A settlement agreement is a legally binding written contract between an employer and employee used to resolve an employment dispute or head off a potential dispute. Generally, the terms of an agreement will involve the employee receiving a payment in exchange for agreeing not to bring an employment claim in relation to specific matters. They were known as ‘compromise agreements’ before July 2013.
Settlement agreements can be used in a range of circumstances – most often (but not exclusively) when terminating an employment relationship. They can be in the best interests of both employer and employee because they can allow both sides to avoid a long, acrimonious and potentially expensive claims process.
However, it is essential that employees understand exactly what they are agreeing to before signing a settlement agreement to ensure it is fair and protects their best interests. For this reason, it is a legal requirement for employees to have independent legal advice before signing.
Let’s take a look at the key things employees need to know about settlement agreements, including when they might be offered, what they can include, practical considerations (such as tax implications) and why the right legal support is so important.
When would you be offered a settlement agreement
Employment settlement agreements can be used for a range of scenarios, including:
- Redundancy (individual or collective)
- Termination due to performance or capability issues
- Workplace disputes, grievances or disciplinary situations
- Discrimination or whistleblowing complaints
- Long-term sickness and mutually agreed exits
In general, they will be used where your employer is concerned that there is a risk you might take them to an employment tribunal.
Is a settlement agreement legally binding?
A settlement agreement will be legally binding, but only if it meets the conditions set out in Section 203 of the Employment Rights Act 1996.
These are:
- The agreement must be in writing
- It must relate to a specific complaint or proceeding
- The employee must have suitable time to consider the agreement
- The employee’s adviser must be named in the agreement and they must have current professional indemnity insurance
- The agreement must state that all statutory conditions have been met
- The agreement must be signed by all involved parties (including a signed certificate from the employee’s legal adviser)
What is included in a settlement agreement
Exactly what will be included in a settlement agreement will depend on the circumstances. Typical provisions include:
- The date on which the employee’s employment will end (where relevant)
- Any payment being made (including notice pay, accrued holiday, pension contributions and bonus/commission)
- A waiver of claims (i.e. the employee’s agreement not to bring an employment claim in relation to specific matters covered by the agreement)
- Agreed reference wording (if required)
- A non-disclosure agreement (barring either party from discussing the terms of the agreement)
- Non-derogatory clauses (preventing either side from saying anything negative about the other in future)
Settlement agreement vs compromise agreement vs COT3
The terms ‘compromise agreement’ and ‘conciliation agreement (COT3)’ sometimes come up in relation to settlements and can cause confusion.
Compromise agreement is an older term for settlement agreements used before July 2013. The name change was introduced by the Enterprise and Regulatory Reform Act 2013.
A conciliation agreement or ‘COT3’ is an agreement to resolve an employment dispute reached through early conciliation facilitated by Acas, which is a publicly funded employment dispute resolution service. They can offer an alternative to settlement agreements if you cannot agree terms directly with an employer.
Settlement agreement vs redundancy: What is the difference?
Redundancy and settlement agreements often go hand in hand. Redundancy is the process of selecting employees for termination because an organisation no longer needs them e.g. due to a reorganisation or downsizing. A settlement agreement may be offered to employees being made redundant to head off the possibility of them making a claim for unfair dismissal.
How much is a reasonable settlement agreement?
What is a reasonable settlement will depend on various factors, including:
- Your current salary
- The strength of any potential employment claim
- Your employer’s financial resources
It can be very complicated to work out what is a fair settlement, which is why it is so important to seek advice from an experienced employment lawyer. They should have the expertise to quickly determine the strength of your position and what a reasonable settlement might look like.
Tax on settlement agreements explained
The first £30,000 of a termination payment included in a settlement agreement is usually tax-free. However, Payment in Lieu of Notice (PILON) and other payments owed (such as for unused holiday entitlements) are taxed as normal.
Please note: This is intended as general guidance only and specific tax advice should always be sought for your individual situation.
Do you have to accept a settlement agreement?
No, signing a settlement agreement is completely voluntary and your employer must not pressure you to sign. They must give you reasonable time to consider the agreement (usually at least 10 calendar days) and ensure you have independent legal advice.
That said, it is often in your best interests to reach a settlement with your employer as this avoids the time and stress of pursuing an employment claim. A settlement also gives you a guaranteed outcome rather than the uncertainty of going to an employment tribunal.
Knowing whether to sign an agreement can be very difficult, which is why it is essential to have expert legal advice. An experienced employment lawyer can make sure you fully understand the proposed terms, then advise on whether they are fair or could be improved upon. If your solicitor believes a better settlement is possible, they can negotiate this with your employers on your behalf.
Without prejudice and protected conversations explained
If you have raised a dispute with your employer or former employer, then they may suggest a ‘without prejudice’ conversation to see if you can resolve the issue.
Nothing either party says in a without prejudice conversation can be used in any subsequent legal proceedings, so you can both talk freely without worrying about compromising your position.
A ‘protected conversation’ is an “off-the-record” discussion between an employer and employee, usually to discuss ending the employment relationship through mutual agreement. Rules for protected conversations are covered under Section 111A of the Employment Rights Act 1996, with the most significant being that neither side can refer to anything disclosed in the conversation in any subsequent proceedings.
It’s important to note that the confidentiality attached to both types of conversations is not unlimited. Neither prevents disclosure of details related to discrimination, whistleblowing, automatically unfair dismissal or improper conduct.
Why you need independent legal advice
It is a legal requirement for employees to receive independent legal advice before signing a settlement agreement. Without this, the agreement will not be legally enforceable.
