Salary, bonus schemes, and commission structures
- Position title and responsibilities
- Workplace location
- Company car or other benefits
- Restrictive covenants and confidentiality obligations
These rights may be explicitly written in your contract or implied through custom and practice, company handbooks, or established working patterns.
Statutory Rights
These rights are created by UK legislation and are typically enforceable through Employment Tribunals:
- Protection from unfair dismissal (usually requiring 2 years’ service if employment started after April 6, 2012, or 1 year if before)
- Protection from discrimination based on protected characteristics (age, disability, gender reassignment, marriage/civil partnership, pregnancy/maternity, race, religion/belief, sex, or sexual orientation)
- Right to receive statutory redundancy payments (with 2+ years’ service)
- Protection from detriment or dismissal after whistleblowing
- Right to request flexible working
- Protection from unauthorized deductions from wages
- Various family-related rights (maternity, paternity, adoption, shared parental leave)
- Right to receive written particulars of employment
- Working time protections and minimum wage entitlements
Statutory rights apply regardless of what is written in your employment contract and often provide the basis for potential Employment Tribunal claims.
Common Law Rights
These rights derive from case law rather than legislation and might include:
- Protection from negligence causing personal injury
- Protection from defamation
- Protection from breach of trust and confidence
Common law claims are typically pursued through civil courts (County Court or High Court) rather than Employment Tribunals.
When Are Settlement Agreements Typically Offered?
Settlement agreements can arise in numerous situations, but are most commonly offered in the following scenarios:
Redundancy Situations
When a position is being eliminated due to restructuring, employers often offer settlement agreements that provide enhanced redundancy packages in exchange for waiving potential unfair dismissal or discrimination claims.
Performance Issues
When an employee is underperforming, employers might offer a settlement agreement as an alternative to completing a formal performance improvement process, which can be stressful and time-consuming for both parties.
Disciplinary Matters
Following allegations of misconduct or during disciplinary proceedings, a settlement agreement may be offered to bring the matter to a close without completing the disciplinary process.
Grievances
After an employee has raised formal complaints through a grievance procedure, particularly if the relationship has broken down or the issues remain unresolved.
Discrimination, Harassment, or Bullying
When an employee has experienced potentially unlawful treatment, employers might offer a settlement to avoid potential tribunal claims and associated reputational damage.
Mutual Agreement
Sometimes both parties simply recognize that the employment relationship isn’t working and agree to part ways on negotiated terms.
Business Changes
During company reorganizations, mergers, acquisitions, or changes in leadership.
Pre-Termination Negotiations
Employers may initiate “protected conversations” or “without prejudice” discussions to propose a settlement before any formal dispute has arisen.
While most settlement agreements coincide with the termination of employment, this isn’t always the case. Some agreements resolve specific disputes while the employment relationship continues.
What Claims Cannot Be Settled?
Certain types of claims typically cannot be waived through a settlement agreement:
- Accrued pension rights: These are protected and cannot be signed away.
- Personal injury claims: Most agreements exclude claims for personal injuries that were not known or reasonably foreseeable at the time of signing. This protects employees who later discover injuries related to their employment.
- Claims to enforce the agreement: You always retain the right to enforce the terms of the settlement agreement itself if the employer breaches them.
Some agreements may also specifically preserve other types of claims, depending on the circumstances and negotiations.
Financial Components of Settlement Agreements
Settlement agreements typically include several distinct financial elements:
Contractual and Statutory Entitlements
These are payments you would be legally entitled to regardless of whether you sign a settlement agreement:
- Salary and benefits up to your last working day or the termination date
- Payment in lieu of notice (PILON) if you’re not working your notice period
- Accrued but unused holiday pay
- Statutory redundancy payment (if applicable, based on age, length of service, and weekly pay)
- Outstanding expenses, commission, or bonus payments that have already been earned
Ex-gratia Payments
These are additional “goodwill” payments beyond your contractual entitlements, offered in exchange for waiving your right to bring claims. The amount typically depends on:
- The strength of any potential claims you might have
- The potential value of those claims if successful
- Your length of service
- The circumstances of your departure
- Your salary level
- How quickly the employer wants to resolve the matter
- Industry standards and the employer’s usual practices
There is no legal minimum for ex-gratia payments, but they typically range from one to four months’ salary for employees with more than two years’ service who might have potential unfair dismissal claims. Potentially stronger claims (such as discrimination or whistleblowing) might command higher settlements.
