Settlement Agreements: Protected Conversations & Advice

A settlement agreement is a legally binding contract in which an employee waives the right to bring specified employment claims, usually in return for a payment. Under section 203 of the Employment Rights Act 1996, it is only valid if it meets several strict conditions, including independent legal advice.

What Is a Settlement Agreement

A settlement agreement is a legally binding contract between an employer and an employee that resolves an actual or potential employment dispute. The employee agrees to waive the right to bring one or more specified claims, most often connected to the ending of their employment, to an employment tribunal or a court. Settlement agreements were previously known as compromise agreements, and the two terms describe the same kind of document. They can be used to end an employment relationship on agreed terms, or to resolve a dispute while employment continues, and either the employer or the employee can propose one. Because a settlement agreement removes an employee's right to pursue specified statutory claims, the law sets out strict conditions before that waiver takes effect; if those conditions are not met, the waiver has no legal effect and the underlying rights remain intact.

Making It Legally Binding: The Section 203 Conditions

Employment law does not generally allow an employee to sign away their statutory rights. Section 203 of the Employment Rights Act 1996 makes void any provision in an agreement that tries to exclude or limit a right under the Act, or to stop an employee bringing a claim to an employment tribunal. A settlement agreement is a specific, narrow exception to that rule, but only where it satisfies every one of the conditions in section 203(3).

A relevant independent adviser is usually a solicitor, but can also include a certified trade union official or an advice centre worker authorised to give this advice, provided they meet the independence and insurance requirements. An adviser who works for the employer, or who has any conflict of interest, does not qualify.

What a Settlement Agreement Typically Covers

Every settlement agreement is individually negotiated, and there is no standard form all employers use. This is a general description of what typically features, not a template or drafting guidance; the exact terms of any real agreement should be checked with an independent adviser before signing.

• The date employment ends, and any final working arrangements
• A breakdown of the payment, distinguishing an ex-gratia termination sum from contractual amounts such as notice pay, accrued holiday pay and any bonus
• Which specific claims the employee agrees not to pursue
• A tax indemnity, under which the employee agrees to cover any further tax HMRC later decides is owed on the payment
• A contribution towards the employee's independent advice costs, common in practice though not a fixed legal requirement
• Confidentiality terms covering the fact and terms of the settlement
• A reference, or agreed wording to give to future employers
• Return of company property, and, where relevant, restrictive covenants already in the employee's contract

When Settlement Agreements Are Used

Settlement agreements come up in several different situations. They often accompany a redundancy process, where an employer adds a further payment on top of the statutory calculation covered in our guide to redundancy pay. They are also commonly used to resolve a dispute that might otherwise turn into an unfair dismissal claim, or simply to end employment by mutual agreement without either side going through a full disciplinary or tribunal process.

Protected Conversations and Without Prejudice Discussions

Employers and employees can discuss ending employment on agreed terms before any formal dispute exists, without those discussions later being used as evidence. Section 111A of the Employment Rights Act 1996 makes evidence of pre-termination negotiations inadmissible in an ordinary unfair dismissal claim, commonly called a protected conversation. A separate, older common law rule protects genuinely without prejudice discussions, which generally requires an existing dispute between the parties rather than simply raising the idea of leaving.

This protection is narrower than it first appears. It only covers unfair dismissal claims brought under Part X of the Employment Rights Act 1996; it does not extend to claims of discrimination, harassment or victimisation under the Equality Act 2010, or to automatically unfair reasons for dismissal such as whistleblowing or asserting a statutory right. Protection is also lost where there has been improper behaviour connected with the discussions or the offer, such as undue pressure, meaning a tribunal can then consider the discussions to the extent it thinks is just.

Tax Treatment: What's Tax-Free and What Isn't

A genuine ex-gratia payment made on account of the termination of employment can be paid free of income tax up to a combined total of £30,000. This tax-free treatment applies to the compensation element of a settlement, not to every sum the agreement covers. Contractual entitlements are taxed as normal earnings regardless of the £30,000 threshold, including unpaid wages, accrued but untaken holiday pay, contractual bonuses, and any payment in lieu of notice. A well drafted settlement agreement sets out how the total payment splits between the tax-free element and the taxable, contractual elements, and an independent adviser will check that split before the employee signs.

Do You Have to Accept? Time to Consider

An employee is never obliged to accept a settlement agreement, and can instead choose to continue with, or bring, a claim through the ordinary employment tribunal process. Because signing away a statutory right is a significant step, the Acas Code of Practice on settlement agreements recommends allowing a minimum of 10 calendar days to consider a formal written offer and to take independent advice, unless both sides agree to a shorter period. An employer that puts unreasonable pressure on an employee to sign quickly risks that conduct being treated as improper behaviour, which can strip away the protection described above.

Northern Ireland

Northern Ireland uses the same underlying concept, agreed under its own employment legislation rather than the Employment Rights Act 1996, with broadly equivalent substance. Disputes in Northern Ireland are heard by the Industrial Tribunal, not the Employment Tribunal used in Great Britain, and the relevant conciliation and enforcement body is the Labour Relations Agency (LRA) rather than Acas. NI legislates separately, so anyone in Northern Ireland should check current requirements directly with the LRA rather than assume the GB position described above applies without adjustment.

For the full picture of UK employment rights, see our UK employment law hub, part of our wider guide to United Kingdom law.

This article is general information about settlement agreements under the law of England, Wales and Scotland, not legal advice, and it is not a template or drafting guide. Whether a specific agreement is valid, and what it should include, depends on individual circumstances; anyone offered a settlement agreement should get advice from a qualified, independent solicitor or other authorised adviser before signing.