What is a settlement agreement?

Last updated: 22 Sep 2021

What is a settlement agreement?

A settlement agreement is a legal contract between an employer and an employee. In a settlement agreement, an employee gives up their rights to bring claims against their employer in an Employment Tribunal or other court. Usually, the employer will offer a sum of money in return.

Settlement agreements are legally binding so long as it is signed by you and your employer. You should also seek advice on the terms of the settlement agreement and their effect by an independent solicitor, barrister or other relevant adviser.

It is crucial that you check the final version of the agreement to make sure you are happy with all the terms including the sum of money to be paid. Once the Settlement Agreement has been signed, it cannot be changed and you will have no further claim against your employer. So it is important you read the final version in full.

We have set out below a list of the more common issues that you need to think about when negotiating a settlement agreement.

Common issues to consider

General

  • By what date will the employer make the payments and how?
  • Are there any conditions to you receiving the payment? Such as:
    • providing a signed letter from your advisor confirming you have been advised on your rights
    • withdrawing a claim that you have already submitted and providing evidence of this
    • withdrawing a data subject access request
    • withdrawing a grievance
    • agreeing to restrictive covenants and/or confidentiality terms
  • When is your employment to end?
  • Will your employer release you from any restrictive covenants in your contract of employment?
  • When you will have to return company property and what property you have to return?

Payments

Do the payments include:

  • Outstanding salary
  • Outstanding holiday, car allowance, expenses, bonuses and/or commission payments
  • Notice pay
  • Any compensation due  (injury to feelings, personal injury, defamation)
  • Any compensation due for new restrictive covenants or confidentiality restrictions
  • Outstanding maternity/paternity/adoption pay

Deductions

Are any deductions to be made? For example, any amounts you owe to your employer such as :

  • Repayment of a travel loan or part of it
  • Payment for holiday taken that you have not yet accrued
  • Repayment of any enhanced maternity/paternity/adoption pay that has been received but which is subject to repayment if you leave employment (note: you cannot be asked to repay Statutory Maternity Pay)

Benefits in kind

What will happen to benefits in kind such as:

  • The company car, health and any other insurance such as life insurance
  • Professional memberships (ensure that any practising certificate is returned. Are they going to charge pro rata in respect of any professional subscriptions which continue to the end of the year?)

Tax

It is important that the payment to be made is tax effective. If in doubt you should consult either an accountant or a tax lawyer. The Money Advice Service also provides free and impartial advice on a range of financial topics, including tax.

As a general rule the following payments can be made without deduction of tax provided that they are not otherwise chargeable to tax:

  • An agreed sum for compensation for loss of employment/office up to £30,000.00. This only applies to employees. Any payment in excess of £30,000.00 will be subject to income tax (see comments below).
  • A payment in a discrimination case for injury to feelings where that discrimination occurs before termination of employment and/or personal injury.
  • A contribution towards your legal costs, provided the sum is paid from your employer direct to your adviser. If you receive the payment direct to use to pay your lawyer, taxes may be applied.
  • It may be tax efficient to make a lump sum payment into a registered pension scheme as part of a compensation package. This is because the payment may benefit from tax relief. But you should take advice on this.

The following payments can generally not be made gross and tax and national insurance deductions will be deducted at source before they are paid to you:

  • Any salary or other earnings due up to the date that your employment ends, including holiday pay
  • Compensation for loss for any amounts in excess of £30,000.00. From April 2020, national insurance contributions will also be owed on the excess of £30,000.00.
  • A payment in lieu of notice where there is a provision in your contract that a lump sum can be made in lieu of your notice (this provision does not exist in all contracts)
  • Consideration for restrictive covenants or confidentiality obligations

Tax indemnity

Employers often ask for a signed an indemnity saying that you will be liable to pay any additional tax that arises on the payments made under the agreement in addition to tax already deducted. You should consider:

  • Are you prepared to give this indemnity?
  • Is the employer prepared to indemnify you in relation to, for example, any miscalculation in relation to tax which is being deducted at source when the initial payment is being made?

Pension

Some initial points for consideration:

  • Are pension payments to continue beyond the date of termination?
  • Do you have the information you need about your existing pension entitlements? Ensure that you have the necessary documentation and contact details so that you can be directly in touch with the pension fund.
  • Does the compensation payment adequately reflect any loss of pension?

Shareholders and share options

If you are a shareholder check your share agreement, for example, you may be required to sell back your shares on the termination of your employment.

How are share options going to be dealt with?

Sometimes it is important in relation to a share option scheme that you are recorded as a “good leaver” as opposed to somebody who leaves “with cause” or as a “bad leaver”. Ask the employer to confirm this, and seek advice if unsure.

Restrictive covenants

How is the employer going to deal with restrictive covenants that apply in your contract restricting, for example, your ability to work for a competitor for a period of time following termination of employment?

If there are any restrictive covenants in your contract of employment, you may want to negotiate that they are either withdrawn or that they will be enforced only in particular circumstances. They may ask you to enter into new restrictive covenants but they should make a payment to you in exchange for this.

“Bad-mouthing”

Your employer will normally require you to agree to a clause in the settlement agreement that says that you will not “bad mouth” the company or any of its employees.

You can ask for something equivalent in return. Some employers are not prepared to agree to such a covenant on their part because they say that a company cannot promise not to “bad mouth” an individual as it does not have sufficient control over all of its employees. One way of dealing with this is to say that the employer will use its best endeavours to ensure that there is no “bad mouthing” or, alternatively, that it will instruct its employees only to talk about you in the terms set out in an agreed reference/reason for leaving. If there are particular employees you are concerned may “bad mouth” you, you should consider specifying these individuals in the agreement.