Payments for Post-termination Restrictions
Some agreements include additional compensation specifically for new or enhanced restrictive covenants or confidentiality obligations that limit your activities after employment ends.
Benefits Continuation
The agreement might include:
- Continued private healthcare for a defined period
- Retained use of company car or car allowance
- Outplacement services to help you find new employment
- Continued pension contributions
Tax Implications of Settlement Payments
Different components of a settlement payment are treated differently for tax purposes:
Taxable Elements
The following payments are subject to income tax and National Insurance contributions:
- Salary payments up to the termination date
- Holiday pay
- Payment in lieu of notice (PILON)
- Compensation for restrictive covenants
- Bonus payments and commission
- Benefits in kind
Tax-Exempt Elements
- Genuine ex-gratia termination payments up to £30,000 are exempt from income tax and entirely exempt from National Insurance contributions
- Payments exceeding £30,000 are subject to income tax and national insurance
- Compensation for injury to feelings in discrimination cases may be tax-exempt if related to treatment before dismissal
- Contributions directly into pension schemes (subject to annual allowance limits)
- Payment of legal fees related to the agreement (when paid directly to the adviser)
The tax treatment can be complex, particularly since changes to taxation of PILON payments introduced in April 2018. Your legal adviser should help you understand the tax implications of your specific agreement.
Key Non-Financial Terms in Settlement Agreements
Settlement agreements typically include several important non-financial provisions:
Reference Provision
One of the most valuable non-financial terms is often an agreed reference for future employers. This can range from a basic factual statement confirming dates of employment and job title to more detailed positive references. The agreement should specify:
- Who will provide the reference
- Whether it will be in writing only or also by telephone
- The exact wording or content
- How long the employer will provide the reference
Confidentiality Clauses
Most agreements require the employee to keep confidential:
- The terms of the settlement
- The circumstances leading to the agreement
- Confidential information about the employer’s business
- The existence of the agreement itself (in some cases)
These clauses should be carefully reviewed to ensure they are reasonable and include appropriate exceptions (such as disclosures to immediate family, professional advisers, or as required by law).
Non-disparagement Provisions
These clauses prohibit the employee (and ideally also the employer) from making negative or derogatory comments about the other party. Senior employees might negotiate for these obligations to be mutual and to specify which individuals within the organization will be bound by them.
Company Property
The agreement will typically address:
- When and how company property must be returned
- Whether the employee can retain certain items (such as mobile phones or laptops)
- Procedures for removing personal data from company devices
- Transfer of telephone numbers or email addresses
Announcement of Departure
Some agreements include agreed wording for how the departure will be communicated to colleagues, clients, and other stakeholders.
Post-termination Restrictions
The agreement might:
- Confirm existing restrictive covenants from the employment contract
- Modify or waive certain restrictions
- Introduce new restrictions with additional compensation
Legal Fees Contribution
Most employers contribute to the cost of legal advice on the agreement. This typically ranges from £350 to £750 plus VAT for straightforward cases, with higher contributions for complex situations or senior executives.
The Role of Independent Legal Advice
Independent legal advice is not merely a formality but a crucial statutory requirement for a valid settlement agreement. A qualified legal adviser must:
- Review and explain the terms and effect of the proposed agreement
- Clarify which potential claims are being waived
- Assess whether the compensation offered is reasonable given the circumstances
- Explain the impact on the employee’s ability to pursue claims
- Sign a certificate confirming advice has been provided
- Confirm they have appropriate professional indemnity insurance
The adviser should be genuinely independent of the employer. While the employer typically pays a contribution toward the cost of this advice, the adviser’s professional duty is to act in the employee’s best interests.
