What is a settlement agreement and when will it be used?

A settlement agreement is a legally binding agreement made between an individual and their former employer. Usually, these agreements will be reached after the employer has agreed to pay the employee a sum of money on the understanding that no legal proceedings will be forthcoming. Sometimes these agreements are referred to as redundancy or severance agreements and were previously known as compromise agreements.

Settlement agreements are usually drawn up once negotiations have concluded following an employment dispute. They are also commonly used when an employee has agreed to an enhanced redundancy package. Depending on the nature of the specific settlement agreement, there may be types of claims listed that the employee will be prevented from bringing.

Is a settlement agreement legally binding?

Yes, a settlement agreement will be legally binding, provided that specific requirements are met. Firstly, an employee who has signed a settlement agreement must have received independent legal advice before doing so. As part of this advice, the solicitor must ensure the employee has been informed of any potential claim they may have in the future so that they are fully aware of the legal issues that are at stake.

The employee must also be made aware of the value of any possible claims. Employees should seek advice from an experienced employment lawyer at the earliest stage to ensure their position is protected during the negotiation stage of the settlement agreement.

The other requirements for a legally binding agreement are that the agreement:

  • Is in writing
  • Is signed by the employee
  • Relates to a specific proceeding or complaint
  • Identifies the employee’s legal advisor and that their advisor is insured
  • States that the requirements regulating a settlement have been satisfied

What are the benefits of signing a settlement agreement?

  • Employees who sign a settlement agreement can receive up to £30,000 (tax-free) in compensation.
  • Your employer will cover all of your legal costs.
  • A settlement agreement offers you the benefit of knowing that no litigation will take and that all your rights and obligations are contained in a single document.
  • You can also be sure that your reputation and references will be protected ensuring you can move smoothly to a new employer. 

What will be included in my settlement agreement?

While settlement agreements can differ depending on the workplace and the circumstances of the employee’s departure, most will include information regarding:

  • Payment of notice and if appropriate a gardening leave clause. 
  • Your termination payment – how much and when payment will be made. 
  • Employee warranties – these are the promises that you have made as part of the settlement agreement, e.g. not to make a claim against your employer in the future. 
  • Confidentiality and reputation protection. 
  • Any additional benefits, e.g. car allowance, healthcare. 
  • Handover and practical steps, eg return of company property, and a leaving accounceement. 

 Negotiation of setttlement agreements:

  • It is often possible to negotiate more money. The whole point of agreeing a potential sum of money to compromise any claims is that it should be of interest to both parties.  Therefore it is also important to be realistic as well as bullish during negotiations.
  • Generally it is not a good idea to resign whilst negotiating.  Please speak to one of our solicitors if you are thinking of resigning.
  • Often an employer will give a strict deadline for you to agree and sign the Settlement Agreement, often at short notice.  However this deadline is sometimes negotiable and if your employer has gone to the lengths of preparing a draft Settlement Agreement, it is a good idea to explain that you need a reasonable amount of time to consider it and seek legal advice.
  • You may wish to issue a grievance.  
  • When negotiating a Settlement Agreement it is good practice to mark all correspondence “Without Prejudice”.

From straightforward, pre-agreed settlements to more complex arrangements that incorporate bonuses, share options and Long Term Investment Plans (LTIPS), we can advise on all aspects of your settlement agreement negotiation.

Tax on settlement agreements

  • A Settlement Agreement should state the correct amount of notice applicable.Since April 2018 payment in lieu of notice (PILON) is subject to tax and National Insurance deductions.
  • Compensatory payments for loss of employment are generally tax-free (up to £30,000). 
  • Compensation apportioned to discriminatory (injury to feelings) is tax-free.
  • Redundancy payments are also tax free, as long as the payment is less than £30,000.
  • There is now the need to use the OT tax code in relation to ex-gratia payments that are greater than £30,000. The appropriate rate is then applied: 20%, 40% or 45%. 

Legal fees

Generally, your employer will agree to fund the advice needed to negotiate and sign a Settlement Agreement on your behalf.

Time Limits

Even though you may be negotiating with your employer, you must always be mindful of the time limits that still apply to any potential Tribunal claim.  It is therefore advisable to complete an ACAS form prior to the time limit expiring.

What happens if I break the terms of my settlement agreement?

As a settlement agreement is a legally binding contract, there can be severe consequences if you breach the terms of the agreement.

Your employer may seek compensation for breach of contract or apply to the court for an order ensuring you comply with the terms of the agreement. Your employer may also try to recover any sum they have paid out to you under the agreement if you have breached its terms.

Contact Our Settlement Agreements Lawyers

Our settlement agreement solicitors can take the time to go through your options with you in detail as part of our comprehensive employment law service. Call us today on 0207 458 4633 or complete our online enquiry form.

Do you need help? Request a free consultation now.

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Mark Sellek
Solicitor View Mark's Profile

"I am very pleased with the outcome I reached with Mark who represented me at the employment tribunal against a local authority who dismissed me unfairly. My case did not go all the way to a full hearing but a settlement and a guaranteed reference was an outcome I have continued to he happy with. I found him responsive and his arguments well analysed and presented. You also get a sense that he is experienced in supporting clients to put well constructed cases against big organisations. I would contact him if faced with similar issues again therefore I would recommend him to others"

A. Abdi


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