Settlement agreements are a common way of bringing an employment relationship to an agreed end. 

Understanding how they work, what rights may be affected and the importance of obtaining independent legal advice can help employees make informed decisions before signing.

What is a settlement agreement?

A settlement agreement is a legally binding agreement between an employer and an employee, whereby the employee agrees to the termination of their employment and waives any and all claims against their employer.

In return, the employee receives a compensation payment (often referred to as an ex-gratia payment), the first £30,000 of which can be paid tax-free, along with their notice pay and pay for accrued but untaken holiday.

Settlement agreements are often used to resolve ongoing disputes to allow the working relationship to be terminated in a mutually agreed manner. They were first introduced in 1993, when they were known as compromise agreements. However, the name changed in 2013 with the introduction of the Enterprise and Regulatory Reform Act.

An employee cannot be forced into signing a settlement agreement by their employer. A settlement agreement must be entered into voluntarily by both parties.

Legal requirements for a valid settlement agreement

A settlement agreement must fulfil specific requirements to be valid. The requirements, found in Section 203 of the Employment Rights Act 1996, are as follows:

  1. The agreement must be in writing.
  2. The agreement must relate to the particular proceedings. In other words, consideration must be given to the potential claims that an employee can no longer bring by accepting a settlement agreement, and these claims must be specified within the agreement.
  3. The employee or worker must have received advice from a relevant independent adviser as to the terms and effect of the agreement and, specifically, its effect on the employee’s ability to pursue their rights before an employment tribunal.
  4. The adviser (or the firm they are employed by) must have a contract of insurance, or an indemnity provided for members of a profession or professional body, covering the risk of a claim by the employee or worker in respect of loss arising as a consequence of the advice.
  5. The agreement must identify the adviser, and
  6. The agreement must state that the conditions regulating settlement agreements under this Act are satisfied.

What information is contained within a settlement agreement?

Some specific provisions within a settlement agreement can be negotiated and agreed upon between the two parties. However, the following provisions should be included as standard:

  1. Confirmation of the termination date and notice period. If an employee is receiving PILON (pay in lieu of notice) this must also be outlined within the agreement.
  2. A section on the withdrawal and waiver of any Employment Tribunal proceedings.
  3. Information regarding the compensation (ex-gratia) payment the employee is due to receive, including whether the payment is subject to tax and confirmation of the timescale within which the payment will be made.
  4. Information on practical arrangements between the employer and the employee, such as the return of any relevant property.
  5. Confirmation of the employee’s ongoing duties of confidentiality and, if applicable, any restrictive covenants the employee may continue to be subject to.
  6. The employer’s contribution to the employee’s legal fees.

How long should an employee have to consider a proposed settlement agreement?

The ACAS Code of Practice on settlement agreements advises that an employee should have a minimum period of 10 calendar days to consider the proposed agreement and obtain independent legal advice, unless the two parties have agreed to a different time frame.

Whilst the ACAS Code is not legally binding, an employer should make reasonable efforts to adhere to it, where feasible.

Claims that may be waived under a settlement agreement

Under a settlement agreement, an employee will agree to waive their legal rights to bring Employment Tribunal claims against their employer. This applies to both contractual claims and statutory claims.

Contractual claims that may be waived include, but are not limited to, claims for contractual holiday pay and breach of contract.

Statutory claims that may be waived include, but are not limited to, claims for unfair dismissal, discrimination, and unlawful deduction from wages.

Claims that cannot be waived under a settlement agreement

There are, however, specific claims that cannot be waived under a settlement agreement. These include, but are not limited to, the following:

  1. Statutory sick pay
  2. Statutory maternity pay
  3. Statutory paternity pay
  4. Statutory adoption pay
  5. Statutory shared parental pay
  6. Statutory parental bereavement pay
  7. Personal injury claims which are unknown at the date of the agreement
  8. Claims in respect of accrued pension rights
  9. Claims to enforce the terms of the agreement

Can future, unknown claims be settled under a settlement agreement?

Questions have arisen as to whether settlement agreements can settle future claims that are unknown to the parties at the date of signing.

However, this point was clarified in the case of Bathgate Technip Singapore PTE Limited [2023] CSIH 48. In this case, the Court of Session held that unknown future claims can be settled under a settlement agreement – if the type of claim has been clearly identified within the agreement and the wording used accurately reflects this.

Independent legal advice

In advance of signing a settlement agreement, an employee must obtain independent legal advice. The employer will normally cover the costs for the employee to receive independent legal advice, up to an amount specified within the agreement.

The independent legal adviser will explain the terms of the settlement agreement and what they mean in practice. Once this has taken place, the settlement agreement can be signed by both parties to become legally binding.

While settlement agreements can provide certainty for both employers and employees, signing one can have significant implications for an employee's legal rights. Taking independent legal advice is therefore essential to ensure the terms are fully understood and that any settlement reached is in the employee's best interests.