Commercial Contracts & Agreements
By Conal McGarrity
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A Guide to Settlement Agreements in Employment Law

What is a Settlement Agreement?

Settlement Agreements are legally binding contracts which usually see a payment of compensation being made by an employer in return for an employee agreeing not to pursue any claims relating to the employment.

Once a valid settlement agreement has been signed, the employee will be unable to make an employment tribunal claim about any type of claim which is listed on the agreement.

Reaching Agreement

For the settlement agreement to be legally binding the following conditions must be met.

  • The agreement must be in writing.

  • The agreement must relate to a particular complaint or proceedings.

  • The employee must have received advice from a relevant independent adviser, such as a lawyer or a certified and authorised member of a trade union.

  • The independent adviser must have a current contract of insurance or professional indemnity covering the risk of a claim by the employee in respect of loss arising from the advice.

  • The agreement must identify the adviser.

  • The agreement must state that the applicable statutory conditions regulating the settlement agreement have been met.

Is a settlement agreement payment agreement tax-free?

The tax position depends on the nature of the payments made under the settlement agreement. 

Wages, holiday pay, bonuses, commission, & contractual paymentsare all subject to usual deductions for income tax and national insurance.

Termination Payments, compensation, redundancy pay and/or ex-gratia payments.

Generally, the first £30,000 of compensation for loss of employment is not subject to tax or employees’ National Insurance contributions. Payments made over £30,000 are subject to tax. 

Payments in lieu of notice

From April 2018 all payments in lieu of notice taxable (contractual and compensatory) are expected to be taxable.

In what situations are Settlement Agreements used?

Settlement Agreements are used in many employment situations, including:


Settlement Agreements are often used in redundancy scenarios, where the employer offers to pay the employee more than the basic statutory redundancy pay entitlement. In exchange for paying more, the employer may require the employee to sign a settlement agreement.


The employer may not be happy with the employee’s standard of work. Rather than go through a formal performance improvement plan / procedure, the employer may decide to offer the employee an alternative to leave earlier in the procedure and receive a settlement payment under a settlement agreement.

Sickness / Incapability

If an employee is not capable of work because of illness or a lack of skill or experience, one option may be to agree to the employee leaving under a settlement agreement. Sometimes, both parties would prefer to agree an earlier amicable settlement rather than go through a long drawn out capability procedure that might end in dismissal.

Work relationship breakdown

Sometime the work relationship breaks down between the employer and employee, or the employee and colleagues. The parties may prefer to agree an amicable parting, where the employee receives a severance / termination payment.

Employee Grievance

The employee may have grievances and potential claims against the employer for the way she/he has been treated at work. Rather than bring employment claims, an agreement may be reached and recorded in a settlement agreement.

What happens if I accept the settlement offer and need a solicitor to sign it off?

If the settlement agreement is ready to sign, a solicitor will advise you on the terms and effect of the agreement and send a legal adviser certificate to your employer. In the present climate, this can be completed on the telephone and via email. 

How much does this legal advice cost?

There is usually a provision in the agreement for your employer to contribute towards your legal fees, subject to that contribution being reasonable, your solicitor will then invoice your employer directly when the agreement is signed-off.

What happens if I am not happy with the Agreement?

If you are not happy with the agreement, your solicitor will negotiate a Settlement and give careful consideration as to what is achievable under an agreement. 

Examples of changes to the Settlement Agreement wording

You may wish to make changes to the Settlement Agreement wording. For example:

  • Adding a clause to require your employer to provide a reasonable job reference to a new employer;

  • making sure all the payments, monies and benefits you are entitled to are covered (accrued salary, accrued holidays, bonuses, commission payments, shares, SAYE, private health cover, company car or car allowance). This is important because usually a settlement agreement will be drafted to be the entire agreement, meaning any payments or benefits not covered in the agreement will be lost;

  • an agreed internal or external announcement to colleagues and customers;

  • changes to the clauses dealing with tax (known as a tax indemnity);

  • amending or removing post-termination restrictions that may make it difficult for you secure new work; and / or

  • deleting clauses that are unreasonable / to remove or minimize risk.

Are there any claims that cannot be settled by a Settlement Agreement?

Not all claims can be settled by means of a Settlement Agreement, for example the right to statutory maternity, paternity and adoption pay and claims under the Agency Workers Regulations 2010.  It is also usual for an agreement not to compromise an employee’s accrued pension right. There is usually a clause dealing with personal injury claims stating either that the agreement does not affect any personal injury claim that the employee may have or a clause signing away the employee’s right to pursue claims for injuries of which he/she is already aware.

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