It is often in the best interest of employees and employers to resolve an issue through mediation, discussions or formal processes. However, where these practices fail, another option is available to end a working relationship — a settlement agreement mutually.

When making a settlement agreement, the correct processes must be followed to ensure it is legally binding between the parties.

In this guide, we will explore everything you need to know about settlement agreements from an HR perspective to make sure you know when to use them and some tips for what you should include in the agreement.

What is a settlement agreement?

A settlement agreement may also by the name of a ‘compromise agreement’ or a ‘termination agreement.’ The agreement is legally binding between the employee and the employer. It will usually provide a severance payment on the grounds that the employee will not pursue a claim in a Tribunal or a Court.

Both parties should always voluntarily enter into the settlement agreement and the process of drawing the agreement will often be through negotiation. However, negotiations and discussions throughout the settlement agreement will not be permissible in a court or before an employment tribunal.

Who can enter into a settlement agreement?

Settlement agreements are between two parties. Groups of individuals cannot enter into an agreement. The agreement will often be between an employer and employee (or former employee). However, it could also be between an employer and job applicant who feels they were discriminated against during the job interview.

When should you consider a settlement agreement?

An employer will often choose to get a settlement agreement when they want to terminate a contract and mutually agree on the terms with the employee to avoid the employee taking action.

Settlement agreements are generally used to avoid something becoming a drawn-out and expensive process. There are many potential circumstances where an employer may choose to draw up a settlement agreement. For example, when there has been a performance review or a disciplinary issue has arisen.

However, the most common situation where a settlement agreement is used is when there has been a redundancy.

While settlement agreements are often used upon the termination of a contract, they can also be used to settle workplace disputes.

However, ACAS does recommend that settlement agreements are not used excessively or as a first resort. They recommend settling disputes through discussion and company procedures.

When all other options have been exhausted, settlement disputes offer a quicker and cheaper solution than going to a tribunal. However, you do have to think about the cost of a settlement dispute.

Employee rights when using settlement agreements

An employer should be aware of some essential factors relating to employee rights when making a settlement agreement.

For example, the employee has the right to reject the settlement agreement and continue with the employment. Of course, this is not common practice, and the employee could still lose their job depending on the circumstances. This may be the case if the employer has sufficient grounds for gross misconduct.
ACAS Code of Practice sets out that employees have ten days to consider an agreement that has been presented to them. However, the code is not legally binding, but an employer would have to show good reason for giving an employee less time to consider an agreement.

Furthermore, the ACAS Code also lays out what it deems to be ‘improper behaviour’ when reaching a settlement agreement. Examples of this include bullying, intimidating or pressuring an employee to agree to the terms of a settlement agreement. Moreover, telling an employee they will be dismissed if they do not accept the terms of a settlement agreement is also seen as ‘improper behaviour.’ A settlement agreement will not be legally binding if improper behaviour has been found.

The employee does not have the right to take any court action or bring the case to an employment tribunal once a settlement agreement has been signed.

How to raise the questions of a settlement agreement

It is recommended that the employer has a conversation before beginning the process of a settlement agreement. This ensures that the employee doesn’t feel like the agreement has been sprung on them ‘out of the blue,’ to provide they won’t be angry during the process, making it harder to reach an agreement.

The first step of raising a settlement agreement is usually the employer making an oral or written offer. It is recommended that the offer be made in writing to avoid misunderstanding and have a thorough paper trail.

The first correspondence should also lay out why the settlement agreement is being sought. For example, is it a disciplinary issue, or is a redundancy offer being made.

The first written offer will often include the proposed terms of the agreement or be a ‘starting point’ to get the ball rolling. The final agreement must be in writing.

What to include in a settlement agreement

Each case of a settlement agreement will be different, so different terms will be agreed upon. The most common terms included in a settlement agreement are the financial offer and the promise of a reference.

An employer is not under an obligation to provide a reference, but it is common practice to do so. There is also no requirement of what a reference should include. Some employers may decide to include a full reference with details of the employee’s job and performance. In contrast, others might choose to simply confirm that an employee worked for the employer, including the dates of employment and job title.

Aside from including the legal requirements explored below, some other vital points are often included in the settlement agreement. There is no requirement for the following points to be in agreement. However, if relevant to the situation at hand, it is a good idea to include them. These points are, but are not limited to:

  • Termination date
  • Reason for termination
  • Notice pay
  • Holiday pay
  • Contractual benefits bonuses
  • Shares
  • Compensation payments
  • Non-disclosure agreements waiver
  • Settlement of employment claims
  • Tax indemnities
  • Practical issues
  • Legal costs
  • Warranties from the employee
  • References
  • Confidentiality

These points should be mutually agreed upon between the parties. It is recommended that the negotiations do not exceed 10 working days unless stated otherwise.

A settlement agreement will also usually result in an employee receiving payment, and they will usually be given a reference.

