Settlement agreements

What is a settlement agreement?

A settlement agreement is a legally binding contract between an employer and an employee or an ex-employee offering a way for employers and employees to resolve a dispute voluntarily, without the need for an employment tribunal claim.

A settlement agreement usually involves the employer making a payment to an employee or a former employee in exchange for the employee agreeing not to bring an employment tribunal claim against the employer. The agreement must be in relation to a specific complaint and cannot be a blanket agreement by the employee not to bring a claim under all circumstances.

The exact details of a settlement agreement will depend on the circumstances and can be tailored towards the specifics of the dispute and the goals of the two parties. They can include such things as a reference or leaving announcement, in addition to making a financial payment to an employee.

What can a settlement agreement be used for?

Settlement agreements can be used in a range of situations involving conflict or potential conflict between an employer and an employee or ex-employee, including:

  • to settle actual or potential workplace disputes
  • where there has been a dismissal, to ensure that there is been a clean break
  • for redundancies where an employee receives an enhanced redundancy payment
  • where there is no dispute, but the employer or employee nevertheless wants to terminate the employment.

Why do employers use settlement agreements?

Employers use settlement agreements for a variety of reasons, including:

  • safeguarding against possible future claims to an employment tribunal or county court
  • ensuring confidentiality is preserved after the employment has ended
  • ensuring post-termination obligations owed to the employer are preserved after the employment has ended
  • ensuring company property is returned
  • preventing employees from saying anything bad about the employer
  • providing an indemnity against tax-free payments.

Are settlement agreements good for employees?

This will entirely depend on the terms of the settlement agreement, which is why it is critical to have specialist legal advice. In general, however, settlement agreements can offer many advantages for employees, including:

  • allowing an employment dispute to be resolved quickly, without waiting for an employment tribunal
  • avoiding the uncertainty of tribunal claim, where the decision might not be in the employee's favour
  • giving you some control over the settlement process, rather than placing the decision in the hands of a tribunal
  • securing a guaranteed payment or other concessions
  • allowing you to avoid the stress and disruption to your life often involved in tribunal proceedings
  • helping to preserve a better relationship with the employer, which may be beneficial to an employee's future career
  • allowing you to receive up to £30,000 in compensation tax-free (depending on the circumstances).

Are settlement agreements legally binding?

Settlement agreements are legally binding on both an employer and an employee if the right conditions are met. For a settlement agreement to be legally binding it must:

  • be in writing
  • relate to a specific complaint or issue
  • state the relevant statutory conditions regulating the agreement

Additionally, before signing a settlement agreement an employee must:

  • not be under pressure to sign
  • have taken independent legal advice from a lawyer or certified trade union representative (who must be identified in the agreement)
  • be given appropriate time to consider the agreement.

Why do you need to see a solicitor when you are offered a settlement agreement?

As stated above, it is a legal requirement that an employee or an ex-employee take independent legal advice on the terms and effect of entering into a settlement agreement.  If they do not, the agreement will not be binding.

While an employee or an ex-employee can take this advice from a trade union representative (where this option is available), there are significant advantages to relying on a solicitor instead.

It is very important that an employee or an ex-employee understands the terms and effect of a settlement agreement before signing it to avoid any risk of unintentionally compromising their interests or settling for less than they may be entitled to. 

Settlement agreements can be written in very legalistic language with lots of details which can be critical, but may not be apparent to those without specific legal training.

Do you have to accept the terms of a settlement agreement?

An employee or an ex-employee is under no legal obligation to sign a settlement agreement and, as stated above, an employer is not allowed to pressure an employee or an ex-employee to sign an agreement as this could mean the agreement will be invalid.

Whether signing a settlement agreement will be in an employee or an ex-employee best interests will depend on the terms of the agreement and facts behind the dispute in question. 

Where appropriate, a solicitor may be able to help an employee or an ex-employee negotiate more favourable settlement terms. On the other hand, a solicitor may advise that it may be better to reject the settlement agreement altogether.

What happens if you reject a settlement agreement?

If an employee or an ex-employee decides that they do not wish to accept a settlement agreement they have been offered by an employer, depending on the circumstances, they may wish to initiate internal proceedings or make an employment tribunal claim.

An employer may continue with any proposed disciplinary or performance action against an employee or a grievance against an employer may just carry on.

How much does legal advice about a settlement agreement cost?

An employer will usually cover the legal costs involved in providing appropriate legal advice to an employee or former employee on a settlement agreement. This is because the agreement will not be legally binding without that legal advice having been given, so it is in the employer’s interests to cover the associated costs.

This means an employee or an ex-employee will usually not have to pay anything towards the cost of legal advice for a settlement agreement.

However, it is worth noting that if an employee or an ex-employee rejects a settlement agreement offered or if the settlement agreement is disputed or needs negotiation, there may be additional legal costs of the advice.

Are settlement agreements tax-free?

Any payment received as part of a settlement agreement will usually be offered by an employer as tax-free, up to a limit of £30,000. However, whether it is truly tax-free will depends on the circumstances and some payments offered as part of a settlement agreement may be taxable.

Payments included in a settlement agreement that are taxable include:

  • any outstanding salary and benefits owed for the period of your employment
  • payment in lieu of holiday owed
  • payment in lieu of notice

any compensation that exceeds the £30,000 threshold.

Do you have to see a solicitor in person for advice on a settlement agreement?

No, advice can be provided over the telephone. 

Can an employee suggest a settlement agreement?

Yes, an employee can request a meeting with an employer to discuss the possibility of using a settlement agreement to resolve a dispute or to manage an exit from the business. It is strongly recommended to have specialist legal advice and support before suggesting this option to an employer and during any settlement discussions that take place.

Anything disclosed in a settlement discussion cannot be used later in employment tribunal proceedings, except in certain circumstances. This allows both parties to discuss the matter without needing to worry that anything they reveal or any concessions they make can later be used against them if a settlement agreement cannot be concluded.

The material contained in this web page is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken.

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