Settlement Agreements

Settlement agreements can be an effective way to manage the end of an employment contract.

What is a settlement agreement?

A settlement agreement (previously known as compromise agreement), is a legally binding and confidential agreement between an employer and an employee. The employer offers the employee a financial sum, and in return, the employee agrees to waive their rights to bring a tribunal or court claim against the employer. Additionally it can be used as a tool to enhance restrictive covenants as well as agreeing as to how to communicate the employee’s departure.

When should a settlement agreement be used?

Settlement agreements are used by employers in various situations. They are a way of terminating an employee’s employment without having to undergo a potentially long and difficult process and where a quick exit is preferred.

What are the advantages of using settlement agreements?

Settlement agreements often reduce the time and stress of managing a difficult situation such as a grievance or disciplinary process. Often these internal processes involve managing just one person over a long period of time, which usually has a negative impact on the wider team. Termination of employment of said employee via a settlement agreement can therefore be beneficial to the morale of those employees remaining in employment.

Settlement agreements, if offered correctly, are often an amicable way of terminating employment on good terms, meaning less difficult conversations. Of course the main benefit of a settlement agreement is the fact that you are safeguarded against an employee making a claim in the tribunal or court.

What are the disadvantages of using settlement agreements?

Widely offering settlement agreements without particular discretion may result in employees expecting that they will always be paid a sum of money if there is a dispute. Another concern would be that employees may not resign if they are unhappy or will react poorly if you seek to dismiss them without offering a settlement agreement.

It is important that you use settlement agreements appropriately and not as a substitute for good management practices. You will also have to consider how you will manage the relationship post the offering of a settlement agreement if negotiations are not effective. If the negotiations are not clearly planned out the financial sum paid to the employee and time invested by both parties could get out of hand.

How much should the settlement be?

The agreement will specify any sums being paid to the employee. Normally this will include pay and other benefits up to the termination date, which will be subject to tax and national insurance in the normal way. In addition, the employee would expect to receive holiday pay (less tax and national insurance) for untaken holidays which have accrued during the period from the start of the holiday year up to the termination date.

Since the employee is waiving their right to bring any claims, the amount of compensation should reflect closely to the value of the claims they are giving up. We can advise you as to the proposed amounts as it is important to get this right at the outset to avoid extensive, time consuming and costly negotiations.

Who can sign off a settlement agreement?

For a settlement agreement to be effective, the employee must have received independent legal advice on the effect of the agreement; essentially that they are waiving their rights to bring an employment claim against the employer.

There is no equivalent requirement that the employer has to obtain legal advice, however, by having the settlement agreement correctly drafted at the outset will reduce the administration time and arguably the negotiations between the parties, therefore saving the employer money.

The employee’s adviser must be named in the agreement and have a current contract of insurance or professional indemnity insurance, covering the risk of a claim against them by the employee in respect of the advice. Hence why this will almost always be signed off by an employment lawyer. In most cases, the employer agrees to pay a contribution in relation to obtaining advice on the agreement.

Can I have a settlement agreement template?

If you have never given an employee a settlement agreement our team can help you draft one based on the particular circumstances. It is important that you get expert advice so that it is a fully inclusive agreement that will limit the amount of negotiations prior to signing or breaches after signing.

Can you review my existing settlement agreements?

If you have used settlement agreements in the past but would like to make sure they are effective our team can also review them.

Our tips when offering a settlement agreement:

Facing a legal claim after they have signed the settlement agreement?

There are some claims which cannot be waived via a settlement agreement. Typically these are claims for accrued pension rights, unknown personal injury claims or a claim for breach of the settlement agreement, ie: if you haven’t paid the employee the sums outlined in the settlement agreement.

More information

You can access further information on Settlement Agreements by viewing our Settlement Agreements FAQs or visiting our Legal Resources centre.

Are you an employee that has been offered a settlement agreement?

If you are an employee that has been given a settlement agreement that you would like reviewed please visit our Settlement Agreements for employees page.

How can we help?

Our employment law team have significant experience advising employers and employees on settlement agreements. This experience allows us to draft effective settlement agreements and provide advice on negotiations. If you would also like advice please do not hesitate to contact our employment team here.