Settlement agreements offer employers and employees a way to end employment on mutually agreed terms.
For the agreement to be legally binding and effective, there are several requirements that must be met, as well as practical considerations for employers when negotiating settlements.
What is a settlement agreement?
A settlement agreement, also known as a compromise agreement, can be used to resolve or avoid a workplace legal dispute between an employee and their employer.
Settlement agreements usually set the terms of contract termination with an agreed severance payment given to the employee in exchange for certain requirements, such as waiving rights to bring future claims against the employer and agreeing to keep the terms of the agreement confidential.
Settlement agreements & contracting out provisions
The majority of claims that can be filed before the employment tribunal derive from statutory provisions. Each of these sets of statutory provisions will contain terms preventing the parties (or potential parties) to an employment tribunal claim from coming to an agreement that would purport to resolve the claim and, in doing so, would purport to remove the employment tribunal’s authority to decide the dispute. These clauses, which are commonly referred to as “contracting-out provisions,” can be found in a number of employment laws, such as the ERA 1996, the Trade Union and Labour Relations (Consolidation) Act of 1992, and the Equality Act of 2010. (EqA 2010). By prohibiting claimants (or potential claimants) from signing away their right to bring a claim without proper protections having been respected, they are intended to protect claimants (or potential claimants).
The contracting-out clauses operate by enforcing the fundamental principle that any agreement established between parties that claims to preclude a person from filing or pursuing a claim with an employment tribunal is void to that extent.
However, there are two possible exceptions that are potentially available to these contracting-out rules. Provided one of the following applies, it is permissible for the parties to settle and avoid tribunal litigation:
- The agreement has been reached with support from an ACAS officer following ACAS Early Conciliation, or
- The agreement complies with the statuotry requirements for a legally binding settlement agreement.
Claims which cannot be settled by a settlement agreement
It is not possible to use a settlement agreement to contract out in relation to the following types of claims:
- Certain claims under TUPE including failure to inform and consult and failure to notify employee liability information
- Certain claims under the Agency Workers’ Regulations 2010 including those in relation to breaching rights to basic working and employment conditions and access to vacancy information
- Certain claims under TULR(C)A 1992, for failure to comply with the duty to consult employee representatives on a collective redundancy
In addition, by law, employees cannot contract out of the right to receive the following statutory entitlements and payments:
- statutory sick pay (SSP)
- statutory maternity pay (SMP)
- statutory paternity pay (SPP)
- statutory adoption pay (SAP)
- statutory shared parental pay (SSPP), and
- statutory parental bereavement pay (SPBP)
Why are settlement agreements used?
Settlement agreements can be particularly useful in situations when no legal action has yet been taken and no actual disagreement exists between the parties.
Where this a dispute, reaching a legally enforceable settlement agreement may have the benefit of requiring no engagement from Acas or any other external entity to bring the matter to a conclusion without further recourse or risk of litigation.
The settlement agreement will also be a separate, legally binding contract between the parties that may be upheld in court just like any other contract.
When are settlement agreements used?
The parties to an employment-related disagreement will frequently want to avoid incurring the expense, uncertainty, and time associated with filing/replying to an employment tribunal claim or, in the event that a claim has been filed, going to a full tribunal hearing. When a disagreement first occurs, before the claim or answer is submitted, or at any other time throughout the employment tribunal process, negotiations to resolve the claim or potential claim may be made (including during any period between determination of liability and remedy).
As such, settlement agreements are widely used by employers as a standard approach to avoiding or settling workplace disputes.
Examples could include:
- Where an employee is being made redundant
- If an employee is subject to disciplinary action
- Executive severance and senior-level exits
- Other workplace disputes or claims
Where there is an actual or potential employment law claim against an employer, and attempts to resolve the issue through internal processes or alternative methods have failed or are not appropriate, a settlement agreement is often used to bring the matter to a close by terminating the employee’s contract of employment on mutually agreeable terms.
