Using Settlement Agreements Legally and Effectively in the Workplace

Introduction

A settlement agreement is an agreement in which a current or former employee or worker agrees to waive or settle a claim (or more usually, all possible claims) against the employer in return for a payment. This guide outlines how to use settlement agreements legally and effectively, ensuring compliance with UK employment law and promoting fair outcomes for both parties.

Understand When to Use Settlement Agreements

Settlement agreements are appropriate in specific workplace situations but should be used carefully to avoid legal pitfalls.

Common Scenarios:

Termination of employment: To end employment amicably during redundancies, performance issues, or irretrievable breakdowns in working relationships.
Resolving disputes: To settle claims such as unfair dismissal, discrimination, whistleblowing, or disputes over pay (e.g., holiday pay or bonuses).
Avoiding tribunal proceedings: To prevent costly and time-consuming employment tribunal claims.

When Not to Use:

As a blanket approach to avoid addressing workplace issues (e.g., bypassing proper disciplinary or redundancy processes).
Without genuine disputes or potential claims, as this may render the agreement unenforceable.
To pressure employees into waiving rights without proper advice or consideration time.

Ensure Legal Compliance

For a settlement agreement to be legally binding in the UK, it must meet specific requirements under Section 203(3) of the Employment Rights Act 1996.

Although common law claims (such as breach of contract or negligence) can be waived or settled by way of any legally binding written or oral contract, certain statutory employment rights and discrimination claims can only be waived or settled by way of Acas conciliation or a settlement agreement that meets certain statutory requirements.

Legal Requirements:

Written agreement: The agreement must be in writing, clearly outlining the terms and specific claims being settled.
Independent legal advice: The employee must receive advice from a qualified independent adviser (e.g., a solicitor, barrister, or certified trade union official) on the terms and effect of the agreement, particularly its impact on their ability to pursue tribunal claims.
Adviser’s insurance: The adviser must have professional indemnity insurance to cover potential claims arising from their advice.
Specific claims identified: The agreement must list the particular claims the employee is waiving (e.g., unfair dismissal, discrimination).
Reference to legislation: The agreement must state that it complies with the conditions regulating settlement agreements under relevant statutory provisions.
Signed by both parties: Both parties must sign. There is no need for the adviser to be a party to the settlement agreement or to sign any confirmatory letter or certificate, although the latter is common practice.

Claims that cannot be waived

When entering into a settlement agreement, the employer’s aim will be to achieve an effective waiver of all possible claims that the employee may have against it. However, the employer should be aware that it is not possible to waive:

Certain statutory employment rights claims, which can only be settled through Acas.
Claims in relation to accrued pension rights.
Claims for personal injury that might be caused in the future.

Additional Considerations:

Pre-Termination Negotiations:

The term “pre-termination negotiations” means “any offer made or discussions held, before the termination of the employment in question, with a view to it being terminated on terms agreed between the employer and the employee” (section 111A(2), ERA 1996).

Admissibility Rules

The potential interaction between the rules on admissibility applicable to pre-termination negotiations under the without prejudice rule and section 111A of the ERA 1996 are summarised below.

In ordinary unfair dismissal claims and where there is an existing dispute between the parties, the offer of, and discussions about, a settlement agreement may be covered by both the without prejudice rule and section 111A. Where there is no existing dispute between the parties, the without prejudice rule does not apply but section 111A can apply.

Where either the without prejudice rule and/or section 111A apply, the offer of, and discussions about, a settlement agreement will not be admissible in an ordinary unfair dismissal claim in the employment tribunal, unless unless there is an applicable exception to the without prejudice rule, the most relevant of which is likely to be unambiguous impropriety, or there has been improper behaviour during discussions.

In court or tribunal proceedings other than ordinary unfair dismissal claims, such as discrimination, wrongful dismissal or unlawful deduction of wages claims, section 111A does not apply. In these cases, the without prejudice rule can apply where there is an existing dispute at the time of the settlement offer and discussions, meaning that these will not be admissible in evidence unless there is an applicable exception.

Tax status of payment

In practice, most payments made to an employee on the termination of employment are likely to be taxable in one of the following ways:

Taxed in the normal way as earnings under ITEPA, as well as being subject to both employer and employee National Insurance contributions (NICs) in the normal way.
Taxed as earnings if the payment is treated as post-employment notice pay (PENP) (either in whole or in part) under sections 402B and 402C of ITEPA. Such a payment is also subject to employer and employee NICs, by virtue of regulation 2 of the Social Security (Contributions) (Amendment No. 2) Regulations 2018 (SI 2018/257). However, there will be no PENP tax liability if the employee serves their full contractual notice period (whether working or on garden leave). This is because the employee’s “post-employment notice period” will be nil (section 402E(6), ITEPA) and, applying the formula in section 402D(1) of ITEPA, this inevitably means that PENP will also be nil.
Taxed as a termination award under sections 402A(1) and 403 of ITEPA. The first £30,000 of such payments is exempt from tax and any excess is subject to income tax. The amount of such payments exceeding £30,000 is subject to employer NICs (not employee NICs)

Draft Effective and Fair Terms

A well-drafted settlement agreement protects both parties and minimises the risk of future disputes.

