When you're facing redundancy, your employer might offer you something called a settlement agreement. This is a legally binding contract that usually provides you with a payment above your statutory redundancy pay. In return, you agree not to bring any claims against your employer to an employment tribunal.
Settlement agreements were known as compromise agreements until the Enterprise and Regulatory Reform Act 2013 changed the name. The idea is the same: you agree not to bring a claim, and they pay you more than the legal minimum and give both you and your employer certainty about where you stand.
Why employers offer settlement agreements
Employers have several reasons for offering these agreements. Mostly, they want to avoid tribunal claims. By paying you an agreed sum, they know you won't be able to claim unfair dismissal or discrimination later. This protects them from potentially expensive tribunal claims and the management time involved in defending them.
Employment tribunal cases are public, and companies often prefer to resolve matters quietly. The agreement will typically include confidentiality clauses that prevent you from discussing the circumstances of your departure.
Sometimes employers use settlement agreements when they're not entirely confident their redundancy process has been perfect. Perhaps they haven't followed proper consultation procedures, or the selection criteria could be questioned. A settlement agreement helps them avoid these issues being tested at tribunal.
What's typically included in a settlement agreement
The financial package is usually the first thing people look at. This often includes your notice pay, any accrued holiday pay, and an additional sum on top. This extra payment is sometimes called an ex gratia payment (a goodwill payment with no legal obligation) or compensation for loss of employment.
You'll see various clauses that restrict what you can do or say after leaving. These might include agreements not to make derogatory comments about the company, not to poach staff or clients, and to keep the terms of the agreement confidential. Some agreements include post-termination restrictions that limit where you can work, though these need to be reasonable to be enforceable.
The agreement will contain a long list of claims you're waiving. This covers everything from unfair dismissal to discrimination claims, breach of contract to claims under the Working Time Regulations. Your employer wants to ensure every possible claim is covered.
There's usually a reference clause setting out what your employer will say about you to future employers. This might be a brief factual reference or something more detailed. Getting this right can be as valuable as the financial settlement.
Getting independent legal advice
For a settlement agreement to be legally valid, you must receive advice from an independent adviser. This is usually a solicitor with a practising certificate, but could be a trade union official or advice centre worker with appropriate insurance. Your employer cannot simply hand you an agreement and expect you to sign it.
The adviser must explain the terms and effect of the agreement, particularly how it affects your ability to bring tribunal claims. They'll go through each clause with you and highlight anything unusual or potentially problematic. The adviser is there to protect your interests and ensure you understand what you're agreeing to.
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Try our Redundancy Pay Calculator free, here on this site →Most employers contribute between £250 and £500 plus VAT towards your legal fees. If the agreement is particularly complex or requires extensive negotiation, you might need to pay additional fees yourself. Some solicitors offer fixed-fee packages for reviewing straightforward agreements.
Tax implications of settlement payments
The tax position on settlement agreements changed in April 2018, making some aspects less generous than before. However, you can still receive some payments tax-free.
The first £30,000 of genuine compensation for loss of employment is usually tax-free. This doesn't include your notice pay, which is always taxable, whether you work it or receive pay in lieu. Holiday pay is also taxable.
Since 2018, employer pension contributions on termination payments above £30,000 are also subject to tax and National Insurance. Your employer must handle the tax calculations and deductions before paying you.
If your agreement includes payment for a restrictive covenant (an agreement not to work for competitors), this is always taxable. Some employers try to structure agreements to maximise the tax-free element, but HMRC looks carefully at artificial arrangements.
Negotiating and reviewing the agreement
Many people don't realise that settlement agreements can be negotiated. The first offer isn't necessarily the final one, though this depends on your circumstances and your employer's approach. Settlement negotiations often take place on a "without prejudice" basis or through "protected conversations", which means they generally can't be used as evidence if the matter goes to tribunal.
Consider what you're giving up. If you have strong claims for unfair dismissal or discrimination, your agreement should reflect this. Calculate what you might win at tribunal, bearing in mind the time, stress and uncertainty involved in bringing a claim.
Look beyond the headline figure. Sometimes you can negotiate better terms on references, confidentiality clauses, or the removal of restrictive covenants. If you need time to find another job, you might negotiate consultancy arrangements or extended benefits like health insurance.
Check the practical side too. When will you be paid? Will it be in one lump sum or instalments? What happens to your company car, laptop or phone? Can you keep your professional development funding?
Rushing to sign is perhaps the biggest mistake. You typically have at least seven days to consider an agreement, often longer. Use this time to get proper advice and think through your options. Once signed, you can't usually change your mind.
Don't assume your employer's first offer is generous just because it's more than statutory redundancy pay. For comparison, statutory redundancy pay is calculated based on your age, weekly pay (capped at £643 as of 2023) and length of service (capped at 20 years). Research what others in similar situations have received. Employment lawyers see many agreements and can advise whether yours is reasonable.
Check the small print carefully. Look specifically for confidentiality breach penalties that might require you to pay back the settlement sum if you break the terms. Also watch for offset conditions where the payment might be reduced by any money you owe the company. Make sure you understand what you're agreeing to.
Be realistic about restrictive covenants. If an agreement stops you working in your field for 12 months, factor in the financial impact. You might be better off with less money but more freedom to earn elsewhere.
If you believe the redundancy isn't genuine or you've been unfairly selected, take particular care before signing away your rights. Similarly, if you've raised grievances about discrimination or whistleblowing, ensure the settlement properly compensates you for giving up potentially valuable claims.
If you're close to retirement, check how the agreement affects your pension. If you have share options or bonuses due, make sure these are properly dealt with. Long-serving employees should ensure their full service is recognised in calculating redundancy payments.
These agreements can give you a better payout than the statutory minimum when facing redundancy. But they're significant legal documents that affect your future rights. A settlement agreement can be useful, but only if the figures and the wording are right. Before you sign anything, get advice, read it properly, and make sure the deal is actually worth it for you. It's often beneficial to carefully consider the terms rather than rushing into a quick settlement.
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