Settlement agreements are commonly used to avoid claims such as unfair dismissal esulting from redundancy processes and performance management; constructive dismissal during misconduct investigations; or following a discrimination grievance. They can also be used to settle an employment tribunal claim at any stage during the proceedings.
In theory, they can be offered at any time during the employment relationship, or afterwards.
While commonly used to bring an employment contract to an end, they can also be used as a method of dispute resolution to resolve an ongoing workplace dispute while the employee remains employed.
How to make settlement agreeemnts legally enforceable
Settlement agreement must meet certain statutory requirements to be legally enforceable. Provided the agreement meets the statutory conditions, the contracting-out provisions will not apply.
The conditions are that:
- The settlement agreement is in writing
- It must relate to the particular proceedings
- The employee must have sought relevant independent advice
- The legal adviser must have relevant insurance in respect of loss arising as a result of the advice
- The agreement must identify the legal adviser
- The agreement must state that its terms comply with the relevant statutory provisions, and make reference to which provisions these are
First, the agreeent has to be in writing, it has to address the specific dispute or issue in question only and it must set out the agreed obligations of both the employer and the employee.
The employee must have received independent legal advice from a relevant independent adviser such as a solicitor. The adviser must be identified in the agreement and they must be insured to cover the risk of a claim from the employee in respect of any loss arising from the advice given. The agreement must also record that the requirements regulating the settlement agreement have been satisfied.
Where these conditions are not all present, the settlement agreement will not provide an effective exception to the contracting out provisions and will not have the effect of settling statutory claims. Take advice to confirm your position.
Generic, template agreements carry significant risk in failing to meet these requirements, and as such may be rendered legally unenforceable.
What should a settlement agreement include?
Employees have a number of statutory employment rights, including:
- Right not to be unfairly dismissed
- Right to be given holidays and paid holiday pay
- Right to a maximum working week
- Right to not to be discriminated against or harassed
- Right to be paid sick pay
- Right to protection as a whistleblower
Settlement agreements can be used to waive the employee’s rights to bring a claim for breaches of these statutory rights where the agreement meets the legal requirements.
The agreement should set out clearly the obligations on both parties given the specific nature of dispute, claim or circumstances. They should offer a ‘clean break’ for both the employee and the employer, with certainty as to the terms of the contract termination.
Details could include the date of termination, an agreed level of severance payment, how the employee’s notice period and outstanding holiday pay will be dealt with and agreed wording for a professional reference.
The employee will usually be agreeing to keep the terms of the agreement confidential, not to speak detrimentally about the company, to waive certain statutory, contractual and tortious claims against the employer and to return company property.
Independent legal advice
Employment rights and claims can only be waived if the settlement agreement meets certain legal requirements. This includes the requirement for the employee to have received legal advice on the terms of the agreement from an independent adviser, such as a solicitor, before they sign the document.
We offer a specialist settlement agreement service for employees. We will review the draft document, assessing whether the level of settlement is fair and if the employer has met all of its contractual obligations in respect of, for example, notice pay, payments for bonuses and commissions owed and other payments due.
In many cases, employers will pay some or all of the legal fees for the employee’s legal advice. You should confirm with your employer if and how much they will contribute to the legal costs.
Agreement must relate to particular proceedings
Blanket or template agreements that sign away all an employee’s rights will generally be ineffective.
However, the statutory requirement that a settlement agreement must relate to the particular proceedings does not limit the scope of the agreement to claims that have already been presented to the tribunal. It does also not require that a formal grievance has been raised by the employee.
The basis of the disute could relate to a ‘complaint’ which could simply be an expression of dissatisfaction about something.
Only actual or potential claims raised between the parties at the time the agreement is reached may be validly settled. Claims which have not been raised in this way cannot but an employer does not have to wait until a complaint is made by the employee before a settlement agreement can be offered if it is apparent that there may be a potential claim, ie the complaint may be one identified by the employer as opposed to one identified by the employee.
