Guide: Employer’s Guide to Settlement Agreements

A settlement agreement (formally known as a compromise agreement) is a legally binding agreement between a business and an employee under which the employee agrees to settle their potential claims often in return the employer will agree to pay financial compensation. Sometimes the settlement agreement will include other things of benefit to the employee, such as an agreed reference.

Settlement agreements are more typically associated with the ending of an employee’s employment – issued either shortly before or after the employment has ended. However, settlement agreements can also be used when an employee’s employment is to continue with the business – for example, if the employee has alleged harassment and that allegation is upheld on investigation.

An employee can make a claim against the business under both their contract of employment (e.g. a wages claim) and under statute (e.g. discrimination and/or unfair dismissal claims).

The claims can arise:
• on recruitment;
• during employment; or
• when their employment has been terminated.

Accordingly, settlement agreements can be used at any point during the employment (or potential employment) relationship

• For a settlement agreement to be legally binding there are a number of conditions that must be met which include:
• The agreement must be in writing;
• The agreement must relate to a particular complaint or particular proceedings;
• The employee must have received legal advice from a relevant independent adviser (for example, a qualified lawyer or union official) on:
• the terms and effect of the proposed agreement; and
• It’s effect on their ability to pursue any rights before an employment tribunal
• The independent adviser must have a current contract of insurance (or professional indemnity insurance) covering the risk of a claim against them by the employee for the advice;
• The employee’s adviser must be identified in the Agreement; and
• The agreement must state that the conditions regulating settlement agreements have been satisfied.

Other than complying with the legal requirements listed above, the contents of a settlement agreement are largely at the discretion of the business and therefore subject to possible negotiation with the employee involved. Examples of common clauses include:

• Compensation for loss of employment.
• Contribution to the employee’s legal fees.
• A waiver of claims by the employee, including a warranty that the claims listed are the only claims which the employee has against the business.
• Re-assertion or modification of existing restrictive covenants and/or inclusion of new restrictive covenants.
• Re-assertion or modification of existing confidential information obligations and/or inclusion of new confidential information obligations.
• An Indemnity from an employee in relation to tax and national insurance contributions.

There are a number of statutory claims that cannot be settled by entering into a settlement agreement, such as some types of:

• Personal injury claims;
• Pension claims; and
• Claims following the transfer of a business.

Employees don’t necessarily need to have a claim or a particular dispute in order to be offered a settlement agreement, though in the majority of cases, a claim or dispute (or the expectation of one) will often be the reason for this.

If an employer needs to dismiss employees due to performance or conduct issues, or make them redundant, then specific processes must be followed to avoid a claim for unfair dismissal. A settlement agreement can be used as a means to bypass any redundancy/disciplinary/dismissal processes and proceed straight to a termination – avoiding the risk of any costly claims.

Additionally, even if there isn’t a redundancy situation or performance/conduct issue, an employer could simply use a settlement agreement to cut headcount.

Provided the settlement agreement is adequately drafted (which we can prepare or review for employers), an employee would agree to waive all types of claims, whether employment related or not, except for a few.

An employee cannot be required to waive claims for:

• enforcing the terms of the settlement agreement itself – i.e. if the termination payment has not been paid, reference has not been provided, etc.
• any personal injury that the employee is not or cannot be reasonably expected to be aware of at the date of the agreement; and
• accrued pension rights.

Recent case law (how cases have been decided in the past) indicates that it’s possible for employers to be able to settle claims that have not yet arisen or are not yet known about at the time of signing.

However, it is important for the settlement agreement to reflect this and for the correct and intricate wording to be used.

If an employee brings a claim that they had waived, then an employer can take a number of measures.

Provided the settlement agreement allows for these, an employer can:

• refuse to pay the termination payment;
• require repayment of the termination payment; and
• require payment of its costs (incl. legal costs) for suing the employee for the termination payment or having to defend themselves against the waived claim.

Depending on how the settlement agreement has been drafted, employers could also take the above steps for other breaches, too – i.e. speaking/posting about confidential matters, refusing to abide by their restrictive covenants, failing to return company property, etc.

On 10 October 2024, the Employment Rights Bill (“Bill”) made headlines as part of Labour’s promise to “Make Work Pay” and introduced 28 significant reforms to the employment landscape – you can find more on that here and here. One of these reforms include a ban on confidentiality clauses covering harassment and discrimination at work – meaning employees cannot be prevented from speaking about allegations of work-related harassment or discrimination.

Although most employers will have a regularly used settlement agreement template already in place, as a result of these expected changes, it would be best practice to have those reviewed and be ready for the impending changes – due to take effect in stages throughout 2026 and 2027.

Additionally, irrespective of the Bill, if the template that you use doesn’t account for the above recommendations, then you could be at risk of not being in the best position to protect your business – despite having paid employees in the first place for peace of mind.