If your employment is coming to an end – or you are an employer managing an employee’s exit from your business – you might come across something called a settlement agreement. These types of agreements are commonly used to bring an employment relationship to an end, often allowing for financial provision in return for the employee waiving their rights to bring a claim to an Employment Tribunal.
What is a Settlement Agreement?
A settlement agreement is legally binding agreement between an employer and employee. It usually records the terms under which an employee agrees to leave the business, and subsequently waive their rights to make a claim against the employer in the future. This agreement is often entered into in exchange for financial payment or some other benefit.
There is, however, one important caveat – settlement agreements are not binding until the employee receives independent legal advice on the terms and effect of the agreement. The employer usually pays the employee’s legal fees in connection with obtaining this advice.
When are Settlement Agreements used?
Settlement agreements can be used in a number of situations. Most commonly, this includes:
- Disputes at work – such as grievances, disciplinary issues or long-term sickness, where all parties want to avoid formal processes.
- Mutual exits – where there’s no real dispute, but both parties agree that it’s time to part ways on good terms.
- Redundancy – to streamline and ultimately make the redundancy process quicker.
These agreements are often a way to avoid uncertainty. Employers can get peace of mind that no future claims will be made, and employees get a financial cushion and certainty about their next steps.
What’s usually included in a Settlement Agreement?
There are a number of terms that settlement agreements usually include:
- Termination Payment (Compensation)
This is usually a lump sum offered in exchange for waiving employment rights or claims. It’s often called “ex-gratia” or “settlement” payment. The first £30,000 can usually be made free from deductions for tax and National Insurance.
- Payment in Lieu of Notice (PILON)
Instead of an employee working their notice period, a PILON clause may allow an employer to terminate the employee’s employment without serving the usual notice. Instead, the employee shall receive payment in respect of what they should have earned throughout their notice period. This payment is usually taxable and the amount of notice an employee is due will often be set out in their employment contract.
- Accrued Holiday Pay
If the employee has unused holiday at the termination of their employment, a settlement agreement should usually provide for payment of the same, subject to any necessary deductions.
- Reference
Settlement agreements often include wording which is to be used by the employer if they are approached by a prospective employer for a reference for the employee. While there is no obligation for an employer to provide a reference, a short and factual reference can be useful to avoid surprises and encourage settlement.
- Announcement or Internal Comms
Sometimes, both parties will agree on what will be said publicly – or internally to colleagues – about the departure. This may be helpful to avoid awkward conversations for both parties.
Important Considerations
Settlement agreements usually provide for a number of other important things, such as:
- Legal fees – Employees must receive legal advice on the agreement before it can be signed. Because of this, most agreements usually include a contribution from the employer towards these costs. These fees are usually between £350 and £500 plus VAT – though this can vary.
- Confidentiality – There will often be a clause preventing both parties from discussing the terms of the deal or making negative comments about each other.
- Return of Property – The agreement will usually confirm the arrangements regarding the return of company property, including laptops, phones, passes or any other work-related items before the agreement takes effect.
- Bespoke Clauses – Not all agreements are one-size-fits-all. Depending on the employee’s role, seniority, or the circumstances of their departure, the agreement may need to include bespoke clauses to address specific issues such as the resignation of a directorship or Trustee role, intellectual property rights, or post-termination cooperation.
Need advice on a settlement agreement?
Whether you’re an employee who’s been offered a deal, or an employer considering how best to manage a departure, it’s important to get the details right. Our employment team can help you understand your options, negotiate fair terms, and make sure everything is legally sound.