It is also common for an employer to cover the legal fees for the employee in the process of a settlement agreement. These are usually around £250-£500. It is not an obligation for employers, but it is very widely practised to do so.

Legal requirements when negotiating a settlement agreement

There are some points that you should be aware of that are necessary to include in the settlement agreement for it to be legally binding. For example, the agreement must be in writing, and it must relate to a particular complaint or proceedings. It is not possible for a settlement to arise from one complaint, and the final agreement relates to another one. In other words, the reason for the settlement agreement must be made clear.

Furthermore, the employee must be given access to an independent legal advisor — the identity of whom must also be clear. The advisor must advise the employee on the terms and effect of the proposed agreement and its impact on the employee’s ability to pursue that complaint or proceedings before a court or an employment tribunal.

Section 111A of the Employment Rights Act 1996 set out the conditions for a settlement agreement to be legally binding:

  • It must be in writing.
  • It must relate to a particular complaint or proceedings.
  • The employee in question must have received legal advice from an independent adviser on the terms and effect of the agreement and its effect on the employee’s ability to pursue that complaint or proceeding before a tribunal.
  • The adviser must be insured or have professional indemnity insurance covering the risk of a claim by the employee covering loss arising from that advice.
  • The settlement agreement must identify the legal adviser.
  • It must show that the applicable statutory conditions regulating the settlement agreement have been satisfied.

Pitfalls to avoid with settlement agreements

Offering a settlement agreement too early

It is important to understand when a settlement agreement is the best course of action. It should not be the first port of call, and you should have a process in place that should be followed leading up to offering the agreement.

Not considering the alternatives to a settlement agreement

You should always carefully consider the other available options before using a settlement agreement. For example, could you give a warning if you have a disciplinary issue, or perhaps you could consider changing the shift pattern of an employee who has an issue with time management.

Not talking to the employee before offering a settlement agreement

It is always a good idea to discuss with the employee before offering a settlement agreement so that the employee is aware of the reasons you have chosen to do it. When employees are surprised with a settlement agreement, it increases the chances of them becoming hostile, refusing to accept the offer, or making unrealistic demands.

However, while it’s only necessary for the final agreement to be in writing, it’s highly recommended that you present your first offer in writing rather than making an offer verbally. This ensures there is no misunderstanding, and your employee has a clear copy of the proposed terms to look over.

Pros and cons of using settlement agreements

Pros:

  • Avoids the cost, stress and time involved in any tribunal claim relating to a contentious exit or workplace dispute.
  • Provides an easy and straightforward method to end an employment relationship
  • Often results in both parties being content with the agreed terms
  • Includes compensation and usually a reference for employees to help them find employment.

Cons:

  • Risking the ongoing employment relationship with the individual if settlement is not agreed
  • The cost of the payment to an employee can be expensive
  • Risking employment relations in the broader workforce if misused or as a replacement for good management practices.

What happens if an agreement is not reached?

If an employee rejects a settlement offer, an employer can decide not to pursue action further and continue the employment. However, depending on the need for a settlement agreement, that may not be the best course to take. It is likely that a continuing employment relationship will not be possible.
Employers are urged to take necessary steps to address the underlying process. For example, employers should reconsider their processes if the issue arises from a dispute about holiday pay. Or, if there is an issue relating to the workplace culture, it is the employer’s responsibility to take steps to fix the underlying problems.

Employers should also have their own processes in place to deal with the issues that may have arisen. For example, if there is an issue with an employee’s performance, it would be good practice for the employee to have access to training to give them the chance to improve before the employer considers dismissal.

A fair process must always be followed before an employee is dismissed. If an employer does not follow a fair process, they will be more likely to lose any unfair dismissal claim the employee brings to a tribunal.

Mediation can also be a good step to take where there has been an issue arising from something other than a disciplinary or performance issue — for example, an issue arising from a lack of communication.
What happens if a settlement agreement is not honoured?

If the settlement agreement is not honoured, the usual process is for the affected party to claim breach of contract and damages.

Settlement agreement FAQs

What is a settlement agreement in HR?

A settlement agreement is a legally binding contract between two parties, normally an employee and the employer. It is mutually agreed upon terms of termination of the working relationship. The most common use of a settlement agreement is when there is a redundancy.

How do employers negotiate settlement agreements?

Settlement agreements are often processes of negotiation between the employer and the employee. It's common for the employer to make the first offer of agreement terms but be open to the employee to want to negotiate. The employee should be given 10 days to consider the terms set out in the agreement.

What should you watch out for in a settlement agreement?

There are some important factors for settlement agreements that ensure the agreement is legally binding. First, the agreement must be in writing. Second, the employee must have access to independent legal advice to make sure that they fully understand the terms and the legal effects of the agreement.

Do you have to take legal advice for a settlement agreement?

Yes, you must seek legal advice for a settlement agreement to be legally binding. For this reason, it is customary for the employee to pay for the legal advice, which will usually cost between £250-£500.

Legal disclaimer

The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.

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