Settlement Agreement: Navigating the Complexities in HR

settlement agreement, both the employee, paid tax free, employment contract

In this article, we'll delve into the intricacies of settlement agreements, highlighting their importance and utility.

What is a settlement agreement?

A settlement agreement is a legally binding contract between an employer and an employee. It provides for a severance payment by the employer in return for the employee agreeing not to pursue any legal claims in an employment tribunal.

This type of agreement is commonly used to resolve disputes or to formalize the terms upon which an employee's employment will come to an end.

One of the fundamental features of a settlement agreement is that it waives an individual's right to make a claim covered by the agreement to an employment tribunal or court. The employee must agree to this in exchange for a financial compensation or a benefit.

Settlement agreement vs compromise agreement

When delving into the realm of employment law, the terms 'settlement agreement' and 'compromise agreement' may appear somewhat interchangeable. However, it's important to clarify that these terms refer to the same legal document, just at different points in time.

Historically, 'compromise agreement' was the term used to describe a legally binding agreement between an employer and an employee under which the employee agrees not to pursue certain types of employment tribunal claims arising from their employment or its termination.

Such agreements were commonly used to resolve employment disputes, including unfair dismissal claims, discrimination claims, and improper behaviour issues.

In July 2013, the UK's Employment Rights Act was revised, and the term 'compromise agreement' was replaced with 'settlement agreement'. While the purpose and function of these agreements remain essentially the same - to offer financial compensation in return for the employee waiving their right to bring certain legal claims - this change was part of wider reforms aimed at making it easier for employers and employees to have 'protected conversations' about settlement agreements without fear that these discussions could be used against them in an employment tribunal.

A key point to remember is that for the agreement to be legally binding, the employee must have received independent legal advice on the terms and effect of the agreement.

Why do employers offer employee settlement agreements?

Employers may offer settlement agreements for a variety of reasons, often related to the resolution of employment disputes, the termination of employment contracts, or addressing improper behaviour.

These agreements provide a structured, legally sanctioned route to conclude matters in a mutually beneficial way for both the employer and the employee. Here are some key reasons why employers use settlement agreements:

Avoid Lengthy Tribunal Proceedings: Employment tribunal claims can be lengthy, costly, and emotionally draining for all parties involved. By offering a settlement agreement, employers can mitigate these issues, finalizing the matter in a more timely and cost-effective manner.

Confidentiality: A significant feature of a settlement agreement is the 'confidentiality clause'. This clause ensures that the terms of the settlement, and potentially the circumstances leading up to it, are kept confidential, protecting the company's reputation.

Control Over Costs: A settlement agreement allows an employer to manage their financial exposure more effectively. The employer can negotiate terms that are acceptable to them, including the amount of financial compensation to be paid.

Prevention of Future Claims: Settlement agreements usually include a waiver for future claims. This means that once the agreement is signed, the employee can't make future claims related to the terms outlined in the agreement, offering the employer peace of mind.

Parting on Good Terms: A settlement agreement can help preserve the relationship between the employer and the employee. This can be particularly important if the employee works in the same industry and the parties might cross paths in the future.

What is a PAYE settlement agreement?

settlement agreement, employment claim, A PAYE Settlement Agreement (PSA) is a distinctive agreement in the UK between an employer and the HM Revenue & Customs (HMRC). It allows the employer to make one annual payment to cover all the tax and National Insurance due on minor, irregular, or impracticable expenses or benefits for their employees.

PSAs are commonly used for items that would be tedious to include in payroll calculations. These might involve small or one-off payments where it's not worthwhile to alter an employee's tax code.

Must Read: Understanding UK Tax Codes: A Comprehensive Guide

These agreements are particularly useful in simplifying the process of reporting and paying tax on benefits provided to employees.

Under a PSA, the employer essentially agrees to bear the tax payable on behalf of the employees. The items covered by the agreement will not need to be reported on a P11D form, nor will the employees have to pay tax on them directly.

Instead, the employer calculates the grossed-up tax and Class 1B National Insurance contributions on these items and makes an annual payment to HMRC.

While a PAYE settlement agreement doesn’t directly correlate with a settlement agreement in the context of employment disputes, it is another instance of how employers can use legal agreements to simplify complex processes and ensure compliance with tax regulations.

Claims that cannot be settled by a settlement agreement

While settlement agreements provide a practical way to resolve many employment disputes, it is crucial to note that they cannot be used to waive all types of claims. There are certain statutory employment rights and claims that are protected by law and cannot be contracted out of using a settlement agreement. Some of these include:

Claims under TUPE: The Transfer of Undertakings (Protection of Employment) Regulations, or TUPE, provides certain protections for employees during business transfers. These include the right to be informed and consulted about the transfer, and the right to receive notification of employee liability information. A settlement agreement cannot waive these rights.