An employment lawyer can protect your best interests by reviewing the agreement terms, explaining what they mean for you, flagging any potential risks and negotiating a better settlement where appropriate. This ensures you get the very best deal for your circumstances.
What happens after you sign?
After you sign the agreement, you can typically expect:
- Your P45 to be issued (if your employment is being terminated)
- Payment within around 7 to 28 days (this should be specified in the agreement), with any tax owed automatically deducted by your employer
If your employer fails to make payment or breaches other terms of the agreement, then you should contact your solicitor who can send a formal letter requesting prompt payment. If this does not work, then you can contact Acas, who can help to resolve the dispute. If this is not successful, then you may need to take your employer to a tribunal or civil court to secure payment or address other breaches of the agreement.
Your next steps if you’ve been offered a settlement agreement
If you have been offered a settlement agreement, your employer should give you at least 10 days to consider it and they must let you know that you are required to have independent legal advice before signing. Your employer will typically cover the cost of your legal advice, although they may specify a maximum amount they are willing to contribute.
Your employer may recommend a solicitor but you do not have to use the person they suggest. You are free to pick your own legal adviser and this is usually a good idea as it helps to ensure they are genuinely independent and only have your interests at heart. Your employer should still provide the same contribution to your legal fees whether you choose your own solicitor of your own choosing or one they recommend.
Our settlement agreement solicitors can provide expert, independent advice on an agreement you have been asked to sign. We’ll make sure you understand exactly what the terms mean and whether they are fair for your situation. If required, we can negotiate with your employer to secure an enhanced settlement, making sure you get the very best deal possible.
For a free, no-obligation consultation, please call us on 0800 043 3699, email info@mccannsettlementagreements.co.uk or use the enquiry form on our contact page. We aim to respond the same day during business hours.
Frequently asked questions
Is a settlement agreement the same as a compromise agreement?
Yes. ‘Compromise agreement’ was the term used for these types of agreements before July 2013. The name was changed to ‘settlement agreement’ after this under the Enterprise and Regulatory Reform Act 2013. In spite of the name change, the basic format and legal effects of settlement agreements are the same as compromise agreements.
Can I be forced to sign a settlement agreement?
No, signing a settlement agreement is entirely voluntary. If you feel you have been made to sign a settlement agreement under pressure from your employer, this could be grounds to have the agreement overturned.
How long do I have to consider a settlement agreement? The Acas Code of Practice recommends employees should be given at least 10 calendar days to consider a settlement agreement before signing. You can ask for longer if the offer is complex and it is important not to allow yourself to be pressured into signing before you are ready. This consideration time is when you should be seeking expert legal advice on the proposed settlement terms.
What happens if I refuse a settlement agreement?
If you refuse to sign a settlement agreement, what happens next will depend on the situation.
If the agreement relates to a termination, your employer may go ahead with ending your employment without an agreement in place or they may seek to negotiate with you to see if you would be willing to sign a settlement agreement with different terms.
If the settlement relates to a potential employment claim not involving termination, then your employment will continue and, again, your employer may attempt to negotiate an alternative settlement.
In either case, you have the right to move forward with an employment claim. In the first instance, this will likely need to be handled through Acas. Acas will guide you through an ‘early conciliation’ process to try to find an amicable resolution for your dispute. If this is not successful, you would need to take your claim to an employment tribunal, which will decide the outcome of your claim.
How much tax do you pay on a settlement agreement?
Generally, the first £30,000 of any termination payment made as part of a settlement is tax-free, but you should seek specialist advice on this before signing the agreement. Any contractual sums paid alongside a termination payment (such as for a contractual notice period, bonuses and outstanding holiday entitlements) are taxed as normal earnings.
Do I need a solicitor for a settlement agreement?
Yes. It is a statutory requirement for employees to receive independent advice from a relevant independent adviser (usually a solicitor) before signing a settlement agreement. Without this independent advice, the agreement will not be legally binding.
Who pays the legal fees for a settlement agreement?
The employer typically contributes towards the employee’s legal fees because a settlement agreement is only legally binding if the employee has had independent legal advice. In many cases, the employer’s contribution will cover the full cost of an employee’s legal advice, but this is not guaranteed so you should be clear about how much they will contribute. An employer may offer to cover the cost of a solicitor they recommend, but it is usually advisable to choose your own solicitor and your employer should still make the same financial contribution whoever you pick to advise you.
Can I still get a reference if I sign a settlement agreement?
Yes. Signing a settlement agreement does not prevent an employer from giving a reference and provision of a written reference can be included in the terms of the agreement. While an employer is not generally legally required to give a reference, if they do, it must be fair and accurate.
What is the difference between a settlement agreement and a COT3?
A settlement agreement and a COT3 agreement are both ways to resolve employment disputes, but the process used to reach the agreement is different.
A settlement agreement will be agreed directly between an employer and employee, with the support of their legal advisers. A COT3 or ‘conciliation agreement’ is reached through an early conciliation process facilitated by Acas.
In both cases, the employee typically receives a payment for signing the agreement, the terms of which mean they will be unable to take their claim to an employment tribunal after signing.
Can I claim benefits after signing a settlement agreement?
You may be able to claim benefits such as Universal Credit after signing if your employment has been terminated, but any payment you have received as part of the settlement may be used for means-testing. If you anticipate having to claim benefits or are currently in receipt of means-tested benefits, it is strongly recommended to seek expert legal advice on how your entitlements may be affected before signing a settlement agreement.