Employee Guide to Settlement Agreements

10 March 2021

What is a settlement agreement?

A settlement agreement is a legal contract between an employee and their employer, in which the employer offers the employee a payment in exchange for the employee not bringing an Employment Tribunal claim (or multiple claims) against the employer.

A settlement agreement is often used because the employment rights of the employee have been breached in some way. Or it will act as a severance payment if the employer wishes to terminate the employment in a way that breaches the employee's employment contract.

A common misconception is that a settlement agreement will always result in the employment being terminated. This is not necessarily the case and some employees may settle a dispute with their employer in this way and then remain in their employment. This can be the case if the dispute concerns pay, workplace discrimination or holiday pay issues, for example.

What to do if your employer suggests a settlement agreement

Under employment law, an employer can offer a settlement agreement on a confidential basis. This means that the conversation between the employer and employee can be regarded as a “protected conversation” which means it can't be referred to in any unfair dismissal claims to the employment tribunal.

This doesn't apply if there are issues relating to discrimination, whistleblowing or health and safety.

If you have been offered a settlement agreement by your employer, then it’s important to know that you have the right to negotiate the terms of that agreement. You are in no way obliged to accept the offer or the terms. Also, you should be given a reasonable amount of time to consider the proposal. ACAS recommends a minimum period of 10 days.

The amount of compensation that has been offered should be a fair reflection of the seriousness of the dispute or breach of contract. It should also reflect the amount that you might expect to be awarded from a claim in the employment tribunal (although this amount could be affected if litigation is needed).

The details of any payments due and when they'll be paid should be included in the settlement agreement. You may also want to negotiate getting an agreed reference from your employer as part of the settlement, so you know what's being said about you to a prospective employer.

We'd always recommend getting legal advice from an Employment Solicitor, who can discuss your circumstances and talk through the terms of the settlement offer with you. The Employment Solicitor could then negotiate with your employer on your behalf to ensure that you receive a fair Settlement Agreement.

Your employer will usually pay for you to receive legal advice on the terms of your settlement agreement.

We only represent employees, meaning there is no conflict of interest as we don't deal with employers. Our fixed fee services mean there are no nasty surprises at the end of your claim.

We can provide legal advice on the meaning of the terms in your settlement agreement for a fixed fee (without any financial negotiations and without advice on the merits of any Employment Tribunal claims). Your employer will usually pay these legal costs. Details of our fixed fee pricing can be found on our settlement agreement page.

If you're not sure whether you are getting enough compensation as part of the settlement agreement, we can offer you strategic advice on your options. This may cost more as this is an additional service.

Negotiating a fair settlement agreement

Another option is to negotiate the terms of your settlement agreement with your employer directly, should you choose to do so. It’s a good idea to have decided how much compensation you are looking to get before you start negotiations. It’s also important to know your employment rights so that you are fully aware of any breaches that have been made by your employer, the implications of these breaches, the potential claims you could bring and the compensation that you may be entitled to as a result.

You can choose to negotiate with your employer face-to-face, though some people might not feel confident in doing this. You can carry out the negotiations in writing if you prefer, either by email or post.

All settlement agreement negotiations that take place between you and your employer are confidential. As a general rule, it is not possible for either side to use this correspondence in an Employment Tribunal. However, to be on the safe side, it’s a good idea when negotiating in writing to state that you are discussing the matter “without prejudice” or to ask your employer if you can have a “protected conversation” (see above). The inclusion of these terms means that the discussion is taking place off the record, and as such it cannot be used as evidence in an Employment Tribunal.

Will the compensation payment be taxed?

Most settlement agreement compensation payments made in England and Wales can be tax free up to the first £30,000, if the payment relates to compensation for the termination of employment. The amount of any payment over £30,000 will be liable to tax.

Payments made to an employee in lieu of salary or in lieu of holiday will be recognised as taxable earnings, so income tax and National Insurance will be payable on these. Any payment in lieu of notice is also liable to tax and National Insurance.

Making a settlement agreement legally binding

Once an agreement has been reached, in order for the settlement agreement to be legally binding, it must comply with the following requirements:

  • Specifically state the claims that it intends to cover (such as unfair dismissal)
  • The terms of the settlement agreement must be in writing
  • The employee must have received independent legal advice covering the terms and effect of the settlement agreement from an independent adviser
  • The adviser must be a qualified professional and have Professional Indemnity Insurance covering the risk of a claim
  • The independent adviser will need to be named in the settlement agreement
  • The settlement agreement must state that the applicable statutory conditions regulating settlement agreements have been satisfied

Once the settlement agreement is in place and is legally binding, you will have relinquished any right that you would have had to raise a claim against your employer in an Employment Tribunal.

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