Confidentiality

Many employers want you to keep secret not only the terms of the settlement agreement, but also the existence and the circumstances leading up to the agreement. This is often very difficult to do particularly if a lot of people know about the negotiations. We usually suggest that the employee agree to keep only the terms of the agreement confidential – with the exceptions suggested below. If, following negotiation, it is necessary to agree to keep the existence of the agreement confidential, you should be able to insist on the following exceptions:

  • Close family and friends
  • Future employers
  • For the purpose of making a whistleblowing protected disclosure in accordance with Part IVA of the Employment Rights Act 1996 (Protected Disclosures)
  • For the purpose of reporting, in the public interest, misconduct, or a serious breach of regulatory requirements, to a regulator;
  • For the purpose of reporting an offence or suspected offence to the police or other law enforcement agency and/or co-operating with a criminal investigation or prosecution
  • For the purposes of reporting, in the public interest, any serious wrongdoing to the police or other law enforcement agency or a relevant regulator or an equivalent person or entity which has a proper interest in receiving that information in the public interest
  • For the purposes of seeking medical advice from a qualified medical practitioner or for therapeutic reasons
  • Professional/legal advisers
  • Your Trade Union
  • Statutory authorities such as the HMRC and the Job Centre

It may be advisable not to discuss the settlement with friends and in particular with work colleagues because you may be asked to promise that you have not previously discussed the terms of the agreement with anyone.

If you have been required to give a confidentiality agreement it should be made clear to you:

  • Who you can talk to about the confidential issues;
  • If there are any time limits on the confidentiality;
  • How you can talk about your role in future interviews. You may also be asked to warrant that you have not been offered or do not expect to be offered another job before entering into the settlement agreement.

Future claims

In return for any agreed payment, your employer may ask you to agree to give up all possible future claims you may have against the company. The following categories of claim are excluded from this, and you cannot agree to give up these future claims:

  • Claims in respect of unknown personal injuries (these may not surface until some time after the agreement has been signed). This differs from personal injuries known at the time of the agreement or related to a discrimination claim, which an employer will likely seek to exclude.
  • Claims in respect of accrued pension rights (again, a claim may not surface for some time).
  • Claims other than those arising out of your employment or its termination.
  • Claims by you to enforce the terms of the settlement agreement.

It may also be possible to exclude the following – although many employers will not agree to this:

  • Any claim relating to any future employment relationship with your employer if you are remaining in your job. For example through applying for a job or through a takeover/transfer of undertaking an employer may either employ or have the opportunity to employ you in the future. If they decide not to employ you or to dismiss you because of any alleged trouble that you have caused in the past, this could be unlawful victimisation under the discrimination legislation and you should be entitled to bring a claim
  • Any claim for victimisation after the agreement is signed, e.g. following the provision of a bad reference – for this reason you should ask for the details of any reference to be specified in the agreement.
  • Claims arising after the date of the agreement. Since the basis for the agreement is to achieve a clean break most employers will not agree to this.

Out-placement

In addition to payment of compensation the employer may be prepared to pay for out-placement counselling for example in assisting you with your CV or interview techniques. This is often very valuable and you will be entitled to a number of sessions with a specialist consultant who can assist you with finding alternative work.

Reference

An important part of the settlement is often the reference. This can be written in advance and appended to the agreement. It is not within the power of a Tribunal to order your employer to provide a reference. Most employers will only agree to give a factual reference which states the dates of employment and your job title and will agree that the only reference provided to prospective future employers will be on the terms set out in the agreed reference.

If you are able to agree a personal reference that goes further than the basic reference noted above, it is often a good idea for you to write it as a first draft upon which the employer can then build. It may or may not be that you want to put an agreed reason for leaving in the reference.

Announcements

You may want to agree with the employer a form of internal or external announcement. You may want to produce a first draft which you can agree and adapt further with your employer.

Contributory Job Seeker’s Allowance (JSA) and Universal Credit (UC)

The position with contributory Job Seeker’s Allowance (also known as New Style JSA) and Universal Credit, which you can claim if you meet the eligibility requirements, is usually that if you have left your job without good reason or because of your behaviour you could be sanctioned, which means your benefit will be paid at a reduced (or nil) rate for the period of the sanction.

The sanction is usually applied for 91 days, however, in some cases this could be longer. It may be worth checking with the Department of Work and Pensions before you agree a reason for leaving with your employer. It may be better that the reason for leaving is recorded as redundancy as this may assist you to claim New Style JSA or Universal Credit as you will not be sanctioned if you leave your job due to redundancy.

Please note that Universal Credit is a means tested benefit (benefits that are payable if the household income is below a certain level) and is generally restricted if an individual’s savings or household income are too high. Again, you should check with the Department of Work and Pensions for details.

Mortgage Protection Policy

It is important to check the terms of any mortgage protection policy for exclusions to making payment. If the policy will only make payments if you have not left voluntarily it is important for the agreed reason for leaving to reflect this. For example, it may be preferable for the purposes of claiming on the mortgage protection policy to say that you have been made redundant rather than that voluntary “parting of ways” has been agreed.

Claims against you

If you think that your employer may have a claim against you then you should consider negotiating for a clause in the agreement saying that it compromises claims against you as well as claims by you.



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The information on the law contained on this site is provided free of charge and does not, and is not intended to, amount to legal advice to any person on a specific case or matter. If you are not a solicitor, you are advised to obtain specific legal advice about your case or matter and not to rely solely on this information. Law and guidance is changing regularly in this area.