What is a settlement agreement? | FAQs answered by Paris Smith (2023)

As an employee you may find yourself presented with a settlement agreement. In this blog we answer the most frequently asked questions we receive and also give you some practical guidance on what to do if you are presented with a settlement agreement.

What is a settlement agreement?

A settlement agreement is a legally binding agreement whereby a current or former employee agrees to waive or settle all possible claims against their employer. This is often in return for a payment which is usually made shortly after termination of employment.

The purpose of the agreement is to record the full settlement terms. It will include written details of any financial payments which are being made and a list of the claims that are being waived. The agreement will also set out other important details governing the arrangement. It is highly likely that the agreement will include a confidentiality clause. This means that you should not discuss the terms or existence of the agreement with anyone else.

Why do employers use settlement agreements?

A settlement agreement can provide a clean break to both the employee and employer. It can offer a quick alternative to the time and cost associated with a redundancy procedure or formal disciplinary process. The benefit to the employer is that the employee is waiving all of their employment law claims and the terms of the settlement will be confidential.

What is the benefit to you?

Terms that are negotiated through settlement agreements can often represent a better financial outcome from that which the employee may achieve through issuing a case an employment tribunal. This is partially due to the uncertainty and ‘litigation risk’ of issuing a claim at a tribunal. However, it can also provide the employee with control over specific terms, such as a reference or an agreed announcement. These are terms that can be extremely valuable to an employee.

In addition, by entering into a settlement agreement, the employee can avoid the financial and emotional burden of proceeding to issue a claim at an employment tribunal.

How long will it take to agree the terms of the settlement agreement?

Generally speaking, settlement agreements can be concluded relatively quickly. If you are happy with the terms of the proposed agreement, your solicitor should be able to finalise the agreement within a few days. In some cases it can even be concluded on the same day. Obviously, if there are further negotiations needed then this will mean that the process takes longer. The timeframe is usually dependant on how quickly your employer responds. Your solicitor will be able to keep you updated on this.

If you have a particularly short or specific deadline, your solicitor will do their best to accommodate this. It is helpful if you let them know the timescales at the start of the process so that they are fully aware.

What should you do if you are offered a settlement agreement and why do you need to see a solicitor?

As a starting point, you should carefully read through the settlement agreement. A settlement agreement can only become legally binding once you have taken independent legal advice on the terms. This means that you are required to take a copy of the agreement to an employment law solicitor. Your employer may put you in touch with a solicitor or you may be able to choose a solicitor.

You will then attend a meeting with the solicitor (this can be conducted remotely or via a telephone call), which will typically last between 1-2 hours, depending on the circumstances and any questions you may have. The purpose of this meeting is for the solicitor to advise you on the terms of the proposed agreement. The solicitor will also advise you on its effect on your rights to pursue any employment claims before an employment tribunal. The solicitor will normally be required to sign a certificate to confirm that they have given the requisite legal advice to you.

To ensure that you get the most out of your meeting, it will be helpful if you bring along a copy of your contract of employment. Alongside the financial clauses, there are other important provisions set out within the clauses in the agreement. Your solicitor will explain what each clause means and can answer any specific questions that you may have.

Do you have to sign the settlement agreement and what happens if you refuse?

No. Settlement agreements are completely voluntary and their terms must be agreed by both parties. Once the agreement has been signed by you and your employer it will become a legally binding document.

You should not sign the settlement agreement if you do not wish to do so. If you do not sign the settlement agreement your employer will not pay you the compensation sum and your employer may look to commence a formal process with you depending on the circumstances.

Also, as outlined below, it is common for your employer to pay a contribution towards your legal fees in obtaining advice. However the payment of this contribution is normally conditional upon you signing the agreement. Therefore if you decide not to sign the agreement you will need to personally pay for the fees incurred in obtaining advice on the settlement agreement.

What is a reasonable settlement agreement and how do you know if you are getting a fair deal?

The legal role of your solicitor is to explain the terms and effect of the settlement agreement itself. However, your solicitor will also be able to advise you on the merits of any potential legal claims you may have against the employer. This could involve considering if you could have an unfair dismissal claim or any discrimination protection. This will help you to establish whether you are being offered a fair settlement package.

If you would like to negotiate on the financial package that you have been offered, your solicitor will be able to discuss this with you. The decision to negotiate will involve weighing up the employment rights you are waiving against the benefit of the compensation you are receiving. You may also wish to negotiate the specific wording of certain clauses. This is something that your solicitor will be experienced in advising you on.

When will the compensation be paid?

Usually the sums are paid within 7 to 28 days of you signing the agreement or in the next payroll. However, this can vary depending on your termination date or what has been agreed. The payment terms will be contained in the settlement agreement and your solicitor will be able to confirm this.

Will any compensation be subject to tax?

The company will deduct from the payments under the agreement all the income tax and employee National Insurance contributions (NICs) that it considers it is required to deduct by law. You will therefore receive a net payment, after such deductions have been made.

Under current tax legislation, up to £30,000 of genuine compensation can be paid on a tax free basis in certain circumstances. This will depend on the specific circumstances and payments that are being offered to you.

Do you have to pay for the legal advice?

The agreement is likely to include a legal fee contribution toward the cost of your legal fees. The value of this contribution varies but it is commonly between £350 plus VAT to £500 plus VAT. The contribution can be higher depending on the circumstances. If you wish to negotiate on the financial package which is being offered or the terms of the agreement, you may exceed the legal fee contribution offered by your employer. Your solicitor can discuss this with you and will be able to provide you with a cost estimate if necessary.

Can a settlement agreement be withdrawn or cancelled?

The settlement agreement will not be legally binding until it has been signed by both parties. This means that, prior to both parties signing, it would be possible for either side to change their mind or withdraw from the process.

However, once the agreement is binding, it cannot then be cancelled or changed without the consent of both the individual and the employer.

What happens if you breach a settlement agreement?

This would depend on the nature of the breach and the terms of the agreement itself. The agreement may contain wording about this and what could happen if you were to breach a key provision.

Sometimes the agreement will say that if you breach the agreement then any compensation payable under it will be repayable. You should be very careful to avoid breaching any terms of the agreement as this may result in legal and financial repercussions for you.

Does a settlement agreement need to be witnessed?

In the vast majority of cases it is not necessary for a settlement agreement to entered into as a deed and witnessed. However, this will depend on the specific drafting of the agreement and the terms that are being proposed.

If you are presented with a settlement agreement and need guidance through this process then contact one of our ten-strong team of employment solicitors who advise employees on settlement agreements on a regular basis or take a look at our dedicated “Settlement Agreements” page on our website.

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