Employment Law Guide
Settlement Agreements: Your Rights as an Employee
Everything you need to know about settlement agreements — what they mean, whether to sign, how much compensation to expect, and how to negotiate better terms.
What Is a Settlement Agreement?
A settlement agreement is a legally binding contract between you and your employer. In exchange for a financial payment (and sometimes other benefits such as an agreed reference), you agree to waive your right to bring employment tribunal claims against your employer.
Settlement agreements are used in a wide range of situations: redundancy (where the employer wants a clean break); disciplinary or performance processes (where both parties want to avoid the time and cost of a formal process); discrimination or harassment complaints; and mutual agreement to end employment.
For a settlement agreement to be legally valid, you must receive independent legal advice from a qualified solicitor before signing. Your employer will usually pay a contribution towards your legal fees.
How Much Should You Receive?
The starting point for any settlement negotiation is: what could you recover if you brought employment tribunal claims? The main claims to consider are:
- Unfair dismissal — a basic award (based on age, length of service and weekly pay) plus a compensatory award for financial loss. The compensatory award is capped at the lower of 52 weeks' pay or £115,115 (2024/25).
- Wrongful dismissal — your notice pay if you were dismissed without proper notice. Uncapped.
- Discrimination — compensation for financial loss plus an injury to feelings award. Uncapped.
- Whistleblowing — compensation for financial loss plus a potential uplift. Uncapped.
In practice, settlement payments are often higher than tribunal awards because the employer is also paying for certainty and to avoid the management time and reputational risk of tribunal proceedings. A solicitor can advise on the realistic range for your specific situation.
Tax on Settlement Payments
The first £30,000 of a genuine termination payment is free from income tax and National Insurance. This includes statutory redundancy pay, enhanced redundancy pay, and ex gratia payments. However, payments in lieu of notice (PILON) are always taxable, as are payments for accrued holiday pay and bonuses.
The structure of the payment matters. A solicitor can advise on how to maximise the tax-free element of your settlement.
Negotiating Better Terms
Many employees accept the first offer without negotiating. This is a mistake. Settlement agreements are negotiable, and employers expect some negotiation. Areas where you can often improve the terms include:
- The financial payment — particularly if you have strong tribunal claims
- The reference — an agreed positive reference attached to the agreement
- Confidentiality — the scope of any confidentiality obligations
- Announcement to colleagues — the wording of any internal announcement
- Return of company property — timing and logistics
- Outplacement support — career coaching or CV assistance
Frequently Asked Questions
What is a settlement agreement?
A settlement agreement (formerly called a compromise agreement) is a legally binding contract between an employer and an employee. In exchange for a financial payment, the employee agrees to waive their right to bring employment tribunal claims against the employer. Settlement agreements are commonly used to resolve disputes, manage redundancies, or end employment on agreed terms.
Do I have to sign a settlement agreement?
No. You are never obliged to sign a settlement agreement. It is entirely voluntary. However, if you refuse to sign, your employer may proceed with a redundancy, disciplinary process, or other action. You should take independent legal advice before deciding whether to sign.
Why do I need independent legal advice?
A settlement agreement is only legally valid if you have received independent legal advice from a qualified solicitor (or other authorised adviser) about the terms and effect of the agreement. Your employer will usually pay a contribution towards your legal fees — typically £250–£500 plus VAT. The solicitor must sign a certificate confirming they have given you advice.
How much compensation should I receive?
There is no fixed formula. The amount depends on: the strength of any employment tribunal claims you could bring; your length of service; your salary; the reason for leaving; and how much your employer wants to avoid the risk and cost of litigation. As a starting point, consider what you could recover at tribunal — unfair dismissal compensation, for example, is capped at the lower of 52 weeks' pay or £115,115 (2024/25). Discrimination claims are uncapped.
Is the settlement payment tax-free?
The first £30,000 of a genuine termination payment is tax-free, provided it is not a payment in lieu of notice (PILON) or a contractual payment. Payments in lieu of notice are always taxable. Payments for injury to feelings in discrimination cases may also be tax-free up to certain limits. Your solicitor will advise on the tax treatment of each element of the payment.
Can I negotiate the terms of a settlement agreement?
Yes. Settlement agreements are negotiable. Common areas for negotiation include: the financial payment; the reference (a positive agreed reference is often included); the wording of any announcement to colleagues; confidentiality obligations; and the return of company property. Your solicitor can negotiate on your behalf.
What claims does a settlement agreement waive?
A settlement agreement will typically waive all employment-related claims, including unfair dismissal, wrongful dismissal, discrimination, harassment, whistleblowing, breach of contract, and unpaid wages. It should list the specific claims being waived. Claims that arise after the agreement is signed (such as personal injury claims you are not aware of at the time) are not usually waived.
What is a without prejudice conversation?
A without prejudice conversation is a protected discussion between employer and employee about the possibility of ending employment on agreed terms. What is said in a without prejudice conversation cannot generally be used as evidence in employment tribunal proceedings. Employers can also use the statutory "protected conversation" procedure under section 111A of the Employment Rights Act 1996 for pre-termination negotiations.
How long do I have to consider a settlement agreement?
The ACAS Code of Practice recommends that employees are given at least 10 calendar days to consider a settlement agreement. Your employer cannot pressure you to sign immediately. If you feel pressured, tell your solicitor — this may be relevant to the negotiations.
What happens if I reject the settlement agreement?
If you reject the agreement, your employer may proceed with whatever process was underway — redundancy, disciplinary, or performance management. The without prejudice discussions cannot be used against you in tribunal. You retain all your employment rights and can bring tribunal claims if your employer acts unlawfully.
Can I include a reference in a settlement agreement?
Yes. It is common to negotiate an agreed reference as part of a settlement agreement. The reference is usually attached to the agreement as a schedule. This gives you certainty about what your employer will say to future employers, which can be particularly important if the departure is on difficult terms.
Get Independent Legal Advice on Your Settlement Agreement
PDA Law's employment team advises employees on settlement agreements across England and Wales. We offer fast turnaround and can often see you the same day or next day. Your employer will usually pay our fees.