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An Employer’s Guide to Settlement Agreements

Employers can offer settlement agreements to employees as a means of ending their period of employment.

Previously known as compromise agreements, settlement agreements are entirely voluntary and can offer both parties a clean break.

In a settlement agreement, the employee waives their right to any legal claim against the employer, and the employer offers a settlement payment to the employee.

Once both parties sign the agreement, it is a legally binding document.

Why Should You Offer a Settlement Agreement?

You can offer a settlement agreement to an employee at any stage of their employment. It is a useful alternative to lengthier procedures for ending someone’s employment, such as redundancy, disciplinary or capability procedures.

Under employment law, your employees have various protections. When it comes to dismissing an employee, these protections ensure that you act correctly. As an employer, you want to avoid the potentially high cost of employment tribunal claims.

Also, formal redundancy procedures involve time and resources, and can only apply in certain circumstances.

Therefore, it’s worth considering a settlement agreement as a practical alternative for ending an employee’s term of employment while avoiding conflict or additional expense.

How Do You Make a Settlement Offer?

You should discuss the settlement offer with your employee first. You can begin these discussions at any time, and they can be either verbal or in writing.

During these discussions, you can propose the settlement, agreeing on what terms it should include.

These will include the settlement payment and other non-financial terms (see below).

All discussions should take place without prejudice. This means anything either party says during discussions cannot be used in any subsequent legal action or tribunal claim.

Once you’ve tabled the agreed offer, you should give the employee a reasonable amount of time to decide. ACAS recommends 10 calendar days.

After reaching an agreement on the terms of the proposed settlement, you can draft a formal written agreement for the employee.

How Should You Calculate Settlement Payments?

You’ll need to take various factors into account when calculating the settlement payment offer you make:

  • How long the employer has worked for you
  • Your reasons for offering a settlement agreement
  • How long it would take you to resolve matters without a settlement
  • The potential cost and liability of an employment tribunal and having to defend a claim
  • How difficult it would be for you to fill the employee’s position
  • How long it might take the employee to find a new job.

You’ll need to weigh up these various factors and tax issues – you can offer up to £30,000 tax-free to an employee.

What are Non-financial Settlement Terms?

Besides the settlement payment, the agreement will usually include non-financial terms.

One example is the reference you provide for the employee.

You may also wish to include and non-disclosure clauses. These prevent the employee from revealing the terms of the agreement, or the payment, to others.

Clauses preventing the employee from making derogatory comments about the employer are also a common feature of non-financial settlement terms.

In some circumstances, you may want to include clauses that prevent key employees from working with similar employers in your industry for a specified amount of time.

You may need to negotiate some, or all, of these non-financial terms with the employee.

What is the Formal Written Agreement?

After you’ve agreed on what you will include in the agreement with the employee, you must then submit a formal written agreement to them.

This should include all the detail you’ve agreed and it must meet certain statutory requirements for it to become legally binding:

  • It must be in writing
  • The agreement must relate to a specific complaint or proceedings
  • It must be made by an independent lawyer, and include their name must be included in it
  • The agreement must set out what it intends to happen
  • It must state that it meets the statutory regulations covering settlement agreements.

If the formal written agreement you submit fails to meet any of these statutory requirements, it cannot be a valid legal document.

At this stage, the employee must take independent legal advice from an adviser who is named in the agreement. Typically, this advice will come from a solicitor. Normally, the employer pays the cost of the employee taking this advice.

This part of the process is essential if the settlement agreement is to become legally binding.

The solicitor will advise the employee on the impact of the settlement on their legal rights to pursue any claims against you (the employer).

They will also provide a signed certificate that confirms they have given the employee relevant legal advice.

If on receiving this advice, the employee is satisfied with the terms of the agreement, they should sign it. If, on the other hand, they query various terms or uses of wording, you may need to amend and redraft the formal written agreement.

It makes sense to have proper legal support and advice of your own when making a settlement agreement offer.

Are there any Potential Disadvantages?

Settlement agreements can be highly effective in ending terms of employment without dispute or lengthy procedures.

However, as an employer, you should be aware of potential disadvantages.

There is the cost of paying out the agreed sum, and you must weigh this up against going to a tribunal, and whether you would defend a claim successfully.

You should also consider what impact a settlement agreement will have on your workplace culture and whether it will affect your relationship with other employees.

Finally, these types of agreements are voluntary, so there’s always the risk that negotiations will break down, further complicating your relationship with the employee concerned.

It’s always important to get sound legal advice before making a settlement offer, to try and ensure that the process is successful.

What happens if you breach a Settlement Agreement?

If an employer breaches a settlement agreement, serious legal and financial consequences can follow. These agreements are legally binding and outline resolution terms for disputes. Breaching the agreement may prompt the employee to take legal action, seeking enforcement and potential damages. The employer’s reputation could also suffer, leading to negative publicity. Both parties usually aim to honor the agreement to avoid these unfavorable outcomes.


What happens if a settlement agreement is rejected?

Initially, you can simply leave it how it is and not follow up with any further action. However, consideration should be made as to the reason why the agreement was suggested from the start. Due to this, it is unlikely to be the best way to resolve issues. Employers ought to try to improve communication, training or working arrangements to help improve staff motivation and engagement.

If the agreement arose due to a performance or disciplinary issue then an investigation surrounding this can be resumed but we would encourage the importance of a fair process so as to protect yourself from any claims of unfair dismissal.

Employers cannot put pressure on the employee to attempt to force them into the agreement. If this seems to be the case, then an employee may be able to rely on the negotiations if they bring a claim in the future.

For more information about settlement agreements, please call us on 0800 088 6004, or complete our online contact form, and we will be in touch as soon as possible.