Settlement Agreements: The Complete UK Employee Guide (2025)

• It is a legal requirement that receive independent legal advice from a qualified adviser, e.g. a solicitor. It’s standard practice for your employer to pay.
• Settlement agreements are voluntary.
• Payments can include notice pay, holiday pay, bonuses, pension contributions, shares, and often a tax-efficient exit payment.
• Up to £30,000 of a genuine termination payment can be paid tax-free (usually).
• You may want to negotiate the settlement agreement wording or the severance amount.
• This guide, written by a specialist employment solicitor with mover 20 years experience, explains your rights, the process, what to expect, and what to do next.

1. What is a Settlement Agreement?

A settlement agreement is a written, legally binding contract between you and your employer, commonly used to bring your employment to an end on agreed terms. In return for signing, you usually receive a financial package and your employer receives certainty that you will not bring specific claims against them.

Before 2013, settlement agreements were known as compromise agreements. The purpose remains the same: to resolve workplace issues swiftly giving the parties certainty and closure.

A legally binding settlment agreement must:

• be in writing.
• Identify specific claims you are waiving, i.e. settling or agreeing not to bring.
• identify your legal adviser.
• state that the conditions regulating settlement agreements under the relevant legislation are satisified.

For a more detailed defintiion and examples, see out dedicated guide What is a Settlement Agreement?

2. Key Legal Concepts You Need to Know

2.1 – Without Prejudice

You may see this at the top of an email or letter from your employer, making the offer. The ‘Without Prejudice’ rule protects genuine settlement discussions from being used as evidence in a court or employment tribunal, if the settlement agreement is not signed. The without prejudice rule only applies when there is an existing dispute, which means an actual or contemplated legal proceeeding. The without prejudice rule cannot generally speaking be used to hide serious bad behaviour, like blackmail, fraud, or unfounded allegations of serious misconduct.

2.2 Protected Conversations

Frequently employers label correspondence containing a settlement agreement offer as ‘made under section 111A’ of the ERA.

Under section 111A of the Employment Rights Act 1996 (‘ERA’), employers may have a pre-termination negotiation, also known as a protected conversation, about a settlement agreement, even if there is no existing dispute. A protected conversation cannot ordinarily be used in an unfair dismissal claim but may be used in other claims, such as discrimination or breach of contract. If an employer acts inproperly it may lose protection, meaning the conversation could then be used in an unfair dismissal claim.

2.3 Independent Legal Advice

You must have received advice from an independent legal adviser, e.g. a solicitor, on the terms and effect of the settlement agreement, otherwise it is defective and will not prevent you from bringing statutory employment claims. The adviser must have a policy of insurance or an indemnity in place covering the risk of a claim by the employee or worker in respect of loss arising from the advice.

As it’s in the employer’s interests to achieve a valid and binding settlement agreement, it is standard for employers to contribute towards the cost of the employee receiving the required legal advice.

3. Your Rights and What You’re Giving Up

When you sign, you agree to not bring certain claims. It is common for a settlement agreement to contain a schedule listing the particular claims being settled, for example unfair dismissal, redundancy payments, discrimination, harassment, victimisation, and unlawful deductions of wages.

Claims that are not generally waived in a settlement agreement include claims relating to a latent personal injury (exluding those arising from unalwful discrimination), accrued pension rights, and the ability to enforce the settlement agreement. Your solicitor should walk you through the excepted claims you can still bring.

3.1 Voluntary

A settlement agreement is voluntary. You do not have to sign and you cannot be made to sign. Improper threats, or duress, may render the settlement agreement voidable, which means you may elect to treat it as cancelled. A court would need to find on the evidence that the behaviour was so extreme that you had no choice but to sign.

Importantly, in the UK, there is no cooling-off period after you sign, so you can’t unilaterally cancel or undo a settlement agreement once it’s binding.

3.2 Time to consider the Settlement Agreemeny offer

You should be given reasonable time to consider the offer, and if the timescales are not reasonable your solicitor can advise you on when and how to push back. Acas guidance suggests 10 days but that is not a legal requirement, and only really relevant to whether a shorter period might deemed improper for the purposes of making a protected conversation admissible in any subsequent unfair dismissal claim.

Most employers understand you will need reasonable time to arrange an appointment with a solicitor, and review the payments, check the offer is fair, undertand the tax and benefits, and consider whether to accept.

