Settlement Agreements

Welcome to the fully updated 2022 employee guide to settlement agreements. In this guide, we’re going to cover what settlement agreements are, why employees are offered them, and when and how they are used. We’ll also explain how to make and respond to settlement offers, how to negotiate the best deal, as well as how to calculate your settlement payment. Finally, we’ll look at how you can ensure the terms are right for you. Ready for the low-down? Read on …

Updated July 2022


What is a settlement agreement?
Why do employers offer settlement agreements?
When are they used?
What is included in a settlement agreement?
Is a settlement agreement the same as redundancy?
Tax-free or taxable Termination Payments?
Can I request a settlement agreement?
How do I offer a settlement agreement?
When to make the offer?
How to protect a settlement agreement conversation?
What does Without Prejudice mean?
Settlement or employment tribunal?
Who can advise on a settlement agreement?
Do employers pay legal fees for settlement agreements?
Should I accept a settlement offer?
Can I negotiate a settlement agreement?
What’s a good settlement offer?
How do I respond to a low offer?
Settlement Agreement Calculator
What happens if I don’t accept a settlement agreement?
New job offer?
Job References and Settlement Agreements?
Sickness cases and Settlement Agreements
Disciplinary cases and Settlement Agreements
Redundancy Settlement Agreements
Confidentiality and Non-Disclosure Agreements
Reaffirmation Certificates
Post-Employment Notice Pay

definition settlement agreement

What is a settlement agreement?

A settlement agreement is a legally binding document between and employee and employer, which settles claims the employee may have arising from the employment or termination of employment. The employee must be advised by a qualified independent adviser, usually a solicitor, before signing the agreement.

Why do employers offer settlement agreements?

Usually, it’s for speed, risk-management, certainty and closure. The general idea is that Settlement Agreements achieve a clean break with the certainty that in return for the payment, the employee will not be be able to bring employment claims. A settlement agreement means claims and disputes are quickly settled in a legally-binding document. Everyone can move on.

When are they used?

Settlement agreements are typically offered when an employee is leaving their job.

Group Scenarios – such as large-scale redundancy or dismissal processes when an employer is offering an enhanced termination (voluntary redundancy) payment.

Individual Scenarios – in many cases, the agreements are proposed as an alternative to an employee performance, incapability due to ill-health, disciplinary or redundancy process. For an employer, taking an employee down a disciplinary procedure entails management time and money. Offering a settlement agreement can be an efficient, cost-saving and speedy way to terminate employment safely.

However, settlement agreements can also be used to settle existing disputes with employees, without the employee leaving the company.

By signing the agreement the employee agrees to settle the statutory claims listed in the agreement. It is standard practice for there to be a substantial list of claims, for example, breach of contract, constructive dismissal, unfair dismissal, claims for discrimination under the Equality Act, redundancy.

What should a settlement agreement include?

Each settlement agreement differs, and the terms are only decided once any negotiations have taken place. However, as a general rule, a typical settlement agreement will cover:

  • Notice pay, and any holiday pay you are due;
  • Any contractual benefits, bonuses and shares;
  • The value of any termination payment (commonly also known as compensation or ex-gratia payments);
  • Confidentiality and non-derogatory comments (known as Non-Disclosure Agreements);
  • Waiver and settlement of employment claims;
  • Which payments are free of tax and which are subject to income tax and national insurance deductions;
  • Post Employment Notice Pay and tax indemnities;
  • Practical issues like handovers, resignation of directorships, return of property;
  • Legal costs;
  • Some warranties from the employee, for example that the employee has not committed a breach of his employment contract that would have entitled the employer to dismiss;
  • Repayment of termination payment from the employee if he/she commences a claim or breaches the agreement, and
  • A reference.

Is a settlement agreement the same as redundancy?

No. Redundancy is a potentially fair reason to end an employee’s employment. But often an employer will ask an employee to sign a settlement agreement in exchange for an enhanced redundancy package.

Tax-free or taxable termination payments?

Generally speaking any payments you are entitled to under your employment contract like salary, holiday pay, bonuses and payment in lieu of notice are taxable but a termination payment, including a redundancy payment, is not taxable up to £30,000.

