Settlement Agreements Made Easy

What is a Settlement

A Settlement Agreement is a formal agreement between an employer and an employee dealing with the settlement of claims that the employee may have arising out of his/her employment or its termination. Usually an employee accepts a sum of money in return for agreeing not to bring certain legal claims against the employer.

What is a Compromise Agreement?

‘Compromise Agreement’ is the old name for a Settlement Agreement. The name-change took place in July 2012 when new laws were introduced making it easier for employers to make settlement offers.

Is a settlement agreement payment agreement tax-free?

The tax position depends on the nature of the payments made under the settlement agreement.

Wages, holiday pay, bonuses, commission, & contractual payments – are all subject to usual deductions for income tax and national insurance.

Termination Payments, compensation, redundancy pay and/or ex-gratia payments

Generally the first £30,000 of compensation for loss of employment is not subject to tax or employees’ National Insurance contributions. Payments made over £30,000 are subject to tax. IMPORTANT NOTE: The law in relation to post-employment notice pay and tax liabilities has changed. This part of our guidance is under review so please consult your solicitor and / or tax adviser about how this may affect you.

Tax liability if you work your notice period

If you work your notice period under a settlement agreement the money you earn during notice is taxable as wages, as normal.

Payments in lieu of notice

Currently, depending on your employment contract and employer’s practices, a payment in lieu of notice may or may not taxable, depending on whether it is contractual or compensatory. If your employer gives your employer a right to terminate and pay in lieu the risks of it being contractual increase.

From April 2018 all payments in lieu of notice taxable (contractual and compensatory) are expected to be taxable.

What is post-employment notice pay?

From April 2018 it is expected that all termination payments will be taxable, up to the value of any notice pay, unless you have served notice. In effect the argument about whether the termination payment is contractual or compensatory will be dead because both will be treated as taxable as post-employment notice pay.

Is a payment for outplacement under a settlement agreement taxable?

A qualifying payment in relation to outplacement is capable of being paid without incurring tax liabilities.

Settlement Agreement and  retirement

Retirement payments are usually taxable.

Why do we need Settlement Agreements?

Settlement Agreements are used to resolve employment disputes and/or end the employment relationship on agreed terms. They are an effective way of preventing or resolving employment disputes and provide certainty to both parties.

Once signed, an employee will be prevented from bringing employment claims.

Is the settlement offer fair (and should I accept)?

That depends on the offer, the strength of any claims, how long you’ve been employed and factors personal to you. Read our guide: Five things you need to think about before accepting a settlement agreement offer.

In what situations are Settlement Agreements used?

Settlement Agreements are used in many employment situations, including:


Settlement Agreements are often used in redundancy scenarios, where the employer offers to pay the employee more than the basic statutory redundancy pay entitlement. In exchange for paying more, the employer may require the employee to sign a settlement agreement.


The employer may not be happy with the employee’s standard of work. Rather than go through a formal performance improvement plan / procedure, the employer may decide to offer the employee an alternative to leave earlier in the procedure and receive a settlement payment under a settlement agreement.

Sickness / Incapability

If an employee is not capable of work because of illness or a lack of skill or experience, one option may be to agree to the employee leaving under a settlement agreement. Sometimes, both parties would prefer to agree an earlier amicable settlement rather than go through a long drawn out capability procedure that might end in dismissal.

Work relationship breakdown

Sometime the work relationship breaks down between the employer and employee, or the employee and colleagues. The parties may prefer to agree an amicable parting, where the employee receives a severance / termination payment.

Employee Grievance

The employee may have grievances and potential claims against the employer for the way she/he has been treated at work. Rather than bring employment claims, an agreement may be reached and recorded in a settlement agreement.

I’m happy with the settlement offer and need a solicitor to sign-off. What next?

If the settlement agreement is ready to sign you can go for our fast solicitor advice service from our solicitors. It can all be done by telephone and email. The solicitor will advise you on the terms and effect of the agreement and send a legal adviser certificate to your employer. You will probably find the template certificate in a schedule (at the back of the Settlement Agreement).

If you’re happy with the deal and just need a solicitor to sign-off the agreement, many of the firms in our ‘find a solicitor’ directory will agree to only charge whatever your employer agrees to contribute towards your legal fees. Your solicitor will then invoice your employer directly when the agreement is signed-off.

Negotiating a Settlement Agreement

When employees are offered a Settlement Agreement, they should give careful consideration to what they want to achieve by signing such an agreement.

I’m not happy with the financial terms

Some employees are not satisfied with the financial deal and/or the terms of the agreement and will instruct their solicitor to negotiate on one or both fronts. The ability to negotiate will very much depend on the circumstances and strength of the individual’s case. The stronger the legal basis for a claim, the more likely it is that employers will be receptive to negotiations to increase the compensation and amend terms in the employee’s favour.

