Compromise Agreements.

Settlement Agreements in Employment Law

A settlement agreement is a legally binding agreement between an employer and an employee or a worker. It usually records the terms on which employment will end, or on which an employment dispute will be resolved.

Settlement agreements were formerly called compromise agreements. The modern term is settlement agreement, although some people still use the old wording.

What Does a Settlement Agreement Do?

A settlement agreement usually prevents the employee from bringing specific employment tribunal or court claims against the employer, in return for agreed terms. These terms may include a termination payment, notice pay, holiday pay, an agreed reference, confidentiality wording and other practical arrangements.

Because the employee is giving up important legal rights, the agreement will only be valid if certain legal requirements are met.

Independent Legal Advice

An employee must receive advice from a relevant independent adviser before signing a valid settlement agreement. This is usually an employment solicitor, although some certified trade union advisers and advice centre workers may also qualify.

The adviser must explain the terms and effect of the agreement, including how it affects the employee's ability to bring employment tribunal claims. The adviser will usually sign an adviser's certificate confirming that advice has been given.

Who Pays for the Advice?

Employers commonly contribute to employees' legal advice costs. The contribution may cover a straightforward meeting and advice on the agreement, but it may not cover extended negotiation, complex tax advice or wider employment claims.

If the agreement is complicated or amendments are needed, the employee should check whether the employer will increase the contribution or whether the employee will need to pay any extra legal fees.

What Should Be Included?

A settlement agreement should clearly set out the termination date, payments to be made, tax treatment, notice arrangements, holiday pay, bonus or commission issues, benefits, company property, confidentiality, reference wording, restrictive covenants and any claims being settled.

The agreement should also explain when payments will be made, whether deductions will be taken, and what will happen if either side breaches the agreement.

Payments Under a Settlement Agreement

Payments may include unpaid wages, holiday pay, notice pay, redundancy pay, compensation for loss of employment, bonuses, commissions, pension contributions, benefits, legal fees, and agreed expenses.

It is important to distinguish between contractual payments, which are usually taxable, and qualifying compensation payments, some of which may be paid tax-free up to the statutory limit.

Tax and National Insurance

Unpaid wages, holiday pay, bonuses, commission and most benefits are usually taxable and subject to National Insurance in the normal way.

Payments that are equivalent to notice pay are also taxable and subject to National Insurance. This applies even where the employment contract does not contain a payment instead of notice clause, because the post-employment notice pay rules may still apply.

The £30,000 Tax Exemption

Some genuine compensation payments for loss of employment may be paid free of income tax up to £30,000. Amounts above that may be taxable.

The £30,000 exemption does not automatically apply to every payment made under a settlement agreement. The tax position should be checked carefully, especially where the agreement includes notice pay, bonuses, benefits, restrictive covenant payments, injury payments or foreign service.

Tax Indemnities

Settlement agreements often include a tax indemnity. This usually means the employee agrees to reimburse the employer if HMRC later decides that additional tax is due on payments made under the agreement.

Employees should understand this clause before signing. The employer is usually responsible for operating PAYE correctly, but a tax indemnity can still create future risk for the employee.

Restrictive Covenants

A settlement agreement may repeat, confirm or amend existing restrictive covenants. These clauses may restrict what the employee can do after leaving, such as working for a competitor, contacting clients, dealing with customers or poaching staff.

Restrictive covenants are not automatically enforceable. They are more likely to be enforceable if they protect a legitimate business interest and go no further than reasonably necessary.

Checking Future Work Restrictions

Employees should check restrictive covenants carefully before signing, especially if they have a new job, plan to set up a business, work in a specialist sector or rely on client relationships.

If the restrictions are too wide, unclear or likely to prevent future work, the employee should raise this with their solicitor before signing.

Confidentiality Clauses

Settlement agreements commonly include confidentiality clauses. These may prevent the employee from disclosing the terms of the agreement, the amount paid, or the circumstances leading to the settlement.

Confidentiality clauses should not prevent lawful whistleblowing, reporting a crime, co-operating with regulators, speaking to medical advisers, receiving legal advice, or making disclosures permitted by law. Acas says settlement offers should explain what a confidentiality clause means if one is included.

Non-Derogatory or Non-Disparagement Clauses

These clauses are sometimes called non-derogatory, non-disparagement or "slander" clauses. They usually prevent one or both sides from making damaging or derogatory comments about the other.

Employees may ask for the clause to be mutual, so the employer and senior managers are also restricted from making negative comments about the employee.

References

It is often sensible to agree on the wording of a reference as part of the settlement agreement. This can reduce uncertainty and help the employee move on to new employment.

Employers are not always legally required to provide a reference, but if they do, it should usually be true, accurate, and not misleading. The agreed reference may be attached to the agreement as a schedule.

Claims Usually Excluded

Some claims may be excluded from the settlement. Common exclusions include accrued pension rights, personal injury claims the employee is unaware of, claims to enforce the settlement agreement, and, sometimes, future claims that cannot lawfully be waived.

The employee should check exactly which claims are being waived and which rights remain.

Negotiating the Agreement

An employee does not have to accept the first offer. Possible negotiation points include the termination payment, notice pay, holiday pay, bonus, references, announcements, confidentiality wording, restrictive covenants, benefits, garden leave, legal fees, and the timing of payments.

The strength of the employee’s negotiating position will depend on the facts, potential claims, evidence, length of service, employer risk, and commercial considerations.

Protected Conversations and Without Prejudice Discussions

Some settlement discussions may be protected from being used as evidence in an employment tribunal or court. Acas explains that settlement discussions are sometimes referred to as protected conversations and usually cannot be used as evidence in certain proceedings.

Protection is not absolute. Improper behaviour, discrimination, automatically unfair dismissal issues, whistleblowing and other factors can affect whether discussions remain protected.

Before Signing

Before signing, the employee should check that all payments are correct, the tax wording is understood, the reference is agreed, restrictive covenants are acceptable, the termination date is correct, and all benefits, expenses, bonuses and holiday pay have been dealt with.

Employees should also gather relevant documents before the advice meeting, including the employment contract, staff handbook, payslips, bonus scheme, dismissal letter, grievance documents and any relevant emails or messages.

After Signing

Once both sides have signed, the agreement becomes binding. The employer should then make the agreed payments by the deadline in the agreement and provide any agreed reference or announcement.

If either party breaches the agreement, the other may bring a claim to enforce it. For example, an employee may be able to claim if the employer fails to make the agreed payment.

When Legal Advice May Be Needed

Legal advice is required for the settlement agreement to be valid, but further advice may be needed where the employee has potential claims for unfair dismissal, discrimination, whistleblowing, unpaid wages, redundancy, bonus, commission, restrictive covenants, tax issues or personal injury.

An employment solicitor can advise on the value of claims, whether the offer is reasonable, tax treatment, negotiation strategy, confidentiality, references, restrictive covenants and the legal effect of signing.

Current Position

Settlement agreements are widely used to end employment or resolve workplace disputes. They can provide certainty for both sides, but they also usually prevent the employee from bringing the listed claims in an employment tribunal.

Employees should not sign until they have received independent advice, understood the tax position, checked all payments and considered whether the terms are fair and workable.

Disclaimer

Solicitors.com is not a firm of solicitors and does not provide legal, tax, or employment advice. The information on this page is for general guidance only. It should not be relied upon as a substitute for advice from a regulated solicitor, accountant, tax adviser or other qualified professional. Employment law, tax rules and tribunal procedures can change, and how the law applies will depend on the facts of each case.

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