However, if you have not fully worked (or been paid in lieu of) the contractual notice period your employer is required to serve under your employment contract, a sum equal to the unserved (or unpaid) notice will be taxable from any termination payment you receive. This is known as post-employment notice pay.

Can an employee request a settlement agreement?


However, in most circumstances, an employer will initiate a settlement agreement process to resolve a dispute or agree severance terms.

How do I offer a settlement agreement?

“Remember that employers settle when it’s in their interests to do so.”

  1. Be commercial – an employer is more likely to have the benefit of legal advice from an employment solicitor. If your offer is ridiculously high your employer may not even engage with your offer.
  2. Win the argument – briefly point to facts and evidence to back up why you feel you have been treated badly and have a claim.
  3. The easy way – draw attention to why your offer is a good option for your employer.
  4. The hard way – this is the mirror of the above – draw attention to the worse alternatives, for example, facing an employment tribunal.
  5. Value / discount for early settlement – Don’t overvalue your claim or pitch an offer on the best case scenario, assuming you will win.
  6. Subject to Contract – if you make an offer make sure it is communicated as ‘subject to contract’ (i.e. subject to agreeing and signing-off a settlement agreement).
  7. Without Prejudice – hopefully you will be able to reach an agreement with your employer. But if that’s not possible, consider whether your offer could be used against you in any subsequent employment tribunal to undermine your case.

When to make the settlement offer?

This is all about context. Factors include:

  • The needs / pressures that cause the employer to contemplate ending the employee’s employment.
  • Awareness and acceptance of these needs / pressures.
  • The importance of moving quickly, saving time and resource.
  • Risks associated with making the offer sooner or later in the process.

Assessing each of the above, and weighing up their importance, will help to determine the best time to make the offer.

How to protect a settlement agreement conversation?

If negotiations fall down, one party may wish to refer to what was said in a settlement agreement discussion / offer. If the conversation is protected it can’t be used. If an employer has made an offer and it’s not protected, that could be used as leverage in negotiations by an employee or to support an unfair dismissal claim.

So what’s protected?

If a letter or discussion is ‘without prejudice’ it means it cannot be used in any legal proceedings including an employment tribunal claim. This allows the parties to talk frankly without fear the discussion will be used against them, and this can be helpful where they wish to settle an existing dispute or contemplated legal proceedings.

There are two ways a settlement offer will be protected, i.e. inadmissible in legal proceedings:

  1. It is without prejudice; and/or
  2. It is a Protected Conversation.

What does Without Prejudice mean?

If a letter or discussion is Without Prejudice it means it cannot be used or referred to in any legal proceedings like an employment tribunal claim. The opposite of a without prejudice communication is an ‘open’ communication which is capable of being used or ‘admitted’ in legal proceedings.

How does an offer become Without Prejudice?

For the without prejudice rule to apply there must be:

  • an existing dispute or contemplation of a claim / legal proceedings; and
  • a discussion with a view to settling that dispute, i.e. an offer to settle.

Why are letters marked ‘without prejudice and subject to contract’?

While it is sensible to label communications as without prejudice if you want to rely on the protection afforded by the without prejudice rule – not doing so is not fatal, provided the other conditions are met. Equally, labelling the conversation without prejudice will not magically make it without prejudice – there still must be an existing or contemplated dispute for the offer to qualify as genuinely without prejudice.

If an offer is ‘subject to contract’ this means acceptance of it will not create a binding settlement, as the terms of settlement are to be recorded in a written settlement agreement, i.e. settlement contract.

What is a Protected Conversation?

In some instances, even if the without prejudice rule does not apply, the offer may still be inadmissible in relation to ordinary unfair dismissal claim only – if it is deemed to be a protected conversation (Section 111A ERA 1996). That means the discussion about settlement is open for the purposes of other claims, for example discrimination (unless the without prejudice rule applies).

A protected conversation occurs where an offer of a settlement agreement is made. However, if the employer acts improperly, for example by placing undue pressure on the employees, or misrepresenting the circumstances, an employer will lose protection and the employee may refer to the settlement agreement discussion in an unfair dismissal claim.

Settlement or employment tribunal?

