Settlement Agreements Explained: How the Process Works

A settlement agreement is one of the most common ways of ending an employment relationship on agreed terms, and one of the least well understood. Employers often assume it is a simple exit document. Employees are often unsure whether to sign, what they can ask for and what they are giving up. Both are dealing with a legally binding contract that waives significant rights.

This post explains what a settlement agreement is, how the process works from the first conversation to signature, and what a fair approach looks like. It is written primarily for employers and managers, but it is also relevant for employees who have been offered one. It is general information, and either side should take advice on the specific terms.

What a settlement agreement is

A settlement agreement, previously called a compromise agreement, is a legally binding agreement between an employer and an employee, usually recording the end of employment on agreed terms. In return for a payment or other benefits, the employee agrees not to bring specified legal claims against the employer, such as unfair dismissal.

To be valid, the agreement must satisfy statutory conditions. It must be in writing and relate to particular complaints or proceedings, the employee must have received advice from a relevant independent adviser on its terms and effect, the adviser must be identified in the agreement, the adviser must be covered by insurance or an indemnity, and the agreement must state that these conditions are met. A relevant independent adviser can be a qualified lawyer, a trade union official or a certified adviser, and cannot be someone who acts for the employer.

The employer usually contributes towards the employee's legal fees, and this should be agreed in advance.

Before the discussion: preparation

An employer proposing a settlement agreement should be clear about why. It may be used to resolve a dispute, to end a relationship that is not working, to manage a restructuring or to exit someone in a capability situation. The employer should decide what it can offer and what it needs in return, such as a clean exit, confidentiality or agreed wording for references.

It should also think about the surrounding risk. Approaching an employee with an offer where there is no existing dispute can feel to the employee like pressure, and it needs to be handled carefully. Under section 111A of the Employment Rights Act 1996, pre-termination negotiations are generally inadmissible in an ordinary unfair dismissal claim, but that protection does not apply if there has been improper behaviour, such as harassment, bullying, intimidation or unreasonably short deadlines, and it does not cover discrimination or automatically unfair dismissal claims. A separate without prejudice conversation, where a dispute already exists, is protected in the usual way.

The settlement conversation: what actually happens

The first conversation is usually brief. The employer, often HR or a senior manager, explains that it would like to discuss ending the employment on agreed terms, and outlines the proposal. It should be clear that the employee is under no obligation to accept, that they are free to seek advice, and that if they decline, the employer will continue the existing process or the employment will carry on as normal.

The employer should follow the conversation with a draft agreement and, ideally, a short covering letter setting out the key terms. The employee then takes independent advice, considers the draft and responds, usually with questions or a counter-proposal.

The Acas Code of Practice on settlement agreements says employees should be given a reasonable period to consider the terms, and that at least 10 calendar days is reasonable unless the parties agree otherwise. Employees should be allowed to be accompanied at any meeting to discuss the agreement, by a trade union representative or a colleague.

Negotiation is normal. Employees commonly ask for a higher payment, a longer notice period, an agreed reference, a contribution to legal costs, or changes to confidentiality or restrictive covenants. Employers should be open to reasonable requests and keep the discussion professional.

What goes into the agreement

A typical agreement covers the termination date, payments due, including any payment in lieu of notice, accrued holiday pay and any additional termination payment, and a description of the claims being waived. It usually deals with the agreed reference, confidentiality, restrictive covenants, return of property, agreed announcements and, sometimes, warranties from the employee that they know of no other claims.

Tax treatment needs care. Some termination payments, such as an additional compensation payment, may be tax-free up to £30,000, but payments in lieu of notice and other contractual payments are taxable, and the rules on post-employment notice pay should be checked. Both parties should take advice.

What is changing

The Employment Rights Act 2025 will make confidentiality clauses void where they prevent a worker from speaking out about workplace harassment or discrimination, unless they qualify as an excepted agreement. Regulations setting out the conditions for excepted agreements, which are likely to include independent legal advice, informed written consent and a cooling-off period, are still to be made. The Government consulted until 8 July 2026, and the changes are expected in 2027. They will not apply retrospectively to existing agreements. Restrictions already prevent confidentiality terms from stopping certain disclosures by victims of crime.

At the same time, the unfair dismissal qualifying period falls from two years to six months from 1 January 2027, and the compensation cap is removed. That is likely to increase the number of employees with a claim to settle, and the value employers place on a clean waiver.

The final word

A settlement agreement works best when both sides understand what it is and are treated fairly in getting there. That means clear terms, real time to take advice, honest negotiation and no pressure. Done well, it gives both sides certainty and a clean end to the relationship.