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What is a Settlement Agreement? Advice for employers and employees


This practical guide from our Employment Law Team explains what a Settlement Agreement is, what you should expect to get from one, and key factors to take into account.

What are Settlement Agreements?

A Settlement Agreement (formerly known as a Compromise Agreement) is a legally binding agreement between an employer and an employee under which the employee gives up his/her/their rights to pursue future claims against their employer. Usually, the employee will be offered a settlement agreement which consists of a financial sum and, at the same time, leave the employment of the employer.

A Settlement Agreement is usually used in connection with the end of employment. It’s generally a clean break between the parties and signifies an amicable end to an employment relationship, but this isn’t always the case; it could also be used where the employment is ongoing, but both parties want to settle a dispute that has arisen between them.

As businesses are increasingly looking to downsize and save costs in the face of the COVID-19 pandemic, we are seeing a significant increase in the numbers of employers using Settlement Agreements to exit employees from the business.

What needs to be considered before you sign a Settlement Agreement?

Settlement Agreements are often lengthy and complex agreements that address a number of issues that arise out of the employment relationship, the contractual agreement and its termination. It is imperative to obtain legal advice before you sign a Settlement Agreement, so that you are aware of any obligation one party has to the other.

The following are just some of the key issues an employer and employee will need to consider when entering into a Settlement Agreement:

  • The termination date: This will be the date the employment ends and also all contractual arrangement between the parties cease. Either party may need to negotiate this date .
  • Outstanding salary and holidays: When will any outstanding salary be paid? Will the employee be required to take their holidays during their remaining period of employment? If there is outstanding annual leave, will the employee be paid in lieu? These are all things to be thought about. 
  • Benefits: How will any benefits the employee received be dealt with under the Settlement Agreement? For example, company car, private health insurance, etc.
  • Notice periods and pay: Will the employee be required to work out their notice period or will they be leaving the employment of the employer with immediate effect? 
  • Deductions: Is the employer proposing to make any deductions from the employee’s final salary/compensation payment? For example, travel loan, training costs, etc.
  • Pension: The employee will need to understand what impact leaving the employment will have on any pension.
  • Tax: It is important that any payments made under the Settlement Agreement are structured as tax efficiently as possible. Outstanding salary, notice pay and holiday pay will be subject to tax and national insurance contributions in the normal way. However, under current HMRC rules, the general rule is that the first £30,000 of any compensation payment for loss of employment, inclusive of any statutory redundancy payment, can be paid tax-free. In complex termination arrangements the employee may well need specialist tax advice.
  • Giving up your right to claim: It is important the both the employer and employee fully understand what claims they are actually signing away as they may well want to exclude certain claims from being ‘settled’. This will require a discussion and negotiation with your employer/employee or their legal advisers.
  • Restrictive covenants: The employee’s contract of employment may already contain restrictive covenants and the Settlement Agreement may well deal with how these will apply moving forwards. If not, the employee may want to try and seek to limit the scope of any existing restrictive covenants as part of any agreement. It is also quite common for the employer to look to introduce new restrictive covenants via the Settlement Agreement. Any new restrictions will therefore need to be carefully considered.
  • Directorships: The Settlement Agreement will often require the employee to resign from any directorships at the same time as leaving the employment. They will need to understand the impact, if any, that resigning any directorships will have.
  • Shareholdings and share options: If the employee is a shareholder, they will need to carefully consider how their shares will be dealt with as they may well be required to sell those shares back on the termination of employment. If the employee has any share options, their reason for leaving will also be important because this may well determine what, if anything, they receive in consideration for their share options.
  • Confidentiality: The Settlement Agreement may well simply refer to any existing confidentiality provisions in their contract of employment or, alternatively, seek to introduce new confidentiality provisions. The employee will need to understand what information is confidential and what is not.
  • References: The provision of a good reference is often a key issue and may well involve a certain amount of negotiation.

How do I make sure a settlement agreement is legally binding?

A very important point to note is that, in order for the settlement agreement to be valid and binding, it will need to meet a number of statutory requirements, including that it must be in writing and must specify the particular complaints which the agreement is now settling.

Importantly, the employee must have received advice on the terms and effect of the agreement from an independent solicitor (or another adviser specified in the Employment Rights Act 1996, such as a properly certified trade union official). That adviser must be clearly identified in the written agreement and their advice must be covered by insurance.

If the settlement agreement does not meet all of the statutory requirements, then it will not be a valid settlement and will leave it open to the employee still to bring claims against the employer. It’s therefore vital that a lot of care is taken when drafting the agreement.

It’s also very important that any discussions between the parties about the proposed agreement meet certain legal requirements, as otherwise, if the agreement does not end up being entered into, those discussions could end up being used as evidence in any legal proceedings which follow.

Settlement agreements are a very useful way of ensuring that employer/employee disputes (or possible disputes) are concluded without the need for either side to resort to legal action. However, the law relating to them can be complex and it’s always a good idea to take proper professional advice before you begin to go along the settlement agreement route.

Legal advice: how can we help?

For the reasons detailed above, and before you sign up, it is critically important that you obtain professional legal advice on the terms and effect of the Settlement Agreement and there is also a legal requirement to obtain formal advice before entering into the same.

Here at Eric Robinson Solicitors, we can provide you with advice on all of the legal and provide referrals in relation to tax issues which can arise out of a Settlement Agreement as well as how to progress any negotiations. Our advice is always best sought early on in order to maximise the likelihood of getting the best deal.

The solicitors in our Employment Law Team have a wealth of experience in providing employees with independent legal advice on Settlement Agreements and are here to help guide you through the process from start to finish.

Find out more

If you’d like to find out anything more about this article, we’ll be happy to help. Harinder Sangha is a Senior Solicitor in Eric Robinson’s Employment Department. Harinder can be contacted by email: harinder.sangha@ericrobinson.co.uk