Settlement Agreements: A Plain English Guide for UK Employers

A settlement agreement is one of the most useful tools available to UK employers when an employment relationship needs to end cleanly. Used correctly, it protects you from tribunal claims, avoids the cost and disruption of a formal process, and lets both sides move on.

Used incorrectly, it can create more problems than it solves.

This guide covers everything employers need to know: what settlement agreements are, when to use them, how much they cost, and how to get them right.

Last updated: April 2026

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Settlement Agreement Employer Guide UK: The Basics

A settlement agreement is a legally binding contract between an employer and an employee. The employee agrees to waive their right to bring certain claims (typically unfair dismissal, discrimination, and breach of contract) in exchange for a financial payment and agreed terms.

Before April 2013, these were called "compromise agreements." The name changed under the Enterprise and Regulatory Reform Act 2013, but the effect is identical.

For a settlement agreement to be legally valid under UK law, three conditions must be met:

1. The agreement must be in writing. An oral deal is not enforceable as a settlement agreement.
2. The employee must have received independent legal advice from a qualified adviser (usually a solicitor) on the terms and effect of the agreement, and on its effect on the employee's ability to pursue claims before an employment tribunal.
3. The adviser must be identified in the agreement and must have a current professional indemnity insurance policy.

If any of these conditions are missing, the agreement is not valid, and the employee can still bring a claim.

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When to Use a Settlement Agreement as an Employer

Settlement agreements are a practical management tool for a range of scenarios.

Redundancy

When making a role redundant and you want to avoid or supplement a formal consultation process, a settlement agreement can streamline the exit. This is especially useful for individual redundancies where the enhanced payment justifies waiving the process risks. For larger-scale redundancies, see our guide on the step-by-step redundancy process.

Performance Management

Where an employee is underperforming and a formal capability process would be lengthy or disruptive, a settlement agreement offers a dignified exit. The employee gets a financial cushion and an agreed reference. You avoid months of formal process.

Disciplinary Situations

Where you have grounds for dismissal following a disciplinary procedure but want to avoid the risk of a tribunal claim, a settlement agreement is often the pragmatic choice. This is particularly common where the evidence is strong but not watertight.

Relationship Breakdown

Sometimes the working relationship has simply broken down with no single triggering event. A settlement agreement provides a clean break without the need to manufacture a formal process.

Protecting Against Constructive Dismissal Claims

If an employee has raised grievances or there are signs that a constructive dismissal claim may be brewing, a settlement agreement can resolve the situation before it escalates.

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The Protected Conversation: Section 111A

Section 111A of the Employment Rights Act 1996 allows employers to have "pre-termination negotiations" with employees without those conversations being admissible in ordinary unfair dismissal proceedings.

In plain English: you can approach an employee and offer them a settlement agreement without that offer being used against you at tribunal if they reject it.

What Section 111A Covers

• Conversations and written offers made with a view to ending employment on agreed terms
• The fact that you made an offer at all
• The amount you offered

What Section 111A Does Not Cover

• Discrimination claims. If the employee brings a discrimination claim, the protected conversation is not protected.
• Automatically unfair dismissal claims. Claims based on whistleblowing, trade union activity, or pregnancy are not covered.
• Improper behaviour. Bullying, undue pressure, or harassment during the conversation removes the protection.

If the employee has any potential discrimination angle, the s.111A protection may be worthless. In those cases, also rely on the "without prejudice" rule (which applies where there is a genuine dispute). Using both together gives you the broadest protection.

Practical Tips for the Conversation

• Keep it brief and professional. Do not get drawn into lengthy justifications.
• Make clear the conversation is a protected conversation under s.111A.
• Give the employee a written offer to take away.
• Allow at least 10 calendar days (as recommended by the ACAS Code of Practice on Settlement Agreements) for the employee to consider.
• Do not threaten dismissal in the same conversation. That crosses into improper behaviour.

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What Goes into a Settlement Agreement

Financial Terms

• Ex-gratia payment. The core settlement sum. The first £30,000 of a genuine termination payment is tax-free under s.401 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). Anything above £30,000 is subject to income tax and employer NICs.
• Notice pay. If the contract includes a PILON clause, this is taxable as earnings. If there is no PILON clause, it may qualify as part of the £30,000 threshold, though HMRC guidance has tightened.
• Outstanding holiday pay. Accrued but untaken, taxable as earnings.
• Bonus or commission. Any amounts due under contractual schemes.

Non-Financial Terms

• Agreed reference. Often more important to the employee than the money.
• Announcement wording. What both sides will say about the departure.
• Confidentiality clause. Both sides agree not to disclose the settlement terms.
• Non-derogatory comments. Neither side will make negative public statements.
• Return of property. Laptop, phone, access cards, company vehicle.
• Waiver of claims. The core legal purpose of the agreement.

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Settlement Agreement Cost for Employers UK

1. The Settlement Payment

There is no fixed formula. The amount depends on the strength of the employee's claims, their salary and length of service, and the cost of the alternative.

Rules of thumb:

• Straightforward redundancy with no complications: one to three months' salary.
• Potential unfair dismissal and/or discrimination claims: three to six months' salary for mid-range cases.
• Senior employees or complex claims: six to twelve months' salary or more.
• The statutory compensatory award cap for unfair dismissal is currently £115,115. From January 2027, this cap is being removed under the Employment Rights Act 2025.