If you are offered a settlement agreement, you will need to weigh up the pros and cons of the offer versus the benefits and risks of turning it down and bringing an employment tribunal claim.

Key factors:

Settlement AgreementEmployment Tribunal
Relatively quick outcomeDelay
Low riskRisk you will lose (1)
Known Value Potential Value (2)
Little or no legal costs for employee Potential significant costs for employee
ClosureDelayed closure
No day in courtDay in court
Low stress / Focus on the futureStressful / you focus on the past
Table: Settlement Agreement or Tribunal.

Table Footnotes:

(1) & (2) An employment solicitor can advise you on your chance of succeed and the value of your potential claims. This will help you to decide whether to accept the offer.

Who can advise on a settlement agreement?

Settlement agreements are not binding unless the employee receives independent legal advice on the terms and effect of the agreement.

The following categories set out out who can be a relevant independent adviser.

Qualified lawyers.

In England and Wales this includes:

  • Practising Barristers and Solicitors
  • CILEx registered Legal Executives authorised to carry out litigation or advocacy
  • Chartered Legal Executives who are not authorised to carry out litigation or advocacy, providing they are employed by an SRA regulated Solicitor Practice and is supervised when giving advice by a solicitor with a valid practising certificate.
  • Registered European Lawyers (registered either with the SRA or the Bar Standards Board).

In Scotland, this means:

  • an Advocate, or a Solicitor holding a practising certificate.

Trade Union Officials

Trade Union Officials (certified by the union as competent to give advice and authorised to do so on the union’s behalf).

Voluntary sector workers

Advice workers are covered if they work at an advice centre (whether they are employees or volunteers), provided they have been certified as competent to give advice and are also authorised to do so on the centre’s behalf. An important condition on top of this is that they must NOT have been paid by the employee for that advice.

Yes, usually.

It’s standard for employers to pay a reasonable sum to cover the employee’s independent solicitor’s advice on the terms of and effect of the settlement agreement.

Should I accept a settlement offer?

We recommend you talk to a specialist employment solicitor and weigh up the merits of the offer against the alternative options available. The table above provides a framework to help you come to the best decision for you.

Can I negotiate a settlement agreement?

Yes, potentially.

A mix of bluster, gamesmanship and trading-off good personal connections with the decision-makers may help you to get a better deal. But your employer probably isn’t going to be persuaded to increase the offer significantly unless you can communicate the strength of your case. So research the law and think about instructing an employment solicitor to negotiate your settlement deal.

What’s a good settlement offer?

It depends. In some cases it’s all about the money. In others, there may be non-monetary considerations, like a reference or being released from post-termination restrictions.

Start with your basic contractual and statutory rights and then assess what else your employer is offering on top in exchange for you signing a settlement agreement.

Redundancy Example: An employee with 2 years service is concerned about an unfair redundancy. Without having to sign away any right to bring claims in a tribunal, the employee will be entitled to:

  • accrued wages
  • accrued untaken holidays
  • notice (or payment in lieu of notice if not worked)
  • statutory redundancy entitlement

If the employer asks the employee to sign a settlement agreement an employee should reasonably expect something extra to sign. Usually this will come in the form of an enhanced tax-free termination payment.

Whether it’s a good deal for the particular employee will depend on his personal attitude to risk, the strength of the employee’s legal case and likely losses. If the employee has secured a new job he’s less likely to quibble than if he had no offer and was pessimistic about securing a new job quickly. A good employment lawyer will help you to make an informed decision that’s best for you.

Misconduct Example: If you are accused of gross misconduct and things aren’t looking good for you, a low financial offer with an agreed reference may in fact be a fantastic deal. However, if you have a strong case, with potentially substantial losses, a low offer may be far less than you are likely to achieve in tribunal – and you may elect to negotiate or turn the offer down.

How do I respond to a low offer?

If the offer isn’t anywhere near the ballpark you’d accept, you may decide to reject it and make it clear you see no point making a counter offer as your miles apart. That’s a bold strong move but risks killing off the negotiations and pushing you towards a dispute and tribunal claim.

The alternative is to make a sensible counter offer with room between the two positions to allow further compromise. The key word being ‘sensible’. As much as a low offer may end an negotiation so might a very high offer. Pitching the offer at a level that makes sense for both sides is the art of a good settlement agreement negotiation.

