What is a Settlement Agreement? [Employee Guide]

Leaving a job can be stressful – especially if it isn’t your choice or if there’s been conflict along the way. And, whether or not things have ended on good terms, being handed a settlement agreement can feel overwhelming.

This guide is designed to strip away the jargon and help you understand what is a settlement agreement. With the right support, you can wrap things up smoothly and move forward with total confidence when you’re asked to consider and sign a settlement agreement.

What is a settlement agreement?

A settlement agreement (formally known as a compromise agreement) is a contract between you and your employer. They are commonly used in redundancies, restructures, or situations where the employment relationship has broken down.

When signing a settlement agreement, you typically agree to waive your right to pursue an employment claim against your employer (e.g. an unfair dismissal claim). In exchange, you usually get financial compensation.

A settlement agreement is a legally binding contract. In most cases, it will include:

• Confirmation your employer will cover the cost of your legal advice
• Details about any compensation payment
• Details of any benefits you are entitled to
• Terms relating to your notice period or payment in lieu of notice (PILON)
• Information on how various payments will be treated for tax purposes
• Confidentiality clauses
• A reference for future employment
• Any post-termination clauses to protect your employer’s business interests (restrictive covenants)
• Details on what will happen if either party breaches the terms of the settlement agreement.

Fact Check
Your employer should cover the cost of your legal advice during the settlement negotiation period (usually up to £500 + VAT).

Legal framework: Code of Practice and Employment Rights Act

Settlement agreements are governed in part by the ACAS Codes of Practice and the Employment Rights Act 1996. Legally, this means:

• You must receive independent legal advice before signing a settlement agreement
• The settlement agreement must be in writing
• The settlement agreement must specify the employment claim(s) you are waiving
• Your employer must give you sufficient time to review the agreement and obtain advice
• Your employer must not put you under undue pressure to sign
• Discussions about settlement agreements are protected and cannot usually be used in unfair dismissal cases.

These rules help ensure settlement agreements are reached fairly and voluntarily. And that you understand the terms and implications before signing.

GTE Jargon Buster
ACAS stands for Advisory, Conciliation and Arbitration Service. It is an independent public body that receives funding from the government. The ACAS Codes of Practice set the minimum standard of fairness that employers should follow in any employment dispute.

What is included in a settlement payment?

Your employer must clearly outline the payment terms and timelines in the settlement agreement. Any compensation payments are likely to be paid after your employment ends, often within 7 to 28 days.

The payments you are entitled to might include:

• Salary payments
• Compensation payments
• Redundancy pay
• Bonuses due
• Payment in lieu of notice
• Holiday pay due
• Pension contributions.

What is a reasonable settlement agreement?

What counts as a “reasonable settlement agreement” varies depending on your circumstances. However, several factors help guide expectations. These include:

1. Length of service

Longer employment often leads to higher compensation. For example, redundancy calculations are based on years of service and age.

2. Potential claims

If you have a strong constructive dismissal or unfair dismissal case, this could increase the amount your employer is willing to offer to avoid an employment tribunal.

3. Contractual entitlements

Your final payout must include unpaid holiday pay, bonuses, or commission you are due. You are also entitled to either work your notice period or receive PILON.

4. Industry norms

Employers often aim to pay a sum equal to one to three months’ gross salary, but it can be more if there are reputational risks or high legal exposure.

Employers sometimes make an initial low offer. If you believe your payout is insufficient, don’t hesitate to request a higher, more reasonable amount. However, you should also weigh up the cons of not accepting the amount offered. There’s no point pushing for more money if the end result won’t be worth the extra hassle.

GTE Jargon Buster
PILON means Payment in Lieu of Notice. It is a lump sum paid by an employer to an employee. It allows an employer to terminate employment immediately while providing the employee with the money they would have earned had they completed their notice period. Not all employees will be offered PILON as part of their settlement agreement, so you should always check.

Are settlement agreements taxable?

Elements of a settlement agreement are tax-free, but not all payments are treated the same way:

• Tax-free payments: The first £30,000 of compensation for loss of employment (e.g. redundancy or ex gratia payments) is generally tax-free.
• Taxable payments: PILON, holiday pay, and any earnings from your regular salary are subject to income tax and National Insurance contributions.
• Pension payments: Redirecting part of a settlement into a pension can be tax-efficient, but be mindful of annual contribution limits to avoid tax charges.