2. The Employee's Legal Fees

The employer almost always pays a contribution towards the employee's legal costs. Typical range: £350 to £500 plus VAT for straightforward agreements, £750 to £1,500 plus VAT for complex ones. This is not optional in practice: without legal advice, the agreement is void.

3. Your Own Legal Fees

• Template-based, low complexity: £500 to £1,000 plus VAT
• Bespoke drafting, mid complexity: £1,000 to £2,500 plus VAT
• Complex, high-value, multiple issues: £2,500 to £5,000 plus VAT

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The Settlement Agreement Process: Step by Step

1. Assess the situation. What claims could the employee bring? What would a tribunal likely award? What is the cost of a formal process?
2. Have the protected conversation. Use s.111A. Keep it professional. Provide a written offer.
3. Allow time to consider. Minimum 10 calendar days per the ACAS Code.
4. Negotiate. Counter-offers are normal. Common sticking points: settlement sum, reference wording, termination date.
5. Draft the agreement. Include all agreed terms, the full list of claims being waived, and practical details.
6. Employee receives independent legal advice. The solicitor signs the adviser's certificate.
7. Both sides sign. The agreement is now binding. Make payments on the agreed dates.

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Common Mistakes Employers Make

Offering too little. A low-ball offer signals you do not take the employee's claims seriously and can entrench the dispute.

Rushing the process. Pressuring the employee to sign quickly is improper behaviour that can undermine s.111A protection.

Failing to cover legal fees. Without proper legal advice, the agreement is void.

Using a generic template without adaptation. A template that does not properly list the claims being waived, or includes inappropriate restrictive covenants, creates risk.

Forgetting the tax position. Getting the split between taxable and non-taxable elements wrong creates problems with HMRC for both sides.

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Settlement Agreements and the Employment Rights Act 2025

The Employment Rights Act 2025 does not change settlement agreement law directly, but it significantly changes the risk landscape.

Day one unfair dismissal rights (from January 2027). The qualifying period drops from two years to six months, meaning far more employees can bring claims after dismissal. Settlement agreements become more relevant, not less. Read our full guide on day one unfair dismissal rights.

Removal of the compensatory award cap (from January 2027). The uncapped potential cost of getting a dismissal wrong increases the value of a clean exit via settlement agreement.

Zero hours contract restrictions (from Autumn 2026). Employers transitioning workers off zero hours contracts may find settlement agreements useful for managing exits where the relationship is not viable under the new framework.

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Before You Finalise a Settlement Agreement

Before finalising a settlement, check your employment documents are compliant. The EmployerKit Audit identifies gaps in your contracts and policies that could affect your position. From £49. Visit employerkit.com/tools/employerkit-audit.

Settlement agreements often expose weaknesses in contracts and policies that should have been fixed earlier. A non-compliant contract, a missing disciplinary policy, or an outdated restrictive covenant clause can all weaken your negotiating position. Getting your documentation right before you need a settlement agreement is significantly cheaper than patching it during one.

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FAQs: Settlement Agreements for UK Employers

Q: Can an employee refuse a settlement agreement?

A: Yes. A settlement agreement is entirely voluntary. The employee has no obligation to accept or even engage with the offer. If they refuse, you fall back to formal processes: redundancy consultation, disciplinary proceedings, or performance management. You cannot penalise an employee for refusing.

Q: How long does a settlement agreement take from start to finish?

A: Typically two to four weeks for straightforward cases. The ACAS Code recommends at least 10 calendar days for the employee to consider. Add time for negotiation, drafting, and legal advice. Complex cases can take six to eight weeks.

Q: Do I need a solicitor to draft the agreement?

A: No legal requirement for the employer to use one. Many employers use a settlement agreement template for straightforward cases. However, a poorly drafted agreement can be unenforceable. For significant payments or complex circumstances, professional drafting is worth the cost. The employee must always receive independent legal advice for the agreement to be valid.

Q: What happens if the employee breaches the confidentiality clause?

A: A breach is a breach of contract, and you could pursue damages. In practice, confidentiality breaches are difficult to enforce. The more practical deterrent is a "clawback" clause allowing you to recover part of the settlement payment if key terms are breached. Include one and make sure the employee's solicitor explains it.

Q: Is the £30,000 tax-free threshold per employment or per settlement?

A: The £30,000 exemption under s.401 ITEPA 2003 applies per termination of employment, not per agreement. If the employee receives multiple payments connected to the same termination, they share the threshold. Contractual payments (notice pay under a PILON clause, salary, holiday pay) are taxable as earnings and do not use up the £30,000 allowance.

Q: Can I offer a settlement agreement during a probationary period?

A: Yes. Nothing prevents it. In practice this is less common because the employee currently has limited claims during the first two years. From January 2027, when the qualifying period drops to six months, settlement agreements during or after probation will become more common as employees gain unfair dismissal rights earlier.

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This guide is for general information only and does not constitute legal advice. Employment law is complex, and specific situations may require professional legal guidance. Content is accurate as of April 2026.