The actual or potential claim must be identified in the settlement agreement, at the very least, by a generic description (eg ‘unfair dismissal’), or a reference to the section of the statute giving rise to the claim.
Employers should identify claims with as much factual and legal detail as possible, in order to ensure precise identification of each claim intended to be settled.
What are the ‘without prejudice’ and ‘protected conversation’ rules?
There are two possible ways in which the confidentiality of negotiations may be protected:
The starting point is that evidence of any negotiations to settle a dispute or agree terms of the employee’s departure is admissible in any subsequent litigation. However, there are now two possible ways in which the confidentiality of negotiations may be protected:
- under the ‘without prejudice’ rule
- as a protected conversation relating to pre-termination negotiations for ordinary unfair dismissal claims under section 111A of the Employment Rights Act 1996
Communications are not admissible as evidence and cannot be the subject of a disclosure order under the “without prejudice” rule.
The without prejudice rule is only available where there is an existing disoute between the employer and employee.
Communications between you and your employer, such as letters or conversations, may be headed or preceded as being ‘without prejudice’. The intention is to indicate that the item cannot be disclosed or admitted as part of any tribunal proceedings that may follow.
The without prejudice rule can potentially apply in all types of litigation
while the rule regarding pre-termination negotiations can only apply to ordinary unfair dismissal claims.
A ‘protected conversation’ is slightly different in that it relates to discussions instigated by either the employer or employee to first raise the matter of a settlement agreement without a pre-existing dispute.
Again, the intention is to indicate that the discussion cannot be disclosed or admitted as part of any tribunal proceedings that may follow, unless an exemption applies, for example in discrimination cases.
The rule applies to discussions and offers from before employment termination, and there is no requirement for there to be an existing dispute for the rule on pre-termination negotiations to apply.
S111a employment rights act & settlement agreements
The Section 111A Employment Rights Act 1996 permits private discussions between an employer and an employee. This clause resembles the “Without Prejudice” concept in many aspects. Lawyers frequently use the phrase “Without Prejudice” to have “off the record” conversations, usually with the goal of coming to a resolution to a dispute.
It permits an employer to speak with a worker about ending their employment with a settlement agreement off the record and in confidence during an employment dispute without the conversation’s contents being revealed in any future legal procedures, such as a claim before an employment tribunal.
However, there must already be a disagreement for the “Without Prejudice” concept to be applicable.
This created a practical challenge for many employers who wanted to address potential issues with their workers, which prompted the creation of Section 111A of the Employment Rights Act of 1996, which permits such conversations to occur even in the absence of an active dispute.
Pre-termination conversations (including any settlement proposals) cannot be used as evidence in any judicial actions, according to Section 111A.
This regulation does have some exceptions, such as when anything is said or done that the tribunal deems to be “improper.” This would include actions that may be seen as bullying or harassment. Therefore, employers must be cautious while engaging in discussions.
It’s also crucial to remember that not all claims are covered by the provision. Claims of discrimination, automatic unfair termination, or illegal salary deductions, for example, are not included.
If a settlement agreement cannot be achieved, neither party may, with certain restrictions, subsequently refer to or rely on any negotiations that had occurred on a protected basis.
Therefore, the employee is prohibited from bringing up those talks to show that the outcome of the procedure was predetermined when such a discussion happens prior to a future disciplinary or dismissal process.
The purpose of the clause is to encourage out-of-court settlement agreements and to avoid the expenses, inconveniences, and tensions that come with formal judicial processes.
Employers are not required to notify their employees before starting protected conversations since they can do so even if there isn’t a current conflict.
If an employee feels they are receiving unfair criticism during a Section 111A dialogue, they are still free to file a grievance.
When an existing dispute arises at the time of the “off the record” conversation, Section 111A and the Without Prejudice principle will overlap somewhat since talks will be covered by both clauses.
Does the employee have to sign a settlement agreement?
