Being handed a settlement agreement can come as a surprise, and it is natural to feel uncertain about what it means and whether you should sign it. Equally, for employers, a settlement agreement can be the most practical way to bring an employment relationship to an end, but only if it is handled properly.
A settlement agreement is a legally binding contract under which an employee agrees not to bring certain claims against their employer, usually in return for a payment. In this guide, we explain how settlement agreements work, what they normally include, how they are taxed and how the Employment Rights Act 2025 is changing the picture.
What is a settlement agreement?
A settlement agreement records the terms on which an employee’s employment will end, or on which a dispute will be resolved. In exchange for the terms offered, which usually include a financial payment, the employee agrees to waive their right to bring the claims set out in the agreement, including claims in the employment tribunal.
Settlement agreements can be proposed by either the employer or the employee. They are most commonly used where there is a dispute, a performance or conduct concern, or a restructuring, but they are also used in less contentious situations, such as a voluntary redundancy or an agreed exit.
Protected conversations and “without prejudice” discussions
Settlement agreements are often preceded by a confidential discussion. There are two separate rules that can prevent these discussions from being referred to later in a tribunal.
The first is the “without prejudice” rule, which applies where there is an existing dispute and the parties are genuinely trying to settle it. The second is the “protected conversation” rule, which allows an employer to discuss an exit with an employee even where there is no existing dispute. A protected conversation cannot be used as evidence in an ordinary unfair dismissal claim, although it does not provide the same protection in claims such as discrimination, and it will not apply if there has been improper behaviour, such as undue pressure. Our guide to protected conversations explains this in more detail.
What a settlement agreement will usually include
While every agreement is different, most will deal with the following:
- The termination date and the arrangements up to that date, such as garden leave.
- Payments you are contractually entitled to, including salary up to the termination date, notice pay and any accrued but untaken holiday.
- A termination payment, sometimes called a compensation or ex gratia payment, in return for waiving your claims.
- The claims being settled. Agreements usually settle all claims you may have, not just those that have been raised.
- A reference. If the first draft does not include an agreed reference, it is often worth asking for one.
- Confidentiality of the terms and the circumstances of your departure, subject to the exceptions set out in the agreement.
- Restrictive covenants, which may be confirmed or, in some cases, renegotiated.
- A contribution towards your legal fees, because you must take independent legal advice before the agreement can be binding.
- Tax provisions, including an indemnity, which usually makes you responsible for any further tax that becomes due on the payments.
What makes a settlement agreement legally binding
For a settlement agreement to prevent you from bringing statutory employment claims, the law requires certain conditions to be met. The agreement must be in writing and must relate to the particular claims or proceedings being settled. You must have received advice from a relevant independent adviser, usually a solicitor, on the terms and effect of the agreement, and in particular on its effect on your ability to bring a tribunal claim. The adviser must be identified in the agreement and must hold appropriate insurance, and the agreement must state that these conditions have been satisfied.
Because of these requirements, your adviser will normally sign a certificate confirming that the advice has been given. This is also why employers usually contribute towards the cost of that advice.
How settlement agreements are taxed
The tax treatment depends on what each payment represents:
- Salary, holiday pay and notice pay are taxed in the usual way, with income tax and National Insurance deducted.
- A genuine termination payment can usually be paid free of tax up to £30,000. Any amount above £30,000 is subject to income tax, although not employee National Insurance.
- Employer pension contributions can sometimes be used as part of the package, which may be tax efficient depending on your circumstances.
The way a package is structured can make a real difference to what you receive, so this is an area where independent advice is particularly valuable.
How much should a settlement agreement be worth?
There is no fixed amount. The value of an offer will usually reflect the strength of any claims you could bring, your length of service, your notice entitlement, your salary and benefits, and how long it may take you to find a comparable role. It will also reflect the time, cost and uncertainty that both sides avoid by settling rather than going to a tribunal.
An initial offer is not necessarily the final one, and it is often possible to negotiate improved terms, whether that means a higher payment, a longer notice period, an agreed reference or changes to restrictive covenants.
How the Employment Rights Act 2025 affects settlement agreements
Several changes introduced by the Employment Rights Act 2025 are likely to influence how settlement agreements are negotiated.
Longer time limits. From 1 October 2026, employees will generally have six months, rather than three, to bring most tribunal claims. This gives both sides more time to negotiate, but it also means a potential claim remains open for longer.
Unfair dismissal from January 2027. From 1 January 2027, the qualifying period for ordinary unfair dismissal claims will reduce from two years to six months, and the cap on the compensatory award will be removed. For higher earners in particular, the potential value of an unfair dismissal claim will increase, and we expect this to be reflected in settlement discussions.
Non-disclosure agreements. During 2027, clauses that seek to prevent workers from alleging or disclosing work-related harassment or discrimination will become void. Employers will need to review their standard confidentiality wording, and employees can take some reassurance that confidentiality provisions will not prevent them from speaking about these issues.
How long you have to consider an offer
The Acas Code of Practice on settlement agreements recommends that employees are given at least 10 calendar days to consider a proposed agreement and to take independent legal advice. This period can be longer or shorter if both parties agree. If you are offered a settlement agreement, we would recommend taking advice as early as possible, so that there is time to review the terms and, if appropriate, negotiate.
Settlement agreements for employers
For employers, a well drafted settlement agreement provides certainty and a clean break. To minimise risk, it is important to approach any conversation carefully, to follow the Acas Code, to allow the employee reasonable time to consider the offer and to ensure that the agreement meets the statutory requirements. With the NDA restrictions due in 2027 and the removal of the unfair dismissal compensation cap, now is a sensible time to review your template agreements. Our settlement agreement advice for employers covers this in more detail.
Frequently asked questions
Do I have to sign a settlement agreement?
No. There is no obligation to accept a settlement agreement. However, if you reject an offer, there is no guarantee that a better one will follow, so it is important to take advice on the strength of your position before deciding.
Who pays for the legal advice on a settlement agreement?
Because independent legal advice is required for the agreement to be binding, employers usually make a contribution towards your legal fees. The amount varies and can sometimes be negotiated.
Can I negotiate a settlement agreement?
Yes. Terms such as the payment, the termination date, the reference and any restrictive covenants can often be negotiated, particularly where you have potential claims against your employer.
Is a settlement agreement payment tax free?
A genuine termination payment can usually be paid free of tax up to £30,000. Payments of salary, holiday pay and notice pay are taxed in the normal way.
Can I still bring a claim after signing a settlement agreement?
Generally, no. Once a valid settlement agreement is signed, you will not be able to bring the claims it settles. There are limited exceptions, such as claims for personal injury that you are not aware of at the time and accrued pension rights, which are usually excluded.
How our employment team can help
Whether you have been offered a settlement agreement or you are an employer looking to agree an exit, our employment team can help. We advise employees on the terms and value of settlement agreements, and help employers prepare and negotiate agreements that provide certainty for everyone involved.
To discuss a settlement agreement, please call us on 0161 930 5151, email employmentteam@gorvins.com or contact us online.
This guide is for general information only and does not constitute legal or tax advice. The position is as at 28 September 2026.