The words from the three bears children’s story may offer some assistance:

This porridge is too hot!” she exclaimed.

So, she tasted the porridge from the second bowl.

This porridge is too cold,” she said

So, she tasted the last bowl of porridge.

“Ahhh, this porridge is just right,” she said happily and she ate it all up.

Settlement agreement Calculator

settlement agreement calculator

These six factors will help you to calculate your settlement agreement value:

  1. Your length of service.
  2. Length of Notice entitlement.
  3. Discrimination
  4. How long you will take to secure a new job.
  5. Strength of Claim.
  6. Employer attitude to settlement.

Why and how are these important?

1. Length of service – is used to calculate statutory redundancy entitlement. The Basic Award for Unfair Dismissal is calculated in exactly the same way. Generally speaking, the longer the service, the greater the value of the claim. This GOV Page has a redundancy calculator.

2. Length of Notice – If your employer does not have grounds to terminate your employment immediately, for example for gross misconduct, you will normally expect to be paid for your notice.

3. Discrimination – claims for discrimination are unlimited and typically higher value. An award can be made for hurt feelings in addition to compensation for financial losses.

4. How long you will take to secure a new job – awards for unfair dismissal are made to compensate the employee rather than punish the employer. How long you take to secure a commensurate job will determine the potential value of your claim. If you have a job ready to walk into your losses may be minimal or zero, compared to taking say six months to find a new job.

5. Strength of Claim – Even if your losses are potentially substantial – where an employer is confident it of defending your claim successfully – it is likely to at best makes a low or commercial offer.

6. Employer attitude to settlement – some employers are culturally more willing to use settlement agreements – others would prefer to wait to see if you bring a claim and then decide what to do.

Know these numbers

  • Notice Pay (gross) – how many weeks or months’ notice is the employer required to give to end the employment contract (check the up to date employment contract documents)
  • Contractual benefits, including pension, car, private health etc. (Check the employment contract and P11D)
  • Bonuses – check out any scheme rules and entitlements
  • Statutory Redundancy Pay calculation – this Government calculator is helpful.
  • Contractual redundancy scheme (if applicable, find out the terms and formula)
  • Long-Term Incentives such as shares, share options and long-term incentive plans (LTIPS). Read the terms carefully to establish entitlements
  • Salary sacrifice scheme (this may impact on the Post Employment Notice Pay Calculation).

What happens if I don’t accept a settlement agreement?

An employer’s settlement agreement offer is made in the context of a disciplinary, redundancy, ill-health, or performance situation. If the employee rejects the offer often the underlying risk is that the employee’s employment may be terminated following the completion of the relevant process.

New job offer?

The employee gets a windfall termination payment from the old employer with a new commensurate job in the bag and starting with little or no time out of work.

The perfect settlement agreement! But be careful.

If your employer finds out about the offer before the settlement agreement is binding the offer might be withdrawn.

Alternatively, an employer may insert a clause to flush out the offer. These clauses require the employee to warrant i.e. promise that he/she has not received an offer of employment (and make the payments conditional upon that being true). The employee cannot sign the agreement as it is because that would be untruthful and risk the payments. Seeking an amendment or removal is the best option but that too runs the risk of the offer being withdrawn. Your solicitor will be able to advise you on the best communication strategy depending on your particular circumstances.

Job References and Settlement Agreements?

There is no general legal right to a reference, good bad or indifferent. Some regulated sectors will, however, place a duty on an employer to provide a reference. Usually an employer will agree to a clause in the settlement saying the employer will provide reference in the form attached to the settlement agreement, on request from a prospective employer.