Key Components:

Include termination payments, notice pay, accrued holiday pay, bonuses, or ex-gratia payments. Compensation typically ranges from two to three months’ gross salary for straightforward cases but may be higher for discrimination or whistleblowing claims. Ensure the amount reflects the strength of potential claims and the employee’s prospects of finding new employment.

Require both parties to keep the agreement’s terms and circumstances confidential. Be cautious with non-disclosure agreements (NDAs) to ensure they are fair and not overly restrictive, as misuse can lead to legal challenges or reputational damage.

Prevent both parties from making negative statements about each other to protect reputations.

Agree on a standard or enhanced reference (e.g., job title, dates of employment, and optionally, positive remarks). This is not legally required but is often included to aid the employee’s job search.

List specific claims the employee is waiving (e.g., unfair dismissal, discrimination) to ensure clarity and enforceability.

Specify arrangements for returning company property (e.g., laptops, documents).

If included, ensure post-termination restrictions (e.g., non-compete clauses) are reasonable and do not unduly limit the employee’s future employment.

Employers typically contribute £300–£500 (plus VAT) towards the employee’s legal advice, though complex cases may require £1,500 or more. This is not mandatory but is standard practice to ensure the agreement is binding.

Best Practices:

Use plain English: Avoid legal jargon to ensure the employee understands the terms.
Check contractual obligations: Verify entitlements (e.g., bonuses, commission) to ensure all payments are included.
Engage a qualified advisor: A specialist employment law advisor can draft a watertight agreement and check for compliance with tax and employment law.

Follow a Fair Process

A transparent and fair process builds trust and reduces the risk of claims that the agreement was signed under duress.

Key Actions:

Allow sufficient time: The Acas Code of Practice recommends a minimum of 10 calendar days for the employee to consider the offer and seek legal advice, unless both parties agree otherwise. Avoid undue pressure, as this could render discussions admissible in a tribunal.
Conduct protected conversations: Initiate discussions “without prejudice” or under Section 111A to protect confidentiality, but ensure no improper behaviour (e.g., bullying or discrimination) occurs.
Negotiate fairly: Be open to employee requests for higher compensation, enhanced references, or amended terms. Effective negotiation can prevent escalation to tribunals.
Document discussions: Keep records of discussions and offers to demonstrate fairness if challenged.
Facilitate legal advice: Provide contact details for an independent adviser or cover legal fees to ensure the employee can access advice promptly.

Implement and Monitor the Agreement

Once signed, both parties must adhere to the terms to avoid breaches or disputes.

Key Actions:

Ensure all payments (e.g., compensation, legal fees) are made within the agreed timeframe (typically 7–28 days after signing). Late payments can lead to breach of contract claims.

Ensure HR or relevant staff are aware of the agreed reference format to respond consistently to future requests.

Limit knowledge of the agreement to essential personnel to uphold confidentiality clauses.

Check that both parties adhere to terms (e.g., non-disparagement, return of property). If the employer breaches the agreement (e.g., fails to pay), the employee can pursue a breach of contract claim in the county court. If the employee breaches terms (e.g., discloses confidential details), the employer may seek legal remedies.

Keep a copy of the signed agreement and adviser’s certificate for at least six years to address potential future disputes.

Seek Expert Advice

Both employers and employees should consult employment law specialists to ensure the agreement is fair and legally sound.

For Employers:

Engage an employment law advisor to draft the agreement, advise on tax implications, and negotiate terms.
Use Acas early conciliation services to resolve disputes before formal agreements, saving time and costs.
Contact Acas or a specialist employment law advisor for guidance on complex cases.

For Employees:

Seek independent legal advice from a specialist employment law advisor or certified trade union official to understand the agreement’s implications and negotiate better terms.
Contact Citizens Advice or Acas for free, impartial advice.
Check if legal expenses are covered by home insurance or if the employer’s contribution covers all fees.

At Employment Law Services (ELS) LTD, we have extensive knowledge and proven experience in drafting and advising on settlement agreements. Whether you need practical advice, representation, or proactive support, our team is here to help.

Click here to book a free, no obligation consultation with one of our employment law specialists, or call us now on 0800 612 4772.