The Employer’s Guide to Settlement Agreements

As an employer there are a variety of circumstances where you might want to agree an employee’s exit from the business on mutually agreed terms and want the security of knowing that no litigation will follow. The most common way to achieve this is by using a settlement agreement.

Settlement agreements can benefit both employer and employee, but must be specific to the situation and comply with statutory requirements in order to be legally binding, so it’s vital to have the right legal support.

What is a settlement agreement?

A settlement agreement (formerly known as a compromise agreement) is a written document that sets out the specific terms and conditions agreed between an employer and the employee who is leaving.

It’s a full and final settlement of all potential claims the employee may have against the business, and usually involves the employer making a payment to an employee in return for them agreeing not to bring (or continue with) any tribunal or court claims against the employer.

A settlement agreement is one of only two ways to effectively settle both contractual and statutory claims against an employer (the other is to use a COT3 Agreement through ACAS).

Using settlement agreements effectively

Settlement agreements are another tool that employers can use alongside performance management or disciplinary and grievance procedures to deal with workplace problems, resolve an issue or formally end employment.

They can be used by both sides in a dispute but are usually proposed by employers and can help to end an employment relationship in a mutually acceptable way.

One of the requirements for a settlement agreement to be legally binding is that an employee must take independent legal advice (usually from a qualified solicitor) on the terms of the agreement and to help them understand the effect these terms have on their employment law rights. Employers will usually contribute towards the cost of the employee taking such advice.

Key features of a settlement agreement

The specific details of a settlement agreement will always be unique to each individual case, but the structure of these agreements usually have these same key features:

– They are legally binding

– They waive an employee’s rights to bring any claims covered by the agreement

– The employee usually receives a financial payment (and often a reference)

– They are completely voluntary and cannot be forced upon an employee

– There is usually some form of negotiation (in relation to the payment or terms)

– Negotiations are often confidential (even if the agreement isn’t completed)

When might settlement agreements be used?

If an employee tells their employer that they believe they have a claim against them, the employer may want to settle those claims by asking the employee to enter into a settlement agreement.These claims can be made under statute, under an employee’s contract of employment, and under other common law rights that the employee has such as negligence.

Claims can relate to any part of the employment relationship, whether it be the recruitment process, a situation during their employment or on termination of employment following a disciplinary or grievance process, or when a redundancy process has been instigated.

Settlement agreements can also be applied effectively in less complex situations where the employment relationship has simply broken down or is no longer working, and both parties feel that a clean break would be the best way forward.

What’s the process for settlement agreements?

To maintain control over the process, an employer would usually produce a draft settlement agreement which is then negotiated with the employee. The extent of the negotiation process can depend on several different factors:

– The seniority and remuneration package of the employee

– The value of the settlement package on offer

– The validity and complexity of any claims

– Whether the employee is departing on amicable terms

Settlement agreement clauses

To protect its position, the employer should consider including certain clauses in a settlement agreement that cover the following areas:

– Keeping all details of the settlement confidential

– Any continuing obligations of the employee such as post-termination restrictions (e.g., non-solicitation of customers/key employees)

– Preventing the employee from making any derogatory comments about the employer or its officers or employees

It’s also important to be clear about the taxable nature of any payments to be made to an employee in the settlement agreement, to avoid scrutiny by HMRC.

Pros and cons of using settlement agreements

There is no one size fits all when using a settlement agreement and as an employer it’s important to consider the potential advantages and disadvantages before proposing one.


– Can provide an alternative solution to a serious workplace problem

– Can provide a dignified end to a broken employment relationship

– Can avoid the time/cost/stress involved in exhausting internal processes or a tribunal or court claim

– Can provide a tax efficient way to compensate an employee

– Gives the employer reassurance that no claims will be brought against them once the employment relationship has ended.


– Potential cost of an agreed financial sum for the employee

– Potential risk to the relationship if a settlement is not agreed

– Risk to employee relations in the wider workforce if used inappropriately

Our team are experienced in both employment law and human resources and are well equipped to advise and support your business when dealing with settlement agreements.

Contact us today for an informal chat to find out how we could help.