Settlement Agreement – How they work

17 November 2020

Settlement Agreement

If you have been offered a settlement agreement, you may be unsure about what exactly that means for you, your job and your career in general.

Settlement Agreements (previously known as compromise agreements) are most often used in an employer-employee relationship; however, if you have never been offered a settlement agreement before, it is understandable that you will have some questions.

A settlement agreement is typically used to settle an employment dispute or to bring the employment relationship to an end. In the current climate, many businesses are struggling to retain employees and keep their business going; a settlement agreement offers the opportunity for both the business and the employee to move on in a way that they find beneficial to them.

Regardless of the reasons behind a settlement agreement, there are some things that you need to know to fully understand what a settlement agreement is, how one might be used, and what should be included. In this article, we cover some of the most common questions about settlement agreements to help you understand the process and what you can expect.

What is a settlement agreement?

A settlement agreement is a legally binding document which sets out the conditions for ending an employer-employee relationship following a specific event, dispute, claim or proceedings. Typically, it will be the employer that suggests using a settlement agreement; however, an employee can also suggest the use of such a document and bring it to the attention of their employer.

Each settlement agreement is unique, and each employee is entitled to negotiate the terms and clauses with their employer until they are satisfied with what is being offered to them. The terms of the contract will be tailored to reflect the circumstances and dispute that led to its use.

Although usually, a settlement agreement will terminate the relationship between employer and employee, it is possible to use a settlement agreement and stay in your place of employment.

When an employee enters into a settlement agreement, they waive their right to bring a claim before an employment tribunal in relation to specific matters set out in the agreement. In return, the employer will generally provide a financial sum, a reference and negotiate a date to terminate employment.

What is required to make a settlement agreement legally binding?

In order for any settlement agreement proposed by your employer to be legally binding, it must meet the following requirements:

  • All settlement agreements must be in writing.
  • The settlement agreement must make reference to a specific dispute, complaint, event or proceedings.

    You must have received independent legal advice from an adviser, such as a lawyer or an authorised member of a trade union.


  • You must be given a reasonable amount of time to think about and discuss with your advisor the proposed terms of the settlement agreement. The ACAS Code of Practice on settlement agreements recommends that you should be given a minimum of 10 calendar days’ to consider a settlement agreement unless you and your employer agree otherwise.
  • Any independent adviser providing you with advice must have a contract of insurance or professional indemnity policy which covers the risk of a claim brought by the employee.
  • The settlement agreement must identify who your independent adviser is.
  • The settlement agreement document must clearly state that the applicable statutory conditions which regulate the settlement agreement have been met.

What terms should be included in a settlement agreement?

There are many things that a settlement agreement may cover, listed below are the most common terms and clauses that are included in settlement agreements.

  • A notice period

Where you have agreed to a period of notice before terminating your employment, this will be included in the agreement. This could be an amount of time, for example, four weeks from the date of the agreement, or a specified date in the future.

You may also agree on a payment in lieu rather than a notice period, or agree to be placed on garden leave. An important consideration is that any term you have agreed to matches or exceeds what is agreed in your employment contract and any statutory minimum notice period requirements. Your solicitor will be able to advise you on what notice period is most suitable for your circumstances.

  • Details of any payment that is to be made to you

Usually, a settlement agreement offer will include a financial sum. Where payment of a monetary sum is to be made to you, this should be set out explicitly and clearly in the settlement agreement document. The clause referring to the payment should detail:

–    The amount to be paid to you.

  • When payments will be made to you.
  • Whether you will be liable to pay tax on the sums paid to you. There should be a statement outlining tax indemnity. Whether you will be liable to pay tax will depend on the type of payment being made. In the UK, up to £30,000 of your compensation payment can be made tax free but this does not relate to any contractual sums such as a payment in lieu of notice or payment in lieu of accrued but untaken holiday entitlement. This is because the payment is made to you in respect of loss of employment and is not regarded as income. The tax statement will also set out whether tax is still to be paid or whether it has been paid already. The reason behind the tax statement in a settlement agreement is to enable HMRC to see whether tax is due on the payment. You may also wish to include in terms of the settlement agreement that your employer is responsible for notifying you of any demand for payment from HMRC.
  • Whether the payment made to you concerns the termination of employment or another matter. For example, payment may be in respect of outstanding holiday pay.


  • The disputes or claims the settlement agreement is to settle

Generally, the purpose of a settlement agreement is to bring an employment dispute to an end and to settle any potential claim you may have against your employer at an employment tribunal. Waiving the right to bring a claim in this way means that you will not be able to bring a claim at an employment tribunal at a later date concerning any of the issues set out in the settlement agreement. As a result, it is essential to set out clearly what issues the settlement agreement refers to.