Claims under the Agency Workers’ Regulations 2010: Certain rights granted to agency workers, such as equal treatment in working and employment conditions and access to vacancy information, cannot be contracted out of through a settlement agreement.

Claims under TULR(C)A 1992: The Trade Union and Labour Relations (Consolidation) Act 1992 provides certain protections for employees in the event of a collective redundancy. These include the right to consultation with employee representatives. A settlement agreement cannot waive these rights.

Furthermore, a settlement agreement cannot waive an employee's statutory entitlement to certain payments and benefits. These include:

  • Statutory sick pay (SSP)
  • Statutory maternity pay (SMP)
  • Statutory paternity pay (SPP)
  • Statutory adoption pay (SAP)
  • Statutory shared parental pay (SSPP)
  • Statutory parental bereavement pay (SPBP)

Therefore, while settlement agreements can cover a wide range of employment issues, from unfair dismissal claims to discrimination claims, they have their limitations.

Useful Read: Unfair Dismissal Compensation UK : An ultimate guide

What should be included in a settlement agreement?

settlement agreement, proposed settlement, taking legal advice, restrictive covenantsA settlement agreement is a legally binding contract that, when done correctly, provides a 'clean break' for both the employer and the employee, offering certainty regarding the termination of the contract.

The components of the agreement should be tailored to the specific situation, ensuring the needs of both parties are addressed adequately. Here are the key elements that should typically be included in a settlement agreement:

Details of Parties Involved: Both the employer and the employee should be clearly identified within the document. This will typically include names, job titles, and contact information.

Claims Being Settled: The agreement should specify the nature of the claims that are being settled. This could be a dispute over unfair dismissal, discrimination, harassment, or any other issue related to the employee's employment rights. It should be explicitly stated that the employee is waiving their right to take these issues to an employment tribunal.

Termination Details: The agreement should stipulate the date of termination, providing clarity for both parties.

Severance Payment: The settlement agreement should outline the financial settlement to be provided to the employee. This may be a lump sum or could be structured as a series of payments over time. The tax treatment of this severance payment should also be detailed, clarifying whether it is a tax-free payment or if tax will be deducted.

Notice Period and Holiday Pay: The agreement should specify how the notice period and any outstanding holiday pay will be dealt with. This could involve the employee working through their notice period, being paid in lieu of notice, or a combination of both.

Reference: It is common to include agreed wording for a reference within a settlement agreement, ensuring that the employee can secure future employment without unnecessary obstacles.

Confidentiality and Non-Derogatory Clauses: The employee will usually agree to keep the terms of the settlement agreement confidential and not to make derogatory comments about the company or its employees.

Waiver of Claims: The agreement should specify that the employee is waiving their right to bring certain statutory, contractual, and tortious claims against the employer.

Return of Company Property: The settlement agreement may require the employee to return any company property in their possession, such as laptops, mobile phones, or documents.

Remember, settlement agreements can vary significantly depending on the circumstances, and it's crucial to seek legal advice to ensure that all legal obligations are met and rights are protected.

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ACAS code of practice in settlement agreements

The ACAS (Advisory, Conciliation and Arbitration Service) is an independent public body that provides free and impartial advice on employment rights, best practices, and dispute resolution.

In the context of settlement agreements, the ACAS Code of Practice offers important guidelines that can aid both the employer and the employee in ensuring a fair and transparent process.

Confidentiality of Terms and Negotiations: The ACAS code refers to Section 111A of the Employment Rights Act 1996, stating that the agreed terms and conditions within the settlement agreement can be kept confidential. It also asserts that any discussions or negotiations surrounding the settlement agreement can be confidential. This concept is often referred to as 'without prejudice', meaning that offers or discussions cannot be used against either party in future proceedings, such as an employment tribunal hearing.

Limits to Confidentiality: While the ACAS code emphasises the confidentiality of settlement agreements, it also clarifies that claims relating to discrimination, harassment, victimisation, whistleblowing, union membership, asserting a statutory right, breach of contract, wrongful dismissal, or any behaviours prohibited by the Equalities Act 2010 are not covered by the confidentiality provisions of Section 111A.

Improper Behaviour: The ACAS Code of Practice outlines that if either the employer or the employee engages in 'improper behaviour', the confidentiality provisions set out in Section 111A may not apply. However, what constitutes improper behaviour is for an employment tribunal to decide. Examples of improper behaviour may include harassment, bullying or victimisation, discrimination based on protected characteristics, physical assault or other criminal behaviour, and putting undue pressure on a party - for example, not allowing sufficient time to consider the agreement, or threatening dismissal without commencing a disciplinary procedure.