4. Why Employers Use Settlement Agreements.

Employers often use settlement agreement to achieve a prompt, private, mutually agreed termination of employment, and a full and final settlement of claims. They are attractive because they end disputes or greivance processes which might otherwise entail time, risk, cost and a distraction for managers. They give everyone certainty.

4.1 Common Situations

Typical situations settlement agreements are used include: redundancy and restructures, performance or capability concerns, misconduct allegations, long-term illness, relationship breakdowns, greivances and other disputes. If your situation involves redundancy, you may find our redundancy guide useful: Redundancy & Settlement Agreements.

4.2 Why Employers Prefer Settlement Agreements.

Employers achieve certainty, significant confidentiality, speedy outcomes, and protection from future claims. Employees can gain a certain financial termination package, closure, a refererence, and a faster less stressful resolution compared to going through an internal process such as a personal improvement plan, disciplinary, grievance or tribunal process. Bearing in mind many tribunal cases are now taking years to get to a final hearing (yes you read that correctly), speed to achieve an outcome is a key benefit to all the parties.

5. Payments You Should Expect

A typical settlement agreement financial package will consist of multiple elements.

5.1 Notice Pay

Usually the settlement agreement will provide for you to work out your notice entitlement or alternatively be paid in lieu of notice (PILON) or a mixture of both, i.e. part worked, part paid in lieu. You should check your employment contract to esablish the period of notice your employer is required to give you to end your employment.

A PILON is subject to usual deductions for income tax and national insurance, however, where you have not fully worked or been paid in lieu, this may result in additional tax needing to be deducted from any termination payment.

For a fuller explanation of how different kinds of payments made under a settlement agreement are taxed, see our Tax and Payments Guide: Tax and Payments.

5.2 Holiday Pay

You are entitled to be paid in lieu of any accrued but unused holiday entitlement at the termination date, made via the payroll. Sometimes your employer may require you to use your accrued entitlements prior to the termination date. It is worth checking your employment contract, and seeing what that says.

For example, it may say you are required to use annual leave during your notice period or garden leave. Importantly, your settlement agreement should clearly set out the position regarding annual leave entitlements and holiday pay.

5.3 Bonuses, Commissions and Shares / Share Options

Whether you are entitled to these will depend on the relevant contract terms, scheme rules and any performance criteria. Sometimes there is a degree of discretion your employer may be able to exercise as permitted by the relevant scheme rules. These payments are usually taxable and the settlement agreement should specify any payments or benefits you are to receive or retain.

5.4 Compensation (the ‘Settlement Payment’)

Sometimes this may be called an ex-gratia payment, termination payment or severance payment. This is the extra payment you may be offered, in addition to your basic statutory and contractual entitlements, to persuade you to sign the agreement. Depending on your specific case circumstances, this part of the severance may be negotiable or a take it or leave it offer.

6. Tax Treatment Explained

This section gives a summary only. For detailed guidance, see our dedicated guide: Tax and Payments.

6.1 Payments that are taxable

Payments that are taxable as earnings include notice payment, PILON, bonuses, commissions, holiday pay and other contractual remuneration. Your employer should make PAYE deductions for these. Similarly, payments for you agreeing to new restrictive covenants, also called post termination restrictions, are subject to PAYE deductions.

6.2 – £30,000 Tax-Free Rule

Genuine payments for loss of employment, such as a redundancy payment, are usually capable of being paid free of tax up to £30,000. This tax free allowance may not apply to payments made to you because you are retiring. The £30,000 tax free allowance will be reduced if it includes Post Employment Notice Pay and we provide more details about that in our tax guide

6.3 Payments that may be tax-free

Payments made on account of injury to, or disability of, an employee are not subject to tax. Payments for injury to feelings for dismissal related discrimination are taxable subject to the £30,000 allowance. However, payments for injury to feelings for discrimination that occured during employment (as opposed to termination of employment) may be capable of being paid free of tax.

Payments towards the employee’s legal fees relating to the settlement agreement and termination of their employment, and outplacement support, may also be tax-free subject to conditions. As the rules on tax treatment of payments is complex, it is sensible to check with your solicitor and/or tax adviser on your particular circumstances.

7. Types of Settlement Agreements and Alternatives

7.1 Contractual Settlement Agreements

In some cases an employer may use a contractual settlement, recording the agreed terms upon which the employee’s employment terminates by mutual agreement. Importantly, this type of agreement will not satisfy the statutory conditions for a binding (statutory) settlement agreement, meaning they can’t prevent an employee from still bringing statutory complaints, such as discrimination.