It is crucial that the settlement agreement clearly outlines how each payment will be treated by HMRC, as incorrect tax treatment could lead to liabilities in the future.

GTE Jargon Buster
An ex gratia payment is a voluntary “goodwill” payment made by an employer who is not legally obligated to do so. They are often offered as part of a settlement agreement to resolve a dispute without admitting liability or to avoid legal action. In the UK, ex gratia payments up to £30,000 are typically tax-exempt.

Getting a job after a settlement agreement

A common concern is how a settlement agreement might affect your future employment. Rest assured:

• Settlement agreements are not public and do not need to be disclosed to future employers.
• You can request an agreed reference as part of the agreement.

Most employees move on quickly and successfully after signing a settlement agreement, particularly with a fair reference in place. So, your career can continue unaffected.

Nevertheless, you should be aware of any restrictive covenants, such as non-compete or non-solicitation clauses, that may limit your next steps.

What are restrictive covenants?

If your settlement agreement includes restrictive covenants, this could limit what you can do after leaving the job. Typical restrictive covenants include:

• Non-compete clauses: Preventing you from working for a competitor for a specific period.
• Non-solicitation clauses: Stopping you from approaching former clients or colleagues.
• Non-dealing clauses: Restricting you from doing business with your former employer’s customers, even if they contact you.

These restrictions must be reasonable in scope and duration to be enforceable. If they go too far, they may not stand up in court. Your settlement agreement solicitor will review these clauses and advise whether they are fair or need negotiation.

Waiving your rights to future claims

When you sign a settlement agreement, you usually agree to give up your right to bring any claims against your employer concerning your employment or its termination. This is why it’s sometimes referred to as a “clean break.”

Legal actions you might otherwise bring after your employment ends include:

• Unfair dismissal claims
• Constructive dismissal claims
• Discrimination or harassment complaints.

Once you’ve signed a valid settlement agreement, you typically cannot bring these claims (apart from in very specific circumstances). This is why it’s vital that you fully understand the implications of what you’re signing and receive proper legal advice.

Negotiating a settlement agreement

While many agreements are presented as “non-negotiable,” in reality, there is often room for discussion. With the proper legal support, you might be able to secure:

• A higher compensation amount
• Early release from your notice period
• Extended legal fee coverage
• Neutral or positive wording in your reference.

Our same-day service will support you through the settlement agreement process quickly and fairly. Our team, led by Gordon Turner, will:

• Help you understand your situation and options
• Provide immediate advice on the terms of your agreement
• Identify opportunities to negotiate better compensation, references, or clauses
• Highlight any concerns (e.g. references or restrictive covenants)
• Ensure your interests are protected.

What happens if a settlement agreement is breached?

A settlement agreement is a legally binding contract, and both parties must comply with its terms. If either you or your employer breaches the deal, there may be grounds for legal action.

Common breaches include failure to make a payment, violating confidentiality clauses, or breaching post-termination restrictions.

If the agreement is broken, the consequences could include the following:

• You having to return any money that was paid to you (if you broke the agreement)
• You being able to bring back a claim you had agreed not to make (if your employer broke the agreement)
• Taking legal action to seek compensation through the courts.

If the settlement agreement is explicit, and everyone understands what is expected of them, this reduces the risk of disputes arising after it is signed.

FAQ’s on Settlement Agreements

Settlement agreements can raise a lot of questions. Below, we’ve answered some of the most common concerns employees have, so you can feel informed, supported, and confident about what comes next.

Move forward with confidence with a settlement agreement

A settlement agreement can mark the start of a fresh chapter in your career – on your terms. It can protect your rights, secure your finances, and give you closure.

At GTE Settlement Agreements, we provide same-day settlement agreement advice and sign-off. Our approach is friendly, professional, and efficient.

We understand the law, and we understand people. If you’re ready to sign, we’re ready to help – simply call us today on 020 7247 7190 or complete the enquiry form on this page.