Changes to the Settlement Agreement wording

You may want to make changes to the Settlement Agreement wording to protect you. For example:

  • Adding a clause to require your employer to provide a reasonable job reference to a new employer;
  • making sure all the payments, monies and benefits you are entitled to are covered (accrued salary, accrued holidays, bonuses, commission payments, shares, SAYE, private health cover, company car or car allowance). This is important because usually a settlement agreement will be drafted to be the entire agreement, meaning any payments or benefits not covered in the agreement will be lost;
  • an agreed internal or external announcement to colleagues and customers;
  • changes to the clauses dealing with tax (known as a tax indemnity);
  • amending or removing post-termination restrictions that may make it difficult for you secure new work; and / or
  • deleting clauses that are unreasonable / to remove or minimize risk.

What is the effect of a entering into a Settlement Agreement?

By entering into a valid Settlement Agreement an employee agrees to give up certain legal rights usually in return for a severance payment or package. The main effect of the agreement is that an employment tribunal will no longer be able to hear the claims listed in the agreement and an employee will be precluded from bringing these claims. Depending on the terms of the agreement, it may also prevent an employee from bringing any contractual claims and/or common law claims.

Why do I need advice from a solicitor?

if you sign the Settlement Agreement you will not be able to bring a claim in the employment tribunal or courts. It’s therefore really important that you get advice so you know what claims you have, how valuable they are, so you can make an informed decision about whether to accept the settlement agreement offer.

Your employer also has an interest in you obtaining advice from a solicitor because otherwise the written agreement (even if signed by you) will not legally prevent you from bringing statutory employment claims, for example unfair dismissal or discrimination.

Who pays for the employee’s solicitor?

It is normal practice for the employer to make a contribution towards the cost. The solicitor will send the invoice directly to your employer, after the Settlement Agreement is concluded. An employer’s contribution may vary. Usually an employer will offer between £250 and £750 excluding VAT. But the contribution can be more in some instances. Many of the solicitors in our ‘find a solicitor’ directory will agree to limit their charges to the employer’s contribution, so you don’t have anything to pay. But check with the solicitor.

To protect employees who may be unaware of their legal rights, the law states that Settlement Agreements are not legally enforceable unless they meet certain minimum requirements:

  • The agreement must be in writing.
  • The agreement must relate to ‘particular proceedings’ i.e particular complaints that the employee may have.
  • The employee must identify a relevant independent adviser from whom the employee has received advice as to the terms and effect of the proposed agreement and in particular its effect on the employee’s ability to pursue their rights before an employment tribunal.
  • The adviser must be covered by professional indemnity insurance.
  • The agreement must state that the legal conditions regulating settlement agreements are satisfied.

If the agreement does not comply with these minimum legal requirements, it will not be valid and an employee will still be able pursue a claim against their employer, although he/she will probably have to repay any monies received, or they will be deducted from any compensation the employee is awarded.

What terms might a Settlement Agreement include?

The terms included in a Settlement Agreement will vary depending on the circumstances of the particular case. However, it is common for Settlement Agreements to contain clauses dealing with the following:

  • The date employment terminated
  • List of claims settled
  • Settlement package including when payment will be made and by what method
  • Parties understanding of the tax position
  • Tax indemnity from the employee
  • Reminder of any restrictive covenants or confidentiality obligations in the contract
  • Confidentiality about the fact, content and circumstances of the agreement
  • Obligations on the employee or both parties not to make or publish any derogatory comments
  • An agreed reference
  • Repayment provisions for breach by the employee of the settlement agreement
  • Employer contribution to the cost of obtaining legal advice on the terms of the agreement
  • Arrangements on termination

Guide:  The usual terms you find in a settlement agreement (explained)

Ask an Expert: Am I entitled to a job reference?

Are there any claims that cannot be settled by a Settlement Agreement?

Not all claims can be settled by means of a Settlement Agreement, for example the right to statutory maternity, paternity and adoption pay and claims under the Agency Workers Regulations 2010.  It is also usual for an agreement not to compromise an employee’s accrued pension right. There is usually a clause dealing with personal injury claims stating either that the agreement does not affect any personal injury claim that the employee may have or a clause signing away the employee’s right to pursue claims for injuries of which he/she is already aware.

Resource: A list of statutory claims that cannot be settled under a settlement agreement.

Is a Settlement Agreement legally binding?

The agreement is legally binding when it meets the legal requirements as identified above and is signed by both parties.

Other methods of settling claims and/or ending the employment relationship

Where an Acas conciliation officer assists in the negotiation of the settlement of an employment tribunal claim (or potential claim), a COT3 agreement is used to record the terms of settlement. A COT3 agreement is a much simpler straightforward agreement that does not have to adhere to the formalities of a settlement agreement because it is negotiated with the assistance of an Acas conciliation officer.

Can we help?

For solicitor advice, please call 0800 088 4021.

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