Settlement Agreements – A Brief Guide

February 6, 2016

What is a settlement agreement?

Settlement agreements (formerly known as compromise agreements) are legally binding contracts between an employer and an employee (or worker). They are one of a limited number of ways in which employment disputes can be settled. In addition, extensive regulation of the employment relationship means that many employers prefer to cut short normal process and procedure (and the risks of litigation) by offering favourable terms to an employee under a settlement agreement.

Typically, an employee accepts a sum of money (and possibly other benefits) in return for agreeing to not bring certain claims against the employer. Settlement agreements often, but not always, involve the termination of the employee’s employment.

Can an employee be forced to sign a settlement agreement?

Employees cannot be forced to sign a settlement agreement and employers cannot be forced to offer one. However, it is often in both parties’ interests to resolve disputes (or potential disputes) swiftly and without having the cost, inconvenience and stress of having to deal with claims in the employment tribunals or courts. It also avoids litigation risks posed to each party, each side having certainty and protection.

What constitutes a valid settlement agreement?

The law sets out conditions which must be satisfied if the settlement agreement is to be valid and effective. The conditions are:

  • The agreement must be in writing.
  • It must relate to particular complaints or proceedings.
  • The employee must receive advice from a ‘relevant independent adviser’ as to the terms and effect of the agreement, and, in particular, its effect on their ability to pursue their rights before an employment tribunal.
  • The adviser must be insured.
  • The agreement must identify the adviser.
  • The agreement must state that the conditions regulating settlement agreements are satisfied.

What are the main effects of a settlement agreement?

Providing that the agreement is valid, the employee will be prevented from bringing or pursuing claims in the employment tribunals in relation to statutory rights. Most settlement agreements will also have express provisions to prevent the employee from bring other claims, such as contractual claims and/or common law claims, which could be brought in the courts. Where the agreement involves termination of employment, the main effect is often to achieve a ‘clean break’ in the employment relationship; the employee receives benefits under the agreement and the employer obtains peace of mind from the protection against claims being brought against them.

What are the limits of a settlement agreement?

There are certain areas in which a settlement agreement will not protect an employer, no matter how carefully worded they are. For example, although existing personal injury claims can be settled, it would be unlawful to settle any future personal injury claim. It is also not possible to waive any accrued pension rights under occupational pension schemes, except in exceptional circumstances.

Either party to the agreement will also be able to enforce the terms of the settlement agreement if they are breached.

What are the benefits to the employer?

The employer has the benefit of knowing that it will not have to deal with any tribunal claims, therefore avoiding the inconvenience, costs and risks that would be otherwise be a consequence.
Employers can also take steps to protect their business by including clauses to deal with issues such as:

  • Keeping confidential the circumstances leading up to the agreement and any termination of employment, as well as keeping confidential the fact and terms of the settlement agreement.
  • Making sure that and confidential information (e.g. trade secrets or information relating to the business of affairs of the company) is returned, not disclosed to anyone and not copied.
  • Reiterating any restrictive covenants in the employee’s contract of employment.
  • The provision of warranties by the employee, as well as setting out consequences of breach of those warranties by the employee.

What are the benefits to the employee?

Providing they comply with their obligations under the agreement, employees will have the benefit of any payments made to them. They do not have to incur legal costs for representation in any legal proceedings, neither do they face the risk of not succeeding with some or all of their claims. In addition, employees can obtain other types of benefit which the employment tribunals do not have power to award, such as the provision of a reference or outplacement counselling. Settlement agreements can also avoid the stress of tribunal proceedings, as well as achieving a swift resolution.

If the employer does not comply with its obligations (e.g. to pay the agreed compensation) the employee can take steps to enforce the agreement, generally as a breach of contract action in the County Courts.

Contribution to legal fees

Because it is a legal requirement for the employee to take independent legal advice, it is customary for the employer to contribute to the employee’s legal fees incurred in taking that advice. The amount of any contribution can vary. The amount of legal fees incurred by the employee can depend upon the circumstances of the case, including whether the employee only requires advice on the terms and effect of the agreement, or whether further work is required, such as more detailed advice on the merits and/or value of any claims, or whether any negotiations take place to change the wording in, or the payments under, the settlement agreement.

Tax position

Employees can receive up to £30,000 tax free if the money is being paid as compensation for termination of employment. However, payments made under the terms of the contract of employment (e.g. wages, notice pay, holiday pay), or non-contractual payments ‘that the employer is accustomed to make and/or that the employee could reasonably have expected to receive’ will fall to be taxed.

If a tax-free payment is being made, it is common practice for employers to seek an indemnity from the employee in relation to any subsequent demand from HMRC for tax and employee NI contributions.


The above is only a brief guide to some of the main issues to consider when dealing with settlement agreements. Each agreement needs to be prepared or considered in relation to the specific facts and circumstances of each case.
Watsons Solicitors are able to provide expert advice on settlement agreements. For employees we advise on the terms and effect of draft settlement agreements, as well as negotiating more favourable terms and wording. We can also advise on the merits and value of claims.

For employers we prepare settlement agreements to ensure that the employer is properly protected, as well as advising employers on how best to broach the issue with an employee.

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