A settlement agreement is a legally binding contract between an employee and employer that ends the employment relationship and settles any employment law claims the employee might have. They are commonly used when an employer wants a clean break — particularly following a redundancy, performance management process, or dispute — and is prepared to pay more than the statutory minimum in exchange for the employee waiving their right to bring claims.
What does a settlement agreement contain?
A typical settlement agreement includes a termination date, a financial payment, the basis on which the payment is made (redundancy, ex gratia, or payment in lieu of notice), an agreed reference, confidentiality obligations on both sides, non-disparagement clauses, and a list of the specific claims being waived. The waiver covers only claims that existed at the date of signing — it cannot waive future claims or pension rights.
Tax treatment of settlement payments
The first £30,000 of a genuine ex gratia termination payment is free of income tax and National Insurance. Payments in lieu of notice (PILON) are fully taxable. Payments for contractual entitlements such as accrued holiday pay, outstanding commission, and redundancy pay calculated under your contract are also taxable. Your solicitor can help structure the payment to maximise the tax-free element.
Should you negotiate?
The first offer is rarely the best offer. Whether your employer has strong or weak grounds for the action being taken, they want a clean resolution and will often pay more to achieve it. Grounds for negotiation include the strength of any underlying employment claim, your length of service, your notice entitlement, your prospects of finding comparable employment, and the value of any other contractual benefits being terminated.
Protected conversations
Your employer may approach you about a settlement agreement through a protected conversation under Section 111A of the Employment Rights Act. This means the conversation cannot normally be referred to in unfair dismissal proceedings. However, protection does not apply if the employer behaves improperly — such as putting you under undue pressure, giving inadequate time to consider, or making discriminatory remarks.
How long do you have to decide?
The ACAS Code recommends at least 10 days to consider a settlement agreement. You should not feel pressured to sign immediately. Use the time to take legal advice, consider your options — including whether you have a stronger claim worth pursuing — and instruct your solicitor to negotiate if the terms are not acceptable.
Never sign a settlement agreement without taking independent legal advice first. A solicitor can review the terms and negotiate improvements — often significantly.