Navigating the intricacies of a settlement agreement can be a complex process. By adhering to the ACAS Code of Practice, both employers and employees can ensure that the process is fair, respectful, and compliant with employment law. For a more comprehensive understanding of the ACAS Code of Practice on settlement agreements, visiting the ACAS website ( is highly recommended.

Independent legal advice during settlement agreements

settlement agreement, compromise agreements

When it comes to navigating settlement agreements, seeking independent legal advice is not only beneficial but a legal requirement for the agreement to be legally binding. The aim is to ensure that both the employer and the employee are fully aware of the implications of the agreement and can make informed decisions.

Why Independent Legal Advice?

An employee who is presented with a settlement agreement by their employer is required by law to receive independent legal advice before signing the agreement. This legal stipulation under the Employment Rights Act 1996 ensures that the employee understands the terms of the agreement and the rights they are waiving, such as the right to an unfair dismissal claim or an employment tribunal claim.

Who Can Provide Legal Advice?

The independent legal advice can be provided by a solicitor, a certified and authorized member of a trade union, or a qualified advice worker. The advisor should have a clear understanding of employment law and be able to explain the specifics of the agreement, including its effects on the employee's employment rights, potential financial settlement or compensation payment, and future claims.

The Role of Legal Advisors in Settlement Agreements

Legal advisors will ensure that the terms of the settlement agreement are fair and in line with the employee's rights. They also look at the financial compensation offered and whether it adequately reflects the potential claims the employee could bring before an employment tribunal.

Who Pays the Legal Fees?

Typically, the employer contributes to the legal fees involved in seeking this advice, although the amount will depend on the specific terms agreed upon in the settlement discussions.

The Importance of Independent Legal Advice

Independent legal advice is crucial for employees to understand their rights, the full implications of the settlement agreement, and whether the proposed settlement is reasonable given their circumstances. Additionally, without this advice, a settlement agreement is not legally binding.

The ‘without prejudice’ and ‘protected conversation’ rules

In the context of settlement agreements, two essential principles often come into play: the 'without prejudice' rule and 'protected conversations.' Understanding these principles is crucial in conducting successful settlement discussions and establishing a legally binding agreement.

Without prejudice

The 'without prejudice' rule is a cornerstone of legal communications that facilitates open and honest negotiations between parties in a dispute. Essentially, it allows for candid conversations, enabling both the employer and the employee to propose terms and explore solutions without fear of their words being used against them in future legal proceedings, such as an employment tribunal hearing.

However, the 'without prejudice' rule only applies if there is an existing dispute between the parties, and the discussions are aimed at resolving that dispute.

This principle does not cover discussions that involve improper behaviour, which may include harassment, discrimination, or threatening dismissal without due process.

Protected conversation

Protected conversations, introduced under Section 111A of the Employment Rights Act 1996, are a newer concept in employment law. This rule allows employers to have off-the-record discussions with employees about ending their contracts under a settlement agreement.

These discussions cannot be referred to in an unfair dismissal tribunal claim, providing some level of assurance for employers.

It's important to note that protected conversations are limited in their scope. They do not apply to claims other than ordinary unfair dismissal, such as discrimination claims, automatic unfair dismissal claims, and constructive dismissal claims.

Furthermore, if there's an allegation of improper behaviour during these conversations, the protection can be forfeited.

Are employees required to sign a settlement agreement?

settlement agreement, termination payment, pre termination negotiations When it comes to settlement agreements, one of the key considerations is the employee's consent. So, are employees required to sign a settlement agreement? The short answer is no, employees are not obligated to sign a settlement agreement. A settlement agreement is voluntary.

As with any contract, this agreement relies on mutual consent. Both the employer and the employee must agree on its terms for it to be effective.

Negotiations during a settlement agreement

When dealing with a settlement agreement, negotiations between the employer and employee play a pivotal role. The process primarily aims to reach a consensus that serves the interests of both parties, avoiding potential future claims and litigation.

These negotiations often center on financial compensation, but they also involve other aspects such as return of company property and provision of professional references.

Best practices on how to approach negotiations

Navigating the negotiation process can be complex, and it requires a considered strategy. Here are some best practices on how to approach these negotiations:

Realistic Expectations

Employees need to understand that settlement agreements usually entail a financial settlement as the primary form of redress. Other forms of resolution, like reinstatement, are rare and typically impractical.

