Settlement (formerly compromise) agreements: how they work

Where an employee has a claim against an employer (whether the employee still works for the employer or not) they may want to enter into a settlement agreement. A settlement agreement is a contract between the employee and employer under which the employee waives their right to any claim in return for compensation.

There are many different potential claims an employee might have in order to warrant entering into a settlement agreement, for example: harassment in the workplace, discrimination, breach of an employment contract or wrongful dismissal.

Whilst it's not possible to list all the grounds for a settlement agreement here, we've set out everything you need to know about a settlement agreement below. We hope you find it useful and, if you have any questions, just let us know.

What is a settlement agreement?

A settlement agreement (known as a compromise agreement up until July 2013) is an agreement between an employer and employee under which the employee agrees not to pursue a potential claim against the employer in return for compensation (generally a cash sum).

What is legally required?

In order to be effective, a settlement agreement must meet certain criteria, one of the most important being that an employee receives independent legal advice. The reason for this being that the employee is giving up a potentially valuable claim against their employer. It's therefore important that the employee knows what they may have been awarded in court before they accept the terms of a settlement agreement.

Whilst an employee must receive independent legal advice in order for a settlement agreement to be effective, their solicitor isn't legally required to sign the actual settlement agreement itself. However, in order to avoid issues with whether or not the employee obtained advice, the settlement agreement will usually require the employee to obtain a signed certificate from their lawyer confirming that they obtained independent legal advice.

Will the employee be taxed for an award under the settlement agreement?

Provided the settlement agreement is structured correctly, payments made under the agreement will usually be tax free. However, where the payment is large (generally over £30,000) or the employment relationship doesn't terminate, the payment will usually be taxable.

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Does it have to mean the end of the employment relationship?

Whilst entering into a settlement agreement often means an end to the employee's contract with their employer, it doesn't necessarily have to. It's perfectly possible to enter into a settlement agreement and continue working with an employer where the claim arose during the course of employment (e.g. harassment or breach of contract).

However, it should be borne in mind that the relationship between employer and employee can often be strained by whatever led to the settlement agreement, as well as the negotiations over the agreement itself, so it's worth considering carefully whether both parties feel they can continue to work together effectively.

Does a settlement agreement only deal with a cash settlement?

Although generally the most important part, a settlement agreement can deal with more than just a cash settlement. The agreement can include other things which may benefit both the employer and the employee, for example: a contribution towards the employee's legal fees (so they can obtain independent advice), help with finding a new job, restrictive covenants (i.e. agreements not to join a competitor) and a reference.

What happens if I don't accept a settlement agreement?

Whilst it is possible to negotiate the terms of a settlement agreement, employees should take into account the time, cost and hassle of pursuing an employment tribunal claim, as well as the possibility of losing, before rejecting a settlement agreement proposal. Bringing a claim can take months or even years, meaning a lengthy wait an award versus what is usually a quick payout under a settlement agreement.

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If an employee and employer aren't able to reach a settlement agreement, the employee will retain any right they had to make a claim against their employer. They should bear in mind though that many employment claims only have a short time limit to make a claim, so it's important to take legal advice quickly if they feel they may have a right to make a claim.

If the employee is confident they have a claim, they (or their solicitor) will need to issue a claim against the employer at the employment tribunal. The tribunal will then require certain evidence to be presented on both sides and will list a date for a hearing.

It's worth bearing in mind that any previous negotiation over a settlement agreement will generally not be admissible in court as it will be "without prejudice" (a legal term meaning the court can't consider it when making a decision). That means that even if an employer accepts the employee has a claim during settlement negotiations, this doesn't mean this can be referenced in court. The employee may therefore be required to prove their case from the beginning in court.

During the claims process, the parties may wish to reconsider entering into a settlement agreement as taking a claim to court is generally expensive, time-consuming and stressful.

Do you need legal advice?

The amount of the settlement, and anything else included in the agreement, will ultimately come down to a negotiation between employee and employer. This is why it's important for an employee to have good legal advice, so they know the strength of their claim (and so how much is a fair settlement) as well as whether they are in a strong position to ask for any other concessions.


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