Settlement agreements are voluntary. Employees are under no legal obligation to sign a settlement agreement. Employers are not allowed to coerce or force employees to agree and sign.
Employees are required to seek independent legal advice prior to signing an agreement.
Note also that conduct during the settlement negotiations may be scrutinised should the matter proceed to the employment tribunal. Should the employee reject a reasonable offer, they could risk costs awards being made against them by the tribunal.
What is a fair settlement?
Any agreed pay out for signing a settlement agreement will depend on a number of factors including:
- Contract terms
- Whether the employee has a valid claim
- The reason for contract termination
- Employee conduct and whether they have done anything wrong
- Parties’ objectives – for a swift, clean break or to risk and hold out for maximum payout
- How settlement negotiations are handled
- Any offer should be broken down into constituent parts so that parties can understand how the calculation has been arrived at and whether it is fair in the circumstances. Usually this would include:
- Loss of office compensation
- Notice payment, accrued holiday pay
- Bonuses & commissions owed
- Loss of pension
- Private insurance
We can advise employers to ensure any settlement takes account of minimum legal entitlements under statute and under contract, and ensuring these are included within the settlement calculation, as well as additional compensation element eg for loss of office, and what would constitute a fair and reasonable amount.
This requires consideration of multiple factors.
We will first look in general terms at the circumstances of the agreement and how much the employee could expect paid, and apply this to the specific facts of the case.
Some types of claims command higher compensation, for example, there is no cap on the amount of compensation a tribunal can award for discrimination claims, making the financial value potentially greater than other claims, such as unfair dismissal where a limit applies.
In cases of compulsory redundancy, where the employee’s position is not going to be replaced and there is no suitable alternative employment, settlement will usually be limited to the statutory levels, for example if they have more than two years’ continuous service, they can expect between 1 and 3 months’ gross salary payment.
In some circumstances, for example where there are potentially legal or reputational risks for the employee, the employer may be able to negotiate termination without payout, or where the employee makes payment to the employer in favour of a clean break and the employer waiving their rights to bring future claims against the employee.
We have substantial experience in all types of employment claim across market sectors, job roles and seniority levels to provide guidance on compensation levels and help employers determine what would be reasonable in the circumstances.
What happens if the employee breaches a settlement agreement?
The agreement should state what happens in the event either party breaches any of the terms. Failure to meet the obligations under the agreement can give rise to a claim for breach of contract. Generally, this will mean repaying some or all of the payments made by your employer, together with any legal fees incurred as a result of the breach.
Is tax payable on a settlement amount?
In simple terms, whether someone has to pay tax on the settlement amount will depend on how much they are paid.
An agreed amount of compensation for loss of employment to the employee can be tax-free up to a maximum of £30,000 provided it is a compensatory rather than contractual payment.
Specific areas which should be considered professionally include notice payments and impact on pensions, to achieve a tax-efficient arrangement and payment.
Negotiating a settlement agreement
Compliance with the Acas Code
The purpose of the Acas statutory Code of Practice on Settlement Agreements is to assist employers, workers, and their advisers in understanding the consequences of the ERA 1996’s Section 111A’s prohibition on pre-termination conversations.
The Foreword to the Code states that a failure to follow the Code does not in itself make a party liable to proceedings or lead to an adjustment in any compensation award made by an employment tribunal. However, where a provision of the Code appears to a tribunal to be relevant to any question arising in the proceedings before it, the tribunal must take that part of the Code into account in determining that question.
The Code gives guidance as to what may amount to ‘improper behaviour’, which may potentially disapply the rule regarding pre-termination negotiations and comments on the interaction between the rule regarding pre-termination negotiations and the without prejudice rule.
How to approach negotiations
Most employment disputes are resolved by simple negotiation, without resorting to any formal mechanism for resolution. In the majority of cases, monetary compensation is the only realistic form of redress employees can expect to receive for the wrongs they have suffered in the workplace. Tribunals are quick to recognise the futility of ordering two parties to resume working together where good relations have broken down. For that reason, reinstatement and reengagement orders are rarely made. Where you act for an employee, it is important that they come to recognise this as soon as possible, and focus only on what they can realistically expect to achieve from a negotiated settlement.