There are exceptions to this general rule in law however, and employees cannot waive their right to some issues. You may still bring a claim:

  • To enforce the terms of the settlement agreement.
  • In relation to any matter concerning pensions.
  • Concerning any personal injury claim you may have against your employer that you have not yet raised and that you are not yet aware of.


A settlement agreement will also include a clause concerning employee warranties. Employee warranties are promises made by you about your time in the business, for example, stating that you have returned or will return all company property, or that you have not breached your employment contract. Warranties are an essential clause for your employer as if you are in breach of the warranties set out in the agreement; it may affect the enforceability of the agreement as a whole.

Confidentiality agreement

It may be in the interests of your employer that the contents of your agreement are kept confidential. As a result, it is very common for settlement agreements to include a clause relating to confidentiality. Where a confidentiality clause is included, you may not discuss the terms of the deal, or the reasons behind terminating your employer-employee relationship. The clause may also prevent you from speaking in a negative way about your employer, any of your colleagues or the business generally. The confidentiality clause may also be reciprocal, so your employer will be prevented from speaking negatively about you in your industry.

Any additional benefits you will receive

If you have enjoyed additional benefits as part of your employment, the agreement will set out whether you will continue to receive these benefits after the employment relationship has come to an end. This may include things such as shares or private healthcare, and if these benefits are not to continue once the relationship has been terminated, the financial sum you receive should reflect this.


Your employer may also ensure that the agreement includes a clawback clause. A clawback clause will be triggered where you have been paid the monetary amount set out in the agreement but you then later to go on to breach the terms of the agreement, for example, where you fail to return company property or breach another specific clause. The clawback clause allows your employer to reclaim or ‘clawback’ some of the money that you have been paid. Your solicitor should explain all of the terms and clauses in your settlement agreement so that you fully understand your obligations. In some situations, such a clause can be void as a penalty clause but our solicitor will explain this to you in more detail. Understanding your agreement fully will ensure that you do not inadvertently breach the terms of the agreement.

Favourable reference and company statement

It may be to your benefit to negotiate a favourable reference from your employer. You can approve the draft, and this will usually be attached to the agreement for you to use to seek new employment. In many businesses and industries, it is also common for your employer to put out a ‘company’ statement about your departure. This statement is designed to inform your colleagues and clients that you have left the business and can help put to rest any rumours that may be circulating. You can agree on the wording of this statement with your employer as part of the settlement agreement negotiation process.

Do I need to accept the terms of a settlement agreement?

When your employer suggests using a settlement agreement or presents you with a proposed settlement agreement, if it is something you wish to consider, you must seek legal advice on the substance of the agreement.

You do not have to accept the terms of the agreement that have been proposed and you do not have to agree to consider a settlement agreement. It is likely your employer will expect some level of negotiation if you do agree to consider it. If you are unsure or unhappy with the terms of any settlement agreement you have been offered, you should discuss this with a solicitor.

Your solicitor will look at the circumstances leading to a settlement agreement offer, and look to understand how much your case might be worth should it proceed to an employment tribunal. This will help inform how much your employer should offer you as financial compensation. Furthermore, they will discuss with you any specific terms that might be favourable to you. Your solicitor will then communicate your wishes to your employer’s legal advisors, and they may redraft the agreement to reflect these. You can also attend negotiation meetings, and your lawyer may be present. Once both sides are happy with the agreement, it will be signed and will become legally binding – granted all other legal conditions have been met.

What happens after I have agreed to the terms of a settlement agreement?

Once you have accepted the terms of a settlement agreement, received independent legal advice on its contents, and signed the agreement, you will return the signed agreement to your employer. They will provide you with a copy for your reference. Your employer will then note what is agreed to be the ‘termination date’ – this is the date your employer/employee relationship will come to an end. Your employer will create a timetable including your termination date and the dates on which compensation will be paid – along with any other key dates.

On the termination date, you will leave your employment and also waive your right to bring a claim against your employer at an employment tribunal in respect of any matters set out in the agreement. You will also then receive any agreed compensation and benefits on the dates set out in the timetable.

If you have been offered a settlement agreement by your employer, it is essential that you seek advice from a specialist employment solicitor so contact our award winning Employment law Team today. We will be best placed to advise you on the terms of the agreement and can help you to negotiate the best settlement for your circumstances.

We will also be able to advise you as to how much your claim may be worth at an employment tribunal, to help you understand whether a settlement agreement is right for your circumstances.

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The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.