Sickness and Settlement Agreements

If an employee is unable to perform his duties because of long-term illness – the employer, sooner or later, will contemplate ending the employee’s employment. Sometimes, an employer may prefer to seek to agree the ending of employment under a settlement agreement, to avoid the risks of claims, which may include disability discrimination and unfair dismissal. These are important issues to consider:

  • Sick Pay Entitlement – has this been exhausted?
  • Holidays – how many days have accrued in the last 15 months?
  • Notice Entitlement – often, the employee will be entitled to be paid notice even if sick pay has ended.
  • Permanent Health Insurance (‘PHI’) / Critical-illness cover – Check for these and assess. PHI may potentially be very valuable and if available, should be explored as an alternative to termination of employment.
  • Pension / Ill-health retirement benefits – check for these and assess.
  • Alternative roles – a failure to offer a suitable alternative available role that the employee was fit to perform will likely make the dismissal unfair.
  • Reasonable Adjustments – if the employee is disabled under the Equality Act 2010, the employer has a duty to make reasonable adjustments to facilitate a return to work.

Example case: Sickness

The employee is a senior marketing executive, performing a unique role in the business. She has been off work for nine months due to a serious heart condition.  Her sick pay ended two months ago; she is not entitled to PHI. The employer has met the employee twice in the last three months. In the last meeting the employee said there was nothing the employer could do to help her return to work and she is not interested in the alternative roles in the business. She doesn’t think she is going to be able to return to work in the near future. In this scenario, the employee may well be interested in a settlement agreement.

These are sensitive and sometimes risky situations that require care. Before ending an employee’s employment due to ill-health, it will usually be sensible for an employer to obtain medical evidence, consider reasonable adjustments and be able to justify its decision to end employment at that time.

Disciplinary Procedures and Settlement Agreements

Disciplinary case

An employee, with a good track record, and five years’ service, makes a serious error of judgment – causing a major customer to lose a lot of money. The customer has complained and demanded that someone else handles their account. This is a case of potential negligence – to be addressed via the employer’s disciplinary procedure. If the employer decides to have a discussion about a settlement agreement, as an alternative to going to a disciplinary hearing, the employee has a choice: take a deal and financial offer, and avoid dismissal on his/her record, or take his/her chances at a disciplinary hearing, potentially facing immediate dismissal for gross misconduct.

If the settlement discussion takes place at a stage when the employee sufficiently understands the case against him, and appreciates the seriousness of the matter and assesses dismissal is a real possibility / probability, a settlement becomes much more attractive.

But if the employee doesn’t understand the case against them, or feels the investigation is incomplete – and they can convince the employer of their innocence, they may instead decide to reject the offer and carry on with the process – or they may believe they has a stronger hand to negotiate a higher financial package.

An employee facing the possibility of summary dismissal for gross misconduct, may be prepared to take a no-cash settlement deal – one which provides the employee with a neutral agreed job, at the investigation stage, rather than take their chances at a disciplinary in a week or two’s time.

Performance management settlement cases

An offer made before the employee has been managed properly and is aware of the problem (with his/her performance) is much more likely to be rejected or result in a grievance. If the employer has genuinely tried to help the employee to make the grade, via informal and/or formal procedures – and has communicated the employee’s performance is unsatisfactory, the offer is less likely to come as a shock.

The employee then has a choice: take the deal (avoiding the pressures of performance improvement plan / formal process) or reject the deal (and work through the process to try and improve, in the knowledge that failure to improvement may result in dismissal).

For example, if an employee knows they have been underperforming for a while and is then told they are going to start a performance improvement plan, the employer should be able to explain the next steps in the procedure and the likely timescales. The employee may prefer to bail early rather than go through the stress of the procedure, particular when they decide there’s a good chance of dismissal with the same or even less cash.

Whether the conversation about a settlement takes place earlier or later is a judgment call for the employer, balancing the above factors.

HR Tip: Don’t assume your communications about a settlement agree are off the record (inadmissible). A letter marked ‘without prejudice’ doesn’t make it automatically inadmissible. Similarly, the ‘protected conversation’ rules (Section 111A of the ERA’96) offer very limited protection for ordinary unfair dismissal claims only and protection can be lost. Don’t be lulled into a false sense of security – and don’t say anything you are not prepared to justify, if negotiations break down and the conversations become admissible in a tribunal claim. See below for more details on protected conversations.

Redundancy and Settlement Agreements

The timing of these is usually straightforward.