Settlement becomes more likely once an ex-employee has come to accept that they can’t turn the clock back or force their employer to reconsider its decision, and that therefore monetary compensation is the principle remedy available. However, there may be other loose ends to tie up too, such as the return of property and the giving of references, but the primary focus of settlement will be on money. Employees who seek to retrieve their reputation or publicise their former employer’s wrongdoing in the public forum of a tribunal cannot easily be brought to the negotiating table.
Good negotiating involves a certain amount of acting. It depends on the ability to read the other party’s true position from what they tell you, give clear (and possibly misleading) signals about your own intentions which the other party perceives to be your true position, manage the expectations of your own client as well as the other party’s as to what a settlement will involve, recognise what the other party needs to get from the settlement in order to recognise it as a fair deal (or a ‘win-win’ solution), maintain emotional detachment and objectivity in order to prevent any personal acrimony from developing between solicitors and, as far as possible, reduce any personal acrimony between the parties.
In many situations, the difficulty with negotiation lies not in finding an acceptable middle ground but in getting both sides to recognise that ground as an acceptable middle ground when they get there. Too often, false expectations are raised by inflated claims or derisory offers from either side, or by inconsistency in approach (for example, a ‘final offer’ which turn out not to be the best or final offer). A solicitor’s role in negotiation is best understood as being to promote their own client’s interests by cooperating with the other party’s solicitor.
Advisers will need to consider whether negotiations will become admissible in any subsequent employment tribunal and/or civil court proceedings.
Conduct of pre-termination negotiations: Acas good practice recommendations
The following is recommended as appropriate employment practise when holding pre-termination discussions under the Acas Code:
- When proposing a suggestion, it could be beneficial to explain why you think it would work.
- The proposed settlement agreement shall be given to the parties “sufficient time” to evaluate it:
- The facts of the case will determine what a “reasonable amount of time” is.
- Unless the parties agree differently, a minimum of 10 calendar days should be given to evaluate the formal written provisions of a proposed settlement agreement and to get independent counsel.
- Any face-to-face discussions of ideas should take place at a predetermined time and location (ie the meeting should be agreed in advance and the employee should not be taken by surprise)
- While allowing employees to be accompanied at such a meeting by a coworker, trade union official, or trade union representative is not required by law, it is considered good practise and “may help to progress settlement discussions” (see Practice Note: The right to be accompanied—Hearings at which the right applies).
- If a proposed settlement agreement based on the termination of employment is approved, the employee’s employment may be terminated either with the contractually necessary notice period or as of the date indicated in the agreement.
- The agreement should include information on any payments owed to the employee, including the timing of such payments.
- Alternative forms of resolution should be pursued, whether through a performance management, disciplinary, or grievance procedure, if a settlement agreement is rejected and the parties still seek to resolve the conflict or issue that gave rise to the offer.
Our specialist employment lawyers are on hand to support you with any issues relating to settlement agreements, severance discussions and terminating employment contracts lawfully. Contact us for specialist advice.
Settlement agreement FAQs
How does a settlement agreement work?
A settlement agreement is used to bring employment to an end on specific terms agreed by the employer and employee, which typically include a promise by the employee not to pursue employment tribunal claims in return for a settlement amount.
What is a good settlement agreement?
The amount of settlement will depend on the specific individual circumstances, but as a general rules, settlements can be around 2-3 months' of the employee's salary.
What does a settlement agreement cover?
It should meet the conditions of being a legally binding agreement and should cover all types of potential employment claims.
Why do companies offer settlement agreements?
Settlement agreements are used by companies to terminate employment contracts on mutally accepted terms so as to prevent the risk of the employees making tribunal claims.
Last updated: 19 April 2023