When is a settlement agreement used at work?

Employer-employee relationships can go sour in any workplace

First published on Thursday, Jun 04, 2020

Last updated on Friday, Jun 14, 2024

Ideally, problems get resolved through talking, mediation or formal procedures. But when that proves impossible, there’s another tool you can use to mutually end agree the end of an employment relationship: a settlement agreement.

Previously known as ‘compromise agreements,’ settlement agreements set out the terms for agreeing to settle an employment dispute.

It’s usually the employer who proposes a settlement agreement — so here’s what you need to know.

What are settlement agreements?

First, the basics. A settlement agreement is a legally binding contract, usually between an employer and employee. In this contract, the employee often waives the right to bring a financial claim against the employer in return for financial payment.

Settlement agreements are voluntary and are usually reached through a process of negotiation.

When should you use a settlement agreement?

Settlement agreements are versatile. They aren’t just used to end employment relationships. They can settle disputes mid-contract too, at any point in the relationship.

However, employment tribunal overseers Acas advise against using settlement agreements excessively, or out of the blue. It’s better to try to resolve disputes through discussion and company disciplinary procedures first. Jumping straight to a settlement agreement might be considered heavy-handed and inappropriate.

When all other methods have failed, settlement agreements offer a swift resolution and are generally less time-consuming and stressful than a tribunal. However, settlements do carry the cost of financial compensation, and have the potential to damage wider employment relations if used inappropriately.

How to make a settlement offer

Once you’ve decided to offer an employee a settlement, you can make your proposal verbally or in writing. Be clear about what you are offering, and why you are offering to settle.

How much money should you offer?

When deciding how much financial compensation to offer, consider:

  • The potential cost of resolving the issue without a settlement agreement
  • The employee’s contract terms on pay, notice and unspent annual leave, as well as their length of service
  • Your reasons for offering the settlement

Offering the employee a reference

Many settlement agreements also include a reference for the employee. A reference can help the employee find a new job faster, thus reducing the financial impact of their departure from your company.

Providing a reference is not mandatory, but it can make your settlement proposal more appealing to the employee. Don’t be tempted to sweeten the deal with a cooked-up reference, though. References should always be true and accurate.

Negotiating settlement offers

Negotiating a settlement agreement takes time and paperwork. Negotiations work best when you follow a proper process. Acas suggests the following.

  1. Give the employee enough time to consider your offer. This should be a minimum of 10 calendar days.
  2. Be clear about the reasons behind your proposal, and be prepared to meet with and answer questions from the employee.
  3. Allow the employee to be accompanied by a colleague, lawyer or trade union rep in meetings. Consider taking legal advice of your own, too.
  4. Be sensitive about the issues discussed with the employee, with the aim of reaching a mutual agreement.
  5. Include details of payment arrangements and timings in the agreement.
  6. If you are ending the employment relationship, the reason does not have to be dismissal. It could also be ‘by mutual agreement,’ depending on what you agree with the employee.

Tax rules on financial settlement agreements

Compensation paid under a settlement agreement can often be made free of tax and National Insurance contributions, up to a value of £30,000. The rules are complex however, and you should take advice from your accountant.

Jenny Marsden

Associate Director of Service

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