Early offer redundancy cases – In a case of voluntary redundancy (typically with an enhanced redundancy payment) the employee applies for redundancy at an early stage of the process. If the employer agrees to voluntary redundancy, in exchange for allowing paying the employee an enhanced package and/or allowing them not to serve notice (and instead paying in lieu) everything is recorded in a settlement agreement. This is to avoid the risk of disputes later.

Late offer redundancy cases – Where an employer decides to go through a full redundancy consultation procedure and serves notice to terminate due to redundancy with the offer of an enhanced redundancy package, it is common to ask the employee to sign an agreement in exchange for the enhanced package.  

Confidentiality and Non-Disclosure Agreements

Non-disclosure agreements and confidentiality clauses are pretty standard features of settlement agreements. However, they should not go as far as to prevent employees from whistleblowing or speaking to the police or regulators about wrongful acts that happened at work.

The employee’s solicitor should advise the employee where the agreement seeks to improperly prevent public interest disclosures and seek amendments to the agreement.

Reaffirmation Certificates

If the agreed termination date is a while after the settlement agreement is signed, an employer may want an employee to sign a second agreement shortly after employment ends to ensure any potential claims that have arisen since the first signing are also settled. This is commonly called a reaffirmation certificate or agreement because the employee is asked to reaffirm the waiver of claims.

Post-Employment Notice Pay

Post Employment Notice Pay (‘PENP’) – In a nutshell, since April 2018, the practice of combining the value of notice pay into a global termination payment so it can all paid tax free has been stopped. Now, if the employee doesn’t work their full notice period or get paid in lieu of their full notice, any termination payment will usually need to be taxed up to the value of unworked / unpaid notice entitlement. This means an employer will need to undertake a PENP calculation to work out how much tax needs to be deducted from the termination payment.

Generally speaking:

  1. If notice is served and fully (1) worked the PENP will be zero;
  2. If a full contractual payment in lieu of notice is made (net of income tax and national insurance) the PENP will usually be zero.
  3. If notice is partly served and the full balance is paid in lieu (net of income tax and national insurance) the PENP will usually be zero.
  4. Otherwise, an element of the Termination Payment (2) (effectively equal to the gross value of notional unserved / unpaid notice pay) will be subject to income tax and national insurance deductions as PENP, with the balance of the termination payment (up to £30,000) usually being capable of paid without deductions.
  5. It is recommended that a PENP calculation is undertaken to accurately assess the tax charge due (if any).  Complicating factors and quirks (3) to the way the PENP formula works can impact on the tax charge.  

Foot Notes:

  1. ‘notice’ means the period of notice the employer is required to give – not the period of notice the employee is required to give. This means if an employee is only required to serve a weeks’ notice and does so, but the employer would have been required to serve 4 weeks statutory minimum notice, there will usually be a PENP charge.
  2. A genuine statutory redundancy payment is excluded from the PENP calculation and will be paid tax free.
  3. For examples of complicated scenarios, see section below ‘complications to watch out for’.

IMPORTANT: There are exceptions and quirks that may impact on the above general rules. Therefore, a PENP calculation, applying the formula in the tax legislation, should always be undertaken to be completely sure.

Complications to watch out for:

  • Long-term sickness – the employee has been on long term sickness and has exhausted all sick pay or is only receiving reduced pay or statutory sick pay.
  • Salary Sacrifice – these impact on the usual PENP calculation.
  • Retirement – retirement payments fall under a different tax provision and may be taxable.
  • Redundancy payment only (i.e. no payment in lieu of notice / no notice served). 

Tip: If the employer is going to pay the termination payment without deduction for tax and national insurance because notice will be served and fully worked, make sure you have a dated letter / email properly serving notice.

HR Tip: Before you offer a settlement agreement, check the employee’s record to see if there are any potential issues that could cause complications. For example, have they raised any complaints, on an issue that might be discrimination or a potential whistleblowing claim?

Tip – In a long-term sickness case, before making a settlement agreement offer, consider the following: (a) if the employee may have a disability are there any reasonable adjustments that would facilitate a return to work and (b) is the employee entitled to income protection benefits, critical illness or medical retirement benefits?  These are areas where employment solicitor advice is recommended.

For a free, confidential advice chat with our expert team of employment solicitors about your settlement agreement – call 0808 196 9145 or request a call back.

Employment Solicitor


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