Settlement agreements are one of the most effective tools an HR professional has to achieve a clean and managed exit when employment relationships break down. Used well, they provide certainty, finality, and protection against future claims. Used poorly, they can unravel—exposing the organisation to litigation, reputational harm, and regulatory scrutiny.
This guide brings together the essentials you need to manage the process with confidence.
What is a settlement agreement?
A settlement agreement is a voluntary, legally binding contract between an employer and employee. In exchange for compensation and agreed terms (such as a reference or confidentiality protections), the employee waives their right to pursue specified employment claims.
For the waiver to be legally valid, the agreement must:
Be in writing
Relate to particular complaints or proceedings
Confirm the employee has taken independent legal advice from an identified, insured adviser
State that the statutory conditions are satisfied
These requirements stem primarily from section 203 Employment Rights Act 1996, mirrored across other employment statutes. The only alternative route to a valid waiver is through Acas conciliation, resulting in a COT3.
Framing settlement discussions
Before suggesting a settlement, HR must confirm there is a genuine business rationale for doing so. Settlement discussions may be protected in two ways:
Without prejudice conversations – available where there is an existing dispute.
Pre-termination negotiations under s111A ERA 1996 – available even without a dispute, but only in unfair dismissal contexts.
Remember: protections fall away if discussions involve discrimination, automatic unfair dismissal, or improper behaviour. Always:
Label conversations correctly (“without prejudice” or “s111A protected”)
Keep a record of what was said
Allow a reasonable consideration period (Acas suggests 10 calendar days)
Structuring the agreement: scope and money
A strong settlement agreement clearly sets out:
Payments – separate contractual sums (salary, holiday, bonus/commission), post-employment notice pay (PENP), and genuine termination payments. Apply correct tax treatment, including PENP taxation and the £30,000 exemption for ex-gratia sums.
Claims waived – specify by general description and statute, while carving out non-waivable claims (e.g., personal injury not yet known, accrued pensions, certain TUPE rights).
Claims excluded – ensure employees can still enforce the agreement and pursue rights that cannot legally be waived.
Business protections to include
Settlement agreements are more than financial documents—they safeguard business interests. Common provisions include:
Confidentiality and non-disparagement: Protects information and reputation, but must respect whistleblowing, regulatory reporting, and other statutory carve-outs.
Restrictive covenants: Re-affirm or adjust post-termination restrictions, ensuring fresh consideration supports any new terms.
Return of property and handover: Clarify obligations to return IT, documents, and intellectual property.
References and announcements: Pre-agree wording of references and communications to avoid disputes later.
Independent legal advice
No statutory settlement agreement is valid without the employee receiving independent legal advice. Employers usually contribute to this cost. The agreement must:
Record the adviser’s details and insurance
Include a statutory validity statement confirming compliance
Failing to meet these elements risks invalidating the entire deal.
Governance and process discipline
Settlement agreements should not be rushed. Best practice includes:
Drafting hygiene – mark drafts “without prejudice and subject to contract”; reference s111A ERA if using protected conversations.
Sequencing – version control, internal approvals, and sign-off authority should be clear.
Audit trail – record rationales, approvals, and adviser details.
This reduces the risk of future challenges and ensures consistency across cases.
Risks to anticipate and manage
Settlement agreements are powerful, but not risk-free. Key pitfalls include:
Improper behaviour during negotiations, leading to admissible evidence in discrimination cases.
Over-broad waivers that attempt to exclude non-waivable rights, making agreements unenforceable.
Incorrect tax treatment of PENP, inviting HMRC scrutiny.
Unreasonable pressure through coercive deadlines, undermining enforceability.
Misuse of NDAs, which can breach whistleblowing laws and attract reputational damage.
Settlement Agreements vs. COT3
When live Tribunal proceedings exist—or where both parties prefer Acas conciliation—a COT3 may be more appropriate than a settlement agreement. COT3s are often shorter, more flexible, and do not require independent legal advice. However, they may lack the ancillary protections (confidentiality, references, restrictions) that employers often need.
The choice between the two depends on timing, scope, and strategic objectives.
Final thoughts
Settlement agreements, when used strategically, allow employers to manage exits cleanly, minimise risk, and protect reputation. For HR professionals, success lies in:
Framing discussions correctly
Mapping and costing all payments
Balancing waivers with lawful carve-outs
Protecting the business proportionately
Maintaining rigorous governance and process discipline
This article was created with insights from Lex HR - your always-on HR legal assistant. Lex HR helps HR professionals navigate complex employment law with confidence, providing real-time, reliable advice tailored to your needs. Try it free today and see how much easier compliance can be.
