In Brief: A Practical Guide to Settlement Agreements
A settlement agreement is a legally binding way for UK employers and employees to end an employment relationship on agreed terms, offering certainty, confidentiality and reduced legal risk. In return for compensation and other agreed benefits, the employee waives specific legal claims. To be valid, strict legal requirements must be met, including independent legal advice and adherence to the ACAS Code of Practice. Settlement agreements are commonly used where relationships have broken down or disputes may arise, and they often involve negotiation. When handled carefully and drafted correctly, they can provide a clean, professional exit for both parties.
__________________________________________________________________________________________________________________________
Settlement agreements are a common but often misunderstood part of UK employment law. When handled correctly, a settlement agreement can provide a clean, legally secure way to end an employment relationship, protecting both the employer and the employee.
In this guide, we explain everything you need to know about settlement agreements.
What Is a Settlement Agreement?
A settlement agreement is a legally binding contract between an employer and an employee, usually used to bring employment to an end on agreed terms.
Under a settlement agreement UK framework, the employee agrees not to pursue certain legal claims (such as unfair dismissal or discrimination), in return for agreed compensation and other benefits.
Settlement agreements replaced compromise agreements in 2013 but serve the same purpose: offering certainty, confidentiality and risk reduction for employers.
What Is a Workplace Settlement Agreement?
A workplace settlement agreement is most commonly used where:
- An employment relationship has broken down
- There is a dispute or potential claim
- A role is no longer viable
- A disciplinary or grievance process is ongoing
- A protected conversation has taken place
Rather than continuing down a formal process, both parties may agree that parting ways is the best outcome.
Settlement Agreements in Employment Law
An employment law settlement agreement must meet strict legal requirements to be valid:
- It must be in writing
- It must relate to specific complaints or proceedings
- The employee must receive independent legal advice
- The adviser must be insured
- The agreement must confirm these conditions have been met
Without these elements, the settlement agreement contract will not be enforceable.
The ACAS Code of Practice on Settlement Agreements
The ACAS Code of Practice on settlement agreements provides guidance on how employers should approach settlement discussions.
Key principles include:
- Settlement discussions should usually be conducted as protected conversations
- Employees must not be pressured or threatened
- A reasonable period (typically at least 10 calendar days) should be given to consider the offer
- Employers should act in good faith throughout negotiations
Failure to follow the ACAS Code can undermine the effectiveness of a settlement and increase legal risk.
Making a Settlement Offer
A settlement offer is usually made after a protected conversation (one without prejudice) or following legal advice.
A typical offer may include:
- A settlement payment (often tax-free up to £30,000)
- Payment in lieu of notice (if applicable)
- Accrued but unused holiday pay
- An agreed reference
- Confidentiality clauses
- Confirmation of the settlement agreement reason for leaving
The wording of the reason for leaving is especially important, as it may affect future employment references.
What Is a Reasonable Settlement Agreement?
Many employers ask: what is a reasonable settlement agreement?
There is no fixed formula, but factors often include:
- Length of service
- Seniority of the role
- Salary and benefits
- Strength of any potential claims
- Likely cost and risk of litigation
As a general guide, settlement payments often range from one to six months’ pay, but this can vary significantly depending on the circumstances.
Settlement Agreement Negotiations
Settlement agreement negotiations are normal and expected. Employees are encouraged to seek legal advice, and advisers may propose changes to:
- Settlement sums
- Tax treatment
- Restrictive covenants
- References
- Confidentiality wording
Negotiating a settlement agreement should always be approached calmly and professionally. Employers should avoid emotional decision-making and focus on achieving a fair, defensible outcome.
Payment Settlement Agreements and Tax
A payment settlement agreement usually includes several elements:
- Compensation for loss of employment (often tax-free up to £30,000)
- Contractual payments (taxable)
- Employer contribution towards legal fees
It’s essential that settlement payments are clearly broken down to ensure correct tax treatment and avoid HMRC issues later.
Settlement Agreement Contract: What’s Included?
A well-drafted settlement agreement contract will typically cover:
- Termination date
- Settlement payment details
- Waiver of claims
- Confidentiality clauses
- Post-termination restrictions
- Return of company property
- Legal fee contribution
- Entire agreement clause
Clarity and precision are crucial. Poor drafting can expose employers to unnecessary risk.
Settlement Agreements: Common Employer Mistakes
When handling settlement agreements, employers should avoid:
- Rushing the process
- Applying pressure on employees
- Making informal or verbal promises
- Failing to follow the ACAS Code
- Using settlement agreements to bypass fair process without justification
Handled incorrectly, settlement agreements can actually increase the risk of claims rather than reduce it.
Settlement Agreement Example (Simplified)
A basic settlement agreement example might involve:
- An employee exiting the business following a breakdown in working relationships
- A settlement payment equivalent to three months’ salary
- An agreed reference
- Confidentiality clauses
- Legal fees paid by the employer
In practice, every settlement agreement should be tailored to the specific situation.
Final Thoughts
Settlement agreements can be a powerful and effective tool when used appropriately. For employers, they offer certainty, confidentiality and protection from future claims – but only when handled correctly.
If you’re considering a workplace settlement agreement, or need support with negotiations, drafting or risk management, taking expert HR advice early can save significant time, cost and stress.
At Wright People HR, we support employers through every stage of the settlement agreement process – from initial conversations to legally compliant outcomes.
Contact us today to discuss how we can help you navigate settlement agreement procedure or with any other HR issue.