An experienced employment lawyer can also:
- Identify potential claims you might not have considered
- Advise on the reasonable value of those claims
- Suggest improvements to the agreement terms
- Negotiate with the employer on your behalf
- Explain tax implications and other practical aspects
- Ensure the agreement properly protects your interests
Negotiating Better Settlement Terms
If you’re not satisfied with an initial settlement offer, consider these strategies for negotiation:
- Understand Your Legal Position
Before negotiations begin, work with your adviser to:
- Identify all potential claims you might have
- Assess the strength of those claims
- Calculate their potential value
- Understand your minimum legal entitlements
- Research comparable settlements in your industry/situation
- Identify Your Priorities
Determine what matters most to you:
- Maximum financial compensation
- A positive reference
- Announcement wording
- Timing of payments
- Removal or modification of restrictive covenants
- Continued benefits for a period
- Contributing to a narrative about your departure
- Support Your Position with Evidence
Gather documents that strengthen your negotiating position:
- Employment contract and handbook
- Relevant emails or communications
- Performance reviews
- Evidence of discrimination or other mistreatment
- Medical evidence if relevant
- Details of similar cases or industry standards
- Consider Timing and Approach
The negotiation approach might include:
- Submitting a formal grievance to create leverage
- Engaging in “without prejudice” discussions
- Using ACAS early conciliation
- Making a reasonable counter-offer with clear justification
- Focusing on mutual benefits of reaching agreement
- Be Strategic About Communications
- Keep communications professional and focused on facts
- Clearly articulate why you believe you deserve more
- Avoid emotional language or threats
- Document important conversations in writing
- Consider having your legal adviser conduct negotiations
- Be Realistic
- Recognize that negotiation typically involves compromise
- Understand the employer’s perspective and limitations
- Consider the value of certainty versus the risk of litigation
- Factor in the time and stress involved in pursuing claims
Alternative Options: ACAS Conciliation
If you cannot reach an agreement directly with your employer, ACAS (Advisory, Conciliation and Arbitration Service) provides a free conciliation service that can help negotiate a settlement.
The ACAS Process
- Either party can request ACAS involvement
- A neutral conciliator acts as intermediary between employer and employee
- If agreement is reached, it is documented in a legally binding “COT3” form
- Unlike a settlement agreement, no independent legal advice is required for a COT3
Pre-Claim Conciliation
Before bringing most Employment Tribunal claims, you must notify ACAS and go through Early Conciliation. This provides an opportunity to settle before formal proceedings begin. The conciliation period lasts up to six weeks, during which time the limitation period for bringing a claim is “paused.”
ACAS conciliators cannot give legal advice but can explain processes and help parties find common ground. While legal representation isn’t required for ACAS conciliation, having a lawyer advise you behind the scenes can be valuable.
Settlement Agreement Terminology and Approaches
Employers use various terms when proposing settlement discussions:
Protected Conversations
Under Section 111A of the Employment Rights Act 1996, discussions about settlement agreements cannot normally be used as evidence in ordinary unfair dismissal claims, even if there is no existing dispute. This allows employers to propose exit terms without fear that the conversation itself could be used against them.
However, this protection is limited:
- It only applies to ordinary unfair dismissal claims
- It doesn’t cover discrimination, whistleblowing, or other claims
- It doesn’t apply if there is “improper behaviour” (such as undue pressure or harassment)
Without Prejudice Discussions
The “without prejudice” rule prevents statements made in a genuine attempt to settle an existing dispute from being used as evidence in court or tribunal proceedings. Unlike protected conversations:
- There must be an existing dispute
- The protection applies to all types of claims
- The protection doesn’t apply if there has been “unambiguous impropriety”
“Subject to Contract” Communications
This phrase indicates that discussions are not intended to create a legally binding agreement until a formal document is signed. This allows parties to negotiate freely without accidentally creating a binding agreement through email exchanges.
After Receiving a Settlement Offer
When you receive a settlement offer, take these important steps:
- Don’t Feel Pressured to Respond Immediately
- Ask for time to consider the offer and seek advice
- Check if there’s a deadline for acceptance
- Request the offer in writing if it was made verbally
- Seek Professional Advice Promptly
- Contact an employment solicitor with settlement agreement expertise
- Send them the draft agreement and relevant background information
- Discuss your situation openly, including any concerns or priorities
- Evaluate the Offer Comprehensively
With your adviser, consider:
- How the financial offer compares to your legal entitlements
- The potential value of any claims you might have
- The practical implications of all terms (not just financial)
- Any missing elements you would expect to see
- Decide on Your Response
Options include:
- Accepting the offer as presented
- Making a counter-offer with specific requests
- Requesting clarification on certain terms
- Rejecting the offer and pursuing other options
- Document Your Decision
Whatever you decide, ensure clear communication:
- Respond in writing to create a record
- Be professional and factual
- Specify exactly what you are accepting or proposing
- Set reasonable timeframes for responses
Special Considerations for Restrictive Covenants
Settlement agreements often address post-employment restrictions that limit your activities after leaving. These are worth careful consideration:
Types of Restrictions
Common restrictive covenants include:
- Non-compete clauses: Preventing you from working for competitors
- Non-solicitation: Prohibiting approaches to clients or customers
- Non-dealing: Preventing work with clients regardless of who initiated contact
- Non-poaching: Restricting recruitment of former colleagues
- Confidentiality: Protecting sensitive business information
Enforceability Considerations
Courts are generally more inclined to enforce restrictions in settlement agreements compared to those in employment contracts because:
- You’ve received independent legal advice
- You’ve typically received specific compensation for accepting them
- They’re negotiated at termination when the parties have better information about potential competitive threats
Negotiation Points
Consider negotiating:
- The geographic scope of restrictions
- Their duration (shorter periods are more likely to be enforceable)
- The definition of “competitor” or “client”
- Specific exclusions for named entities or activities
- Additional compensation specifically for accepting restrictions
If you’re planning to take up new employment or start a business soon after leaving, review these clauses carefully with your adviser to ensure they won’t unduly limit your options.
