What is a Settlement Agreement: A Guide for Employers

What is a Settlement Agreement?

Compromise Agreements have been around for many years and have often been utilised by employers to bring an end to a contract of employment. In July 2013 Compromise Agreements became known as Settlement Agreement, and whilst some changes were made (for example, a Settlement Agreement does not necessarily have to state that it is made in settlement of a dispute whilst this was an essential feature of Compromise Agreements) the same principles generally apply.

The law states that an individual cannot contract out of his employment rights, but there is an exception to this rule where a settlement is reached by way of a Settlement Agreement.

A Settlement Agreement is a legally binding agreement between an employer and an employee used to set out the terms and conditions reached when a contract of employment is to be terminated or a dispute is to be resolved. It is essential that you fully understand both your rights as an employer and those of your employees before entering into such an Agreement.

Settlement Agreements can be used in a number of circumstances, including redundancy, dismissal, or the settlement of an Employment Tribunal claim. Perhaps the most common use is in redundancy situations where it minimizes the risk of complications, prevents the possibility of future complaints arising, and concludes the employment contract unequivocally with agreement by both parties. However it can also be a useful alternative to entering into a Performance evaluation and/ or disciplinary proceedings. The offer of a Settlement Agreement as a “tax free” alternative will often be a more attractive proposition for the employee, saving time, effort and costs all round.

When is a Settlement Agreement necessary?

If, when making redundancies, you fail to comply with the relevant laws, it would normally be open to employees to make a claim to the Employment Tribunal that the redundancy was unfair, potentially resulting in compensation or even reinstatement. As a result, employers are now increasingly using Settlement Agreements to prevent employees making claims after they have been made redundant. Settlement Agreements can also be used in the settlement of any employment related dispute, giving you certainty and closure.
A Settlement Agreement has the effect of your employee signing away their right to make a future claim against you in an Employment Tribunal and thus turning a redundancy package, or claim settlement, into a full and final settlement of any potential claims.

If you are thinking of making staff redundant, we would first of all advise you on the correct procedures to follow in order to comply with the relevant laws and minimise the risk of a claim being made against you by an employee. We would then assist you in drafting a suitable Settlement Agreement that is specifically geared towards the needs and protection of your business. Where necessary, we will negotiate on your behalf and strive to achieve the best settlement terms possible for you.

Advantages of a Settlement Agreement.

The main reason for you to enter into a Settlement Agreement is that it will provide you with complete peace of mind, and remove the risk of a future (potentially costly) Tribunal claim. In redundancy situations, you are free to include reasonable terms for restricting the future employment of the employee, e.g. if working for a competitor could be adverse to your business’ interests. In addition it can help you speed up the process substantially, avoiding the necessity of having to consult, and having unhappy employees hanging around for longer than is necessary. Finally you can utilise the government’s tax free concession to promote the process.

Why does my employee need to take legal advice on a Settlement Agreement?

The law states that a Settlement Agreement is only valid if the employee has obtained legal advice (this requirement cannot be waived in any circumstances). The required advice can only be given by a qualified lawyer, a qualified trade union official, or a qualified advice centre worker, all of whom must be covered by an appropriate certificate of indemnity insurance.

Will my employee have to pay tax on the amount received?

Compensation received under a Settlement Agreement can often be paid tax-free up to £30,000.
The general rule of thumb is that payments due in accordance with their contract of employment are taxable and ex-gratia payments are not. However the situation is complicated by the Finance (no 2) Act 2017, which brought in a new tax regime relating to Post-Employment Notice Periods (PENP’S). Our solicitors will advise on the tax implications of the figures put forward in the Agreement.

Does my employee have to agree to a Settlement Agreement?

There is no legal or other obligation on an employee to sign a Settlement Agreement if they are not happy with it. Their refusal to sign would mean that there is no agreement between you and them and they would maintain the right to pursue an employment related claim in the Employment Tribunal.

However, in many cases their refusal to sign a Settlement Agreement could mean that you refuse to pay the ‘enhanced’ sum offered in the Agreement, i.e. the full redundancy package, and instead pay only the minimum statutory and contractual entitlement. The employee will therefore have to consider carefully whether the outcome of a potential claim in the Tribunal is likely to exceed what they would have received under the Settlement Agreement taking into account the actual cost of the Tribunal, which with the fees is now considerable. This is also something you should consider when putting forward your settlement offer.
If your employee does refuse to sign a Settlement Agreement, and pursues a claim against you in the Employment Tribunal, our solicitors can provide expert advice on defending such claims.

What claims will my employee be able to make once an Agreement is signed?

If your employee signs a Settlement Agreement, they will generally only be able to make three types of claim in the future;
1. A claim for a breach of the Agreement itself;
2. A claim in respect of personal injury. However, the Agreement may exclude personal injury claims in respect of injuries of which the employee is already aware of at the time the Agreement is signed, e.g. when the reason for termination is due to sickness absence for stress or depression;
3. A claim relating to accrued pension rights.

Should the situation arise where you find that a claim is made against you in the above terms, we have experience in dealing with such disputes and would be happy to provide advice on your particular situation.

Who pays for the legal advice required for a Settlement Agreement?

You will need to pay for the drafting of the Agreement, and the vast majority of employers also offer their employees a contribution to legal fees which is sufficient to cover the costs of the required legal advice. The cost of an employee’s legal advisor to review the Agreement is usually between £250 and £750 depending on the nature of the settlement, but this is often a small price to pay for the peace of mind that it buys. Obviously, if negotiations become extended, then costs may increase further. The costs also constitute a further ‘tax free’ benefit for the employee.

This guide is prepared as general advice and should not be relied upon without taking specific advice about your situation. We hope that this information has helped you to understand Settlement Agreements and how they can help you settle disputes in the workplace and resolve potential problems arising out of redundancies. If you have an employment law query relating to a Settlement Agreement or otherwise, please contact us for a consultation in which we will be pleased to provide you with our expert guidance.

If you have any queries about settlement agreements or any other employment-related query, please get in touch with Charlotte Braham in the Employment Department on 01494 893529.


“Thank you for all of this. It seems to be unbelievably thorough. Thank you for taking such care and thought, I really do appreciate and understand that we are paying you for your advice but it doesn't hurt to also say a very appreciative thank you.”

Mrs. F Wills and Probate Client