A settlement agreement is used to end or sometimes to alter an employment contract. It is a quick and efficient way of parting company with an employee. It is often used to settle a dispute, with the employee agreeing not to pursue legal claims against an employer in return for a severance payment.

What is a settlement agreement?

A settlement agreement is a legally binding contract between an employer and employee. It usually terminates the employment contract, although it can also be used to make alterations.

As well as being used to settle a dispute, a settlement agreement is also frequently used in a voluntary redundancy situation. By entering into a settlement agreement, it is possible to end employment more quickly than by going through the usual notice period.

The agreement is beneficial for both parties. The employee will receive a payment for example, by way of compensation, without having to bring their case to an employment tribunal, or a redundancy payment that is more than the statutory minimum.

The employer will also avoid a time-consuming dispute and have the reassurance of knowing that they will not face a case in the future.

What is included in a settlement agreement?

A bespoke settlement agreement should be drafted addressing the specific circumstances of the situation. Key clauses usually include the following:


The agreement will waive the employee’s rights to bring a legal case in the future against the employer for breach of contract or unfair dismissal. The relevant clauses will need to be carefully drafted to protect the employer as far as possible.

The right to bring legal action in respect of certain issues cannot be waived, such as a personal injury claim where the employee did not know about it until after they had left or the right to accrued pension monies.

Notice period

The agreement will set out how the notice period will be dealt with. The employee could work this, but quite often a payment in lieu is made.


All payments to be made to the employee should be detailed. As well as the compensation payment, money owed for commission or notice should be included.

Confidentiality clause

A confidentiality clause will require the employee to keep the terms of the agreement private and can also extend to the existence of the agreement itself.

Restrictive covenants

The employee should also be asked to agree not to take certain actions, such as soliciting clients, setting up in competition nearby or poaching the employer’s other workers. The restrictive covenants need to be drafted carefully as, if they are too wide, the court will not enforce them.


The wording of a reference is frequently included so that the employee can be sure what you will say about them to their potential next employer.


The employee would usually be asked to give a warranty that there are no circumstances that mean that they could be dismissed, such as gross misconduct or negligence.

Payment for legal advice

The employee must take independent legal advice before signing the settlement agreement as it is a waiver of their rights. It is customary for the employer to pay towards the cost of this advice and the sum they are willing to contribute should be noted in the settlement agreement.

Tax indemnity

The parties will agree on how any future tax liabilities will be dealt with. Generally, the employer will undertake to notify the employee of any tax demand they receive and in return, the employee will undertake to discharge any money due.

Are settlement agreements taxable?

The first £30,000 of a settlement agreement is usually tax-free provided it does not include contractual payments such as ordinary pay, holiday pay or pay in lieu of notice, however it will ultimately be for HM Revenue and Customs to decide whether tax will be payable or not.

Any money paid for restrictive covenants or confidentiality will be taxable.

Putting a settlement agreement in place with an employee

At Springhouse Employment Solicitors we deal only with employment law meaning we have genuine expertise across all employment issues. We have extensive experience in drawing up settlement agreements tailored to protect our clients’ interests. We are strong negotiators and will ensure that the deal reached is the best possible.

If you need a settlement agreement or you would like to speak to us about your options, get in touch. Our employment law solicitors are ready to give you clear, accurate advice.

Contact us for an initial chat with our helpful team.

Expertise for employers

Starting employment: contracts and policies

During employment: handling staff problems

Common issues raised by staff

Ending employment



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