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Settlement agreements

How to use settlement agreements to resolve employment disputes. Covers legal requirements, tax treatment of payments, ACAS early conciliation, employee rights, and negotiation process.

Guide summary

Use a settlement agreement to end an employment dispute on agreed terms. Ensure the agreement is in writing, specifies the claims being settled, and the employee receives independent legal advice. Contact ACAS before any tribunal claim. The first £30,000 of compensation is tax-free, but notice pay and bonuses are fully taxable.

  • Write the agreement down and name the specific claims being settled
  • Give the employee at least 10 calendar days to consider the terms
  • Make sure the employee gets independent legal advice from a qualified adviser
  • Pay the employee's legal fees directly to their solicitor (tax-free)
  • Contact ACAS before the employee can start a tribunal claim
  • First £30,000 of compensation for loss of employment is tax-free
  • Notice pay, bonuses and holiday pay are taxable in full
  • Employer pays Class 1A National Insurance on amounts over £30,000
  • Cannot waive whistleblowing rights or the right to report crimes
  • Keep a record of the signed agreement and advice confirmation
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A settlement agreement is a legally binding contract that typically ends the employment relationship on agreed terms. When properly executed, it prevents the employee from bringing tribunal claims about matters covered by the agreement.

Settlement agreements can resolve disputes at any stage, from initial grievances to pending tribunal claims. They offer certainty for both parties and avoid the cost and uncertainty of tribunal proceedings.

Understanding settlement agreements

When are settlement agreements used?

  • Redundancy - to agree enhanced terms beyond statutory minimum
  • Performance concerns - to exit an underperforming employee cleanly
  • Grievances - to resolve disputes without formal proceedings
  • Discrimination claims - to settle potential or actual claims
  • Whistleblowing - to resolve concerns (but cannot waive whistleblowing rights)
  • Senior departures - to manage departure of important employees

Legal requirements for valid agreements

Settlement agreements must meet specific statutory conditions to be binding.

If conditions are not met

If any condition is missing, the agreement may be unenforceable. The employee could still bring tribunal claims despite signing. Common failures include:

  • Adviser not properly qualified or insured
  • Claims not specifically identified
  • Employee not understanding what they're signing away

Allowing at least 10 calendar days to consider the written terms is ACAS Code guidance. Giving less time is not itselfa missing statutory validity condition, but may be evidence of undue pressure.

ACAS early conciliation

ACAS provides free conciliation services and must be contacted before most tribunal claims.

Settlement agreement vs COT3

Settlement AgreementACAS COT3
Private contract between partiesBrokered through ACAS conciliation
Requires independent legal adviceNo legal advice requirement
More detailed terms possibleUsually simpler terms
Employer often pays legal costsFree ACAS service
Both equally bindingBoth equally binding

Tax treatment of payments

How payments are taxed depends on their nature.

Structuring payments tax-efficiently

Tax-free (up to £30,000):

  • Compensation for loss of employment
  • Ex gratia payments not linked to contract
  • Compensation for discrimination (injury to feelings)

Taxable in full:

  • Notice pay (whether worked or PILON)
  • Contractual bonus or commission
  • Holiday pay for untaken leave
  • Any wages owed
  • Payments for restrictive covenants

Legal fees: Tax-free if employer pays directly to employee's solicitor (not to employee).

Rights that can and cannot be waived

Whistleblowing protection

Critical: You cannot include terms that prevent an employee from making a protected disclosure (whistleblowing). Any such term is void, and attempting to enforce it could itself be detrimental treatment.

Confidentiality clauses must include carve-outs for:

  • Reporting to regulators
  • Reporting crimes to police
  • Making protected disclosures

Independent legal advice requirement

Employer contribution to legal fees

It's standard (though not legally required) for employers to contribute towards the employee's legal costs. Typical contributions:

  • Standard cases - £250-£500 + VAT
  • Complex cases - £500-£1,000 + VAT
  • Senior employees/complex claims - negotiable, potentially higher

Pay directly to the solicitor to keep this tax-free.

Typical terms and negotiation

Negotiation tips for employers

  • Calculate BATNA - know your Best Alternative To Negotiated Agreement (tribunal cost/risk)
  • Lead with legal basis - explain the reasoning for proposed terms
  • Build in flexibility - have room to negotiate on some points
  • Prioritise - know which terms are essential vs nice-to-have
  • Consider timing - employee may need funds quickly, affecting negotiation

Typical timeline

  1. Week 1 - initial approach and offer
  2. Week 2 - employee considers, seeks legal advice
  3. Week 3 - negotiation of terms
  4. Week 4 - final agreement signed
  5. Termination date - as agreed (may be immediate or notice period)