Step-by-Step Guide to Drafting Fair Settlement Agreements

Introduction

A settlement agreement is a legally binding contract between an employer and an employee to resolve workplace disputes or end employment on agreed terms, typically with a financial payment in exchange for waiving tribunal claims. Drafting a fair agreement is critical to ensure enforceability, avoid disputes, and comply with UK employment law. This guide provides a step-by-step process for drafting fair settlement agreements, with a focus on avoiding risks such as legal challenges, reputational damage, or financial penalties.

Step 1: Assess the Need for a Settlement Agreement

Before drafting, confirm that a settlement agreement is appropriate and identify potential risks.

Actions:

Identify the issue: Determine the context, such as redundancy, performance disputes, discrimination claims, or mutual agreement to part ways.
Evaluate potential claims: Assess the employee’s likely claims (e.g., unfair dismissal, discrimination) and their strength to gauge appropriate compensation. Weak claims may justify lower payments, while strong claims (e.g., whistleblowing) may require higher sums.
Check alternatives: Consider other options, such as performance management, mediation, or Acas early conciliation, to resolve disputes without an agreement. Using settlement agreements to bypass proper processes risks tribunal claims.
Ensure genuine intent: Agreements must settle existing or potential claims. Offering an agreement without a legitimate basis risks unenforceability.

Risk Avoidance:

Avoid using agreements to “force out” employees without due process, as this may lead to claims of constructive dismissal.
Document the rationale for the agreement to demonstrate it addresses a genuine issue, protecting against claims of bad faith.

Step 2: Ensure Legal Compliance

Settlement agreements must meet statutory requirements under Section 203(3) of the Employment Rights Act 1996 to be legally binding.

Actions:

Draft in writing: The agreement must be a written document signed by both parties.
Require 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 their effect, particularly on waiving tribunal claims.
Verify adviser’s insurance: Confirm the adviser has professional indemnity insurance to cover potential claims arising from their advice.
Specify claims: List the exact claims being waived (e.g., unfair dismissal, discrimination under the Equality Act 2010, breach of contract).
Reference legislation: Include a statement that the agreement complies with statutory requirements for settlement agreements.
Include adviser’s certificate: The adviser must sign a certificate confirming they provided independent advice.

Risk Avoidance:

Failure to meet any statutory requirement renders the agreement unenforceable, allowing employees to pursue tribunal claims. Engage an employment law solicitor to review compliance.
Ensure the adviser is truly independent (e.g., not the employer’s solicitor) to avoid claims of conflict of interest.

Step 3: Structure the Agreement Clearly

A clear, comprehensive agreement reduces ambiguity and the risk of disputes.

Actions:

Include key components:

Financial terms: Detail all payments, including notice pay, accrued holiday pay, bonuses, ex-gratia payments, and tax-free sums (up to £30,000 for non-contractual termination payments). Specify payment timelines (e.g., within 14 days of signing).
Confidentiality clause: Require both parties to keep the agreement’s terms and circumstances confidential, but ensure the clause is reasonable and allows disclosures to advisers, regulators, or as required by law (e.g., whistleblowing).
Non-disparagement clause: Prevent negative statements about each other but avoid overly broad terms that could be challenged as unfair.
Reference provision: Agree on a factual reference (e.g., job title, dates) or an enhanced one, ensuring consistency with HR practices.
Waiver of claims: Explicitly list all claims being settled to prevent future tribunal proceedings.
Return of property: Outline requirements for returning company assets (e.g., laptops, documents).
Restrictive covenants: If included, ensure post-termination restrictions (e.g., non-compete clauses) are reasonable in scope, duration, and geography to avoid being deemed unenforceable.
Legal costs contribution: Offer £300–£500 (plus VAT) towards the employee’s legal fees, or more for complex cases, to facilitate independent advice.
Use plain English: Avoid jargon to ensure the employee understands the terms, reducing claims of misunderstanding.
Tailor the agreement: Customise terms to the specific situation, avoiding generic templates that may omit critical details.

Risk Avoidance:

Ambiguous or overly restrictive clauses (e.g., excessive NDAs) may be challenged in court or attract public scrutiny. Ensure confidentiality clauses comply with Acas guidance and do not prevent lawful disclosures.
Miscalculating tax liabilities (e.g., failing to deduct tax from PILONs or bonuses) risks HMRC penalties. Consult a tax adviser or solicitor to confirm tax treatment.
Unreasonable restrictive covenants may be struck down by courts, so limit their scope to protect legitimate business interests.

Step 4: Conduct Fair Negotiations

A transparent and fair process prevents claims of coercion or improper behaviour.

Actions:

Initiate protected conversations: Hold discussions “without prejudice” or under Section 111A of the Employment Rights Act 1996 to ensure confidentiality in tribunal proceedings, unless improper behaviour occurs.
Allow sufficient time: Follow the Acas Code of Practice recommendation of at least 10 calendar days for the employee to consider the offer and seek legal advice, unless both parties agree to a shorter period.
Be open to negotiation: Allow the employee to propose changes (e.g., higher compensation, better references) to demonstrate fairness.
Provide clear information: Explain the offer, its implications, and the alternative (e.g., disciplinary process or tribunal) without undue pressure.
Facilitate legal advice: Offer a list of independent advisers or cover legal costs to ensure the employee can access advice promptly.

Risk Avoidance:

Improper behaviour (e.g., bullying, discrimination, or undue pressure) during negotiations removes the “without prejudice” protection, making discussions admissible in tribunal. Train managers to conduct discussions professionally.
Rushing the process or pressuring the employee risks claims of duress, invalidating the agreement. Document all discussions to show fairness if challenged.

Step 5: Review and Finalise the Agreement

A thorough review ensures the agreement is fair, compliant, and mutually beneficial.

Actions:

Engage an employment law specialist: Have an employment law specialist review the draft to confirm compliance with statutory requirements and address risks (e.g., tax errors, unenforceable clauses).
Check contractual obligations: Verify the employee’s entitlements (e.g., notice pay, commission, pension contributions) to ensure all payments are included.
Confirm mutual agreement: Ensure both parties understand and agree to the terms before signing.
Obtain signatures: Secure signatures from the employer, employee, and the employee’s adviser (for the certificate of advice).
Provide copies: Give the employee a copy of the signed agreement for their records.

Risk Avoidance:

Errors in the agreement (e.g., missing claims or incorrect payments) may lead to disputes or tribunal claims. An employment law specialist’s review minimises this risk.
Failing to provide a signed copy to the employee risks claims of non-transparency, so maintain clear records.

Step 6: Implement and Monitor Compliance

Proper implementation and monitoring prevent breaches and ensure the agreement’s terms are upheld.

Actions:

Make timely payments: Process all payments (e.g., compensation, legal fees) within the agreed timeframe (typically 7–28 days) to avoid breach of contract claims.
Adhere to reference terms: Ensure HR provides the agreed reference consistently to support the employee’s job search.
Uphold confidentiality: Limit knowledge of the agreement to essential personnel to prevent leaks.
Monitor compliance: Check that both parties adhere to terms (e.g., non-disparagement, return of property). Breaches by the employer (e.g., non-payment) allow employees to sue for breach of contract, while employee breaches (e.g., disclosing terms) may lead to legal action.
Retain records: Keep the signed agreement and adviser’s certificate for at least six years to address potential disputes.

Risk Avoidance:

Late or incorrect payments risk county court claims for breach of contract. Set up payment schedules and verify amounts before processing.
Inconsistent references or confidentiality breaches may lead to disputes or reputational damage. Train staff to follow agreed terms.

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.