Settlement agreements explained

What a settlement agreement is

A settlement agreement is a legally binding contract between an employer and an employee. The employee agrees not to bring certain claims, usually in return for a payment and other terms such as an agreed reference. It's often used when someone is leaving, but it can be used during employment too.

When it binds

For a settlement agreement to stop an employee bringing tribunal claims, it has to meet conditions set out in law:

• it's in writing and relates to particular claims
• the employee has received advice from a relevant independent adviser, usually a solicitor, on its terms and effect
• the adviser is named and has insurance covering the advice
• the agreement says these conditions have been met

Employers usually contribute to the cost of the employee's advice. A contribution paid directly to the adviser for advice on the termination isn't taxable for the employee.

Protected conversations

Offers made to settle an existing dispute are usually "without prejudice", which means they can't be shown to a tribunal. Section 111A of the Employment Rights Act 1996 goes further: pre-termination negotiations can't be used as evidence in an ordinary unfair dismissal claim, even when there's no dispute yet.

That protection doesn't apply to claims about discrimination, whistleblowing or other automatically unfair reasons, and it's lost if either side behaves improperly, for example through harassment, undue pressure or not allowing reasonable time to consider.

Acas guidance on settlement agreements suggests giving at least 10 calendar days to consider the proposed terms and take advice.

Tax on the payment

A genuine payment for losing your job is tax free up to £30,000. Pay for the notice period, whether worked or not, is taxed as normal income, and so is holiday pay and salary owed. How each part is treated depends on how the agreement is written, which is one reason the advisers settle the final wording.

The Acas alternative: a COT3

If a claim has been raised or is likely, Acas can record a settlement in a COT3 agreement through early conciliation. It's free, it's binding, and it doesn't need separate legal advice. Either side can contact Acas to start.

Agreeing the terms first

Most of the cost and stress comes from going back and forth over the details. Agreeing the practical terms first, in writing, means the solicitors start from an agreed position. Agree it in writing lets both sides do that privately, then download heads of terms for the advisers or a summary for Acas.