What Happens After Signing?
Once you’ve signed a settlement agreement:
Payment Timing
The agreement should specify when payments will be made. Typically:
- Contractual payments (salary, notice pay, holiday) are paid on or near the termination date
- Ex-gratia payments might be paid within 7-28 days of the later of:
- The termination date
- The date the employer receives the signed agreement
- The date the employer receives the adviser’s certificate
Tax Considerations
The employer should make appropriate tax deductions before payment. You’ll typically receive a P45 for payments processed through payroll and may need to account for any tax due on portions exceeding £30,000 through self-assessment.
References
If the agreement includes reference provisions, clarify the process for requesting references when needed. Consider asking for a copy of the agreed reference to keep with your records.
Confidentiality Obligations
Remember your ongoing obligations regarding confidentiality and non-disparagement. Keep a copy of the agreement to refer to if needed.
Breach of Agreement
If either party breaches the agreement:
- The non-breaching party can sue for breach of contract
- This would typically be in the County Court or High Court
- Remedies might include damages or specific performance
- For employer breaches involving non-payment, statutory demand procedures might be available
Refusing a Settlement Agreement
If you decide not to accept a settlement agreement:
Consequences to Consider
- You retain the right to pursue claims in the Employment Tribunal
- You will not receive any enhanced or ex-gratia payment offered
- The employer might proceed with performance, disciplinary, or redundancy processes
- You will typically be responsible for any legal fees incurred in reviewing the agreement
- Your relationship with your employer may deteriorate further
Next Steps
If you decline an agreement, you might:
- Continue in employment and attempt to resolve underlying issues
- Resign (potentially claiming constructive dismissal if appropriate)
- Engage with any ongoing formal processes
- Contact ACAS for Early Conciliation if pursuing tribunal claims
- Submit an Employment Tribunal claim within the applicable time limit
Remember that most Employment Tribunal claims must be brought within three months less one day of the relevant event or termination, though this period is extended by mandatory ACAS Early Conciliation.
Conclusion
Settlement agreements can provide a dignified and financially beneficial way to resolve employment disputes or end employment relationships. However, they involve permanently waiving potentially valuable legal rights, making independent legal advice essential.
By understanding the process, knowing your rights, and seeking appropriate professional guidance, you can make informed decisions about whether a settlement agreement represents the best resolution to your employment situation.
Remember that while your legal adviser can provide information and guidance, the final decision on whether to accept a settlement agreement remains yours. Take time to consider all aspects of the agreement and its implications for your future before signing.
Frequently Asked Questions
This varies widely depending on:
- The strength and nature of your potential claims
- Your length of service
- Your salary
- Your notice period
- Industry standards
- The circumstances of your departure
A common starting point for negotiation might be 1-4 months’ salary plus notice pay and other contractual entitlements, but this can increase significantly for strong discrimination or whistleblowing claims.
Yes, an employer can withdraw an offer before it’s accepted. Once properly signed by all parties, however, it becomes a legally binding contract that cannot be unilaterally withdrawn.
Portions representing salary, notice pay, holiday pay, and benefits are taxable. Genuine compensation for loss of employment up to £30,000 is typically tax-free. Tax treatment can be complex, so specific advice is valuable.
Yes, though professional advice is still required before signing. Many employees choose to have solicitors negotiate on their behalf to achieve better terms and avoid potential missteps.
Possibly. Voluntary severance payments may affect your entitlement to certain benefits. Seek advice from the relevant benefits agency.
This varies widely—from a few days to several weeks or even months in complex cases. Having an experienced adviser can often help expedite the process.
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