Ensuring that employees have realistic expectations of what they can achieve through negotiations can expedite the process.

Understanding the Other Party's Position

A key aspect of successful negotiation is understanding the other party's position and interests. By identifying their needs, negotiators can work towards a solution that provides a fair deal for both parties, creating a 'win-win' situation.

Clear Communication

Negotiators need to clearly articulate their intentions and positions, while also interpreting signals from the other party accurately. Miscommunication can lead to inflated claims or derisory offers, raising false expectations and complicating negotiations.

Emotional Detachment

Maintaining objectivity is critical during negotiations. Emotional detachment helps prevent personal acrimony between parties, which can obstruct the negotiation process.

Collaborative Approach

Rather than viewing negotiations as a battle, consider them as a collaborative effort. A solicitor's role should be seen as promoting their client's interests by cooperating with the other party's solicitor.

Confidentiality Provisions

Advisers need to consider whether negotiations will become admissible in any subsequent employment tribunal and/or civil court proceedings.

It's important to understand the 'without prejudice' rule and 'protected conversation' regulations during negotiations.

In conclusion, negotiating a settlement agreement requires a comprehensive understanding of employment law, clear communication, emotional detachment, and a cooperative approach.

It's always advised to seek legal advice to ensure fair and effective negotiations.

What is a reasonable settlement agreement?

A reasonable settlement agreement balances the interests of both the employer and the employee, providing a mutually satisfactory resolution to a dispute or termination of employment.

Determining what constitutes a reasonable settlement agreement often depends on the specific circumstances of each case, but there are several key factors that generally come into play:

  • Compensation Amount: The sum offered should be appropriate for the situation, considering aspects like the length of service, employee's salary, reasons for termination, and any potential claims the employee may have. The amount should also take into account the time, stress, and legal costs associated with pursuing a tribunal claim.

  • Notice and Holiday Pay: The agreement should clearly specify how the employee's notice period and outstanding holiday pay will be handled. This could involve paying in lieu of notice or actual work during the notice period.

  • Confidentiality: It is common for settlement agreements to include clauses to protect sensitive business information. Employees are usually asked not to disclose details about the settlement agreement or the circumstances leading up to it.

  • Reference: The agreement might include provisions regarding an employment reference, such as the content of the reference and to whom it can be given.

  • Waiver of Claims: The agreement should outline which potential legal claims the employee agrees to waive. In return, the employer typically provides compensation.

  • Taxation: A clear understanding of the tax implications of the settlement sum is necessary. Some parts of a settlement agreement may be subject to tax, while others may be tax-exempt.

The reasonableness of a settlement agreement is subjective and context-dependent. It's always recommended to seek independent legal advice to ensure the agreement is fair, comprehensive, and legally sound.

What happens if the employee breaches a settlement agreement?

If an employee breaches a settlement agreement, legal repercussions could ensue. Breaches may involve confidentiality, non-disparagement, future legal claims, or the return of company property. Violations could result in the employee facing claims for damages, court injunctions to prevent further breaches, or the need to return the settlement payment. The employer could also use the agreement as a defense against future claims. Therefore, understanding the implications of the agreement and seeking legal advice is crucial for employees to avoid potential legal disputes and financial liabilities.

Frequently Asked Questions

  • Settlement agreements and redundancies are different. A settlement agreement is a legally binding contract that resolves an employment dispute, often involving a financial settlement. Redundancy, on the other hand, is a form of dismissal due to the elimination of a particular role or business need.

    Useful Read: What is Statutory Redundancy Pay? A Guide for UK Employers

  • No, a settlement agreement is not the same as a dismissal. It's a contract that both parties agree to, often to resolve a dispute or end the employment relationship on agreed terms, which could include a dismissal.

  • The cost of a settlement agreement varies depending on its complexity and the legal advice obtained. Employers often cover some legal fees, but the total cost depends on the individual situation.

  • Yes, a settlement agreement is a legally binding contract that finalizes the terms of an employment dispute or the end of an employment relationship.

  • Yes, some elements of a settlement agreement may be subject to tax. Payments like notice pay and contractual payment are typically taxed as salary, while the first £30,000 of a compensation payment for loss of employment is often tax-free. Tax treatment can be complex, so it's advisable to seek legal advice.

Topic: Policies
Rinaily Bonifacio

Written by:

Rinaily Bonifacio

Rinaily is a renowned expert in the field of human resources with years of industry experience. With a passion for writing high-quality HR content, Rinaily brings a unique perspective to the challenges and opportunities of the modern workplace. As an experienced HR professional and content writer, She has contributed to leading publications in the field of HR.


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