The legal framework
Settlement agreements are set out in section 203 of the Employment Rights Act 1996 (and equivalent provisions in other employment statutes). To be legally binding, an agreement must meet specific requirements: it must be in writing, relate to a particular complaint or claim, the employee must have received independent legal advice from a qualified adviser, the adviser must be named, the adviser must have insurance, and the agreement must state that the statutory conditions are satisfied.
The independent-legal-advice requirement is the unusual one. Settlement agreements don’t become binding until the employee has had advice from a solicitor (or other named professional adviser) on the terms. Employers usually pay a contribution toward this, typically £350-£750 plus VAT.
What a typical agreement contains
The structure varies by firm but the core elements are consistent. Termination date: the date employment ends, usually the next-month payroll date or a specific agreed day. Financial settlement:the gross amount being paid, broken down by element. Common elements include: salary to termination, PILON, holiday pay, statutory redundancy (if applicable), an ex-gratia or enhanced amount, and sometimes bonus or commission.
Waiver of claims: a list (often long and specific) of the claims the employee is giving up. Common inclusions: unfair dismissal, breach of contract, discrimination, equal pay, working time, holiday, whistleblowing, unauthorised deductions from wages. Personal-injury claims arising from previously unknown causes are usually excluded; accrued pension rights are usually excluded.
Continuing obligations: confidentiality about the terms and the dispute, often a non-disparagement clause (both sides), restrictive covenants (sometimes varied), and continued obligations around the employer’s confidential information. Reference: increasingly agreed wording is attached, so the reference the employer gives is locked in.
When settlement agreements are used
Senior redundancies: employers often wrap senior redundancies into a settlement to avoid tribunal risk and to attach enhanced ex-gratia payments. The payment buys finality. Performance exits: where the employer would rather pay to settle than run a long performance process. Grievance resolutions: where a complaint has been raised and both sides prefer exit to resolution. Restructures: where roles are being changed and one or two affected employees are being paid off rather than redeployed.
They’re less common for junior redundancies, where the employer can usually rely on the statutory redundancy process alone, and rare for clear-cut conduct dismissals, where the employer doesn’t need to buy settlement.
The £30,000 tax exemption
A significant tax feature of settlement agreements is the £30,000 termination payment exemption. The tax-free portion of a settlement is statutory redundancy plus any ex-gratia payment, combined, capped at £30,000. Anything above £30k is taxable as earnings. PILON, holiday pay, and accrued bonus are always fully taxable; they don’t share the £30k allowance.
The settlement agreement calculator on this site applies the allocation correctly. For a more detailed write-up of the tax treatment see redundancy pay tax explained.
The process from offer to signature
Typically the employer sends a draft agreement with a covering letter explaining the offer. The covering letter usually says the conversation is ‘protected’ under section 111A of the ERA 1996, which means it can’t be referred to in any later unfair-dismissal claim if you don’t accept. You then take independent legal advice (the employer pays the agreed contribution), the solicitor advises on the terms and any negotiation, you sign, the employer signs, and the termination follows on the agreed date.
The advice stage is where most of the value is. Solicitors who do these regularly know what’s standard, what’s generous, what’s missing, and where leverage exists. See do I need a solicitor for a settlement agreement? and can I negotiate a settlement agreement? for the next steps.
Frequently asked questions
- What is a settlement agreement?
- A settlement agreement is a legally binding contract between an employer and employee that ends the employment relationship and waives the employee's right to bring most claims against the employer, in exchange for a financial settlement and other agreed terms. It used to be called a 'compromise agreement' before 2013.
- Why do employers use settlement agreements?
- To close out an exit cleanly. The agreement waives the employee's right to bring most types of claim (unfair dismissal, discrimination, breach of contract, unpaid wages) in exchange for an agreed package. Employers use them for redundancies (sometimes), grievance resolutions, performance exits, restructures, and any situation where they want certainty rather than risk of a tribunal.
- Is a settlement agreement the same as redundancy?
- No. Redundancy is a reason for dismissal. A settlement agreement is a contract that ends employment. They overlap when a redundancy is wrapped into a settlement (often the case for senior or higher-risk redundancies), but a settlement can be used for any departure reason and a redundancy doesn't require a settlement.
- Does a settlement agreement go on my record?
- Not externally. The agreement itself is confidential between you and the employer. Future employers won't see it unless one side breaches the confidentiality clause. Internally, the employer will have a record but standard references typically only confirm employment dates and role.
General information about UK settlement agreements, not legal advice. For your specific situation, contact ACAS or an employment-law solicitor.