7.2 COT3 Agreements

A COT3 agreement is an Acas facilitated settlement, commonly used when employment tribunal claim (or Acas Early Conciliation Claim) has already been started. There is no requirement for the employee to receive independent legal advice on a COT3 agreement.

7.3 Continuing with internal processes or a claim

You may decide to not sign a settlement agreement and instead continue with any internal processes, for example a grievance procedure, or disciplinary appeal or capability process. If you do this great care must be taken to weigh up the pros and cons, including the merits of any claims, their value, likely legal costs of a solicitor supporting you with a claim, and other factors, such as reputational risks, your wellbeing, mental health and delay.

You should also ensure you know what the deadlines are for bringing an employment tribunal claim, otherwise you might be out of time. You should not delay seeking legal advice due to these strict time-limits. Our Ask an Expert hub contains further information on these topics.

8. How to Negotiate your Agreement

Whether you’ve already neogtiated with your employer on the key terms or not, it is not uncommon for some negotiation to take place regarding the wording of the settlement agreement, and possibly the financial elements.

8.1 When to negotiate

In cases where you have valuable good potential claims, which may exceed the current offer, you may consider negotiating better financial terms. Equally there may be elements of the settlement agreement that need tweaking, such as to correct an error, or include a payment or benefit that was agreed but missed out of the first draft, or to seek a job reference, release from a non-compete, or other changes to other clause wording. Your solicitor can advise you on these issues.

8.2 What us a reasonable offer?

This really is akin to asking how long is a piece of string. Factors include your length of service, seniortity, the merits of any claims, the potential value of your financial losses, and any entitlements you are giving up.

8.3 Negotiating Strategies

Understanding your basic contractual and statutory entitlements as a baseline, and how your employer has arrived at its figure, are helpful starting points. The strategies will depend on particular circumstances at play and we explore this in more detail in our full negotiating guide: see Negotiating Guide.

Don’t assume the first offer is always open to negotiation. Depending on the context, it may be an excellent and generous offer with no chance to improve or part of a wider process with a take it of leave scenario.

For example the terms may be part of a wider voluntary enhanced redundancy or severance scheme, where the financial terms are hard baked into the scheme and won’t be amended for one employee as that would be seen as unfair on the others participating in the scheme.

9. Case Studies and Real Examples

If you’re unsure about what to do, case studies and examples can really help shape your thinking – athough seeking advice from your solicitor is the best thing to do on your particular circumstances. For further support, visit our case study hub where we give examples of employees facing redundancy, misconduct allegations, performance improvement plans, ill-health and capabiltity processes: Case studies.

10. When not to sign

You should only sign the settlement agreement after you have obtained specialist independent legal advice, e.g. from an employment solitor. You can then make informed decisions about whether to sign the agreement.

11. What to do next?

Helpful next steps include:

• Review your settlement offer and package using the calculator: settlement agreement calculator
• Read our redundancy guide if you’re in a redundancy situation: Redundancy and Settlment Agreements
• Understand more about tax basics: Tax and benefits
• Get your documents ready for your solicitor: e.g. a copy of your settlement agreement, settlement offer letter or email from HR, your employment contract documents.
• Learn more the process: Settlement agreement process.

12. FAQs

13. About the Author

John Hassells acts for employees and employers. He is the founder and Managing Director of Bolt Law, a specialist employment law firm supporting employers. John is also a consultat solicitor at a fully authorised and regulated law firm where he supports senior executives and employees in relation to settlement agreements and related legal issues. Before setting up his own firm John was an employment solicitor at one of the UK leading law firms, and he also headed up a regional commercial firm’s employment team where he was a partner.

John is a fully qualified solicitor with over 20 years experience advising employees and employers on employment law matters, employment disputes and settlement agreements. He is a member of the Employment Lawyers Association, regularly delivers employment law training and provides media comment on employment law developments.

14. Legal Disclaimer

The contents of this article are intended to be be for general information purposes only and do not amount to (nor are they intended to be) legal, tax or financial advice or a complete or authoritative statement of the law nor should they be treated as such. No warranty or promise is given, express or implied, as to accuracy of the information on this page and no liability is accepted for any error or omission.

You should instruct a specialist employment solicitor to advise you on your particular situation and not act or rely on the information on this page.