Settlement Agreements: A Complete UK Guide

A settlement agreement is a legally binding contract that ends an employment dispute — or an employment relationship — on agreed terms. In return for a payment (and often other benefits like an agreed reference), the employee agrees to waive their right to bring employment claims against the employer, such as unfair dismissal or discrimination. Settlement agreements are extremely common on exits, particularly in redundancies, performance situations and disputes, because they give both sides certainty and a clean break. Crucially, a settlement agreement is only valid in waiving statutory claims if the employee has received independent legal advice on its terms, which the employer normally helps pay for. Up to £30,000 of a settlement payment can usually be paid tax-free. This guide explains, for employers and employees, what settlement agreements are, the legal requirements, what they contain, the tax, and how to approach one.

What a settlement agreement is

A settlement agreement (formerly called a “compromise agreement”) is a specific type of legally binding contract recognised in employment law. Its defining feature is that it allows an employee to give up — “settle” — their statutory employment claims, which they cannot otherwise validly do, provided strict statutory conditions are met. In exchange, the employee typically receives a payment, often more than they would get on a simple dismissal, plus agreed terms such as a reference, confidentiality and a clean exit. For the employer, it buys certainty: once signed, the employee cannot bring the waived claims to a tribunal. Settlement agreements are an everyday tool in employment relationships, used to resolve disputes and to manage exits smoothly and with finality on both sides.

When settlement agreements are used

Settlement agreements come up in a wide range of situations. The most common include: redundancy, where an enhanced package is offered in return for a waiver of claims; performance or conduct situations, where both sides prefer an agreed exit to a contested process; disputes, such as a grievance or a potential discrimination or unfair dismissal claim, settled before or instead of a tribunal; restructures and senior exits; and sometimes to resolve a workplace issue while employment continues. They are particularly common where there is any risk of a claim, because the cost of an enhanced payment is often far less than the cost, delay and uncertainty of litigation. For senior roles, a settlement agreement is frequently the standard way an exit is handled.

Legal requirements for a valid settlement agreement

For a settlement agreement to be binding it must satisfy the statutory conditions in section 203 of the Employment Rights Act 1996: it must be in writing, relate to a particular complaint or proceedings, the employee must have taken advice from an identified independent adviser whose advice is covered by insurance, and it must state that these conditions are met. Without all of them the waiver of statutory claims is void and the employee keeps the right to bring a tribunal claim.

For a settlement agreement to validly waive statutory employment claims, the law sets out conditions that must all be met:

If any condition is missing, the waiver of statutory claims is ineffective — so getting the formalities right is essential. This is why a properly advised, properly drafted settlement agreement matters to both sides.

Independent legal advice

That advice must come from a “relevant independent adviser” as defined in section 203(3A) of the Act — in practice a qualified lawyer, a certified trade union official or a certified advice-centre worker — who is independent of the employer and carries professional indemnity insurance. If the employee has not received this advice, the agreement does not validly waive their statutory claims.

The requirement for independent legal advice is central, and exists to protect the employee — they cannot be taken to have given up valuable rights without understanding what they are signing. The adviser must be a “relevant independent adviser”, which means a qualified lawyer, a certified trade union official, or a certified advice-centre worker, and they must be independent of the employer and insured. The adviser explains the terms and effect of the agreement, particularly the claims being waived. Because the advice is for the employee’s benefit and is a legal requirement, the employer almost always contributes to the cost — a contribution of several hundred pounds is typical, and is itself part of the negotiation. The employee is free to choose their own adviser. For the formal sign-off that makes the waiver valid, the adviser must be appropriately qualified and insured.

What is in a settlement agreement

Beyond the payment and the waiver of claims, settlement agreements commonly include a familiar set of terms:

The detail of these terms — especially confidentiality, references and any restrictive covenants — is where negotiation often focuses, and where advice adds real value.

The payment and its tax treatment

The tax treatment of a settlement payment is important and frequently misunderstood. Broadly, a genuine termination (ex-gratia) payment — money paid because the employment is ending, rather than for work done — benefits from a £30,000 tax-free exemption; amounts above £30,000 are taxable. However, certain elements do not qualify for the exemption and are taxed in the normal way: pay in lieu of notice (PILN), contractual bonuses, and accrued holiday pay are all taxable. Statutory redundancy pay falls within the £30,000 exemption. The rules contain anti-avoidance provisions, so the way a payment is structured and labelled matters, and for larger settlements specific tax advice is worthwhile. The headline point for most employees is that a meaningful part of a settlement — up to £30,000 of the genuine termination element — can be received tax-free.

Confidentiality clauses and the 2025 reform

Confidentiality (or “non-disclosure”) clauses remain common, but their scope is narrowing. The Employment Rights Act 2025, which received Royal Assent on 18 December 2025, introduces new limits on the use of NDAs that seek to stop workers speaking out about harassment or discrimination, with the provisions being brought into force in stages.

Confidentiality and non-derogatory clauses are standard in settlement agreements, but the law has tightened significantly on what they can cover. Under the Employment Rights Act 2025, a confidentiality clause is void to the extent it tries to prevent a worker speaking out about harassment or discrimination, or about how the employer responded to it. Detailed regulations are being finalised, expected to take full effect by 2027. Separately, and for many years, a confidentiality clause has never been able to stop someone making a protected disclosure (whistleblowing), reporting a crime, or co-operating with a regulator. The practical message is clear: confidentiality clauses remain valid for protecting genuinely commercial information and the terms of the deal, but they cannot be used to silence complaints of harassment or discrimination — and any clause that tries to is unenforceable. Employers drafting settlement agreements, and employees signing them, should ensure the confidentiality terms comply with these rules.

Without prejudice and protected conversations

Settlement discussions are usually conducted “without prejudice”, and section 111A of the Employment Rights Act 1996 additionally makes pre-termination negotiations inadmissible in an ordinary unfair dismissal claim, even where there is no existing dispute. That protection is narrower than it looks: it applies only to ordinary unfair dismissal, not to discrimination, whistleblowing or automatically unfair dismissal claims, and it can be lost where there has been improper behaviour. The Acas Code of Practice on settlement agreements sets out the expected standards.

Settlement discussions usually take place on a “without prejudice” or “protected” basis, which affects whether they can later be referred to in a tribunal. “Without prejudice” protection applies to genuine attempts to settle an existing dispute and keeps those discussions out of evidence. Separately, the “protected conversation” rule (section 111A of the Employment Rights Act 1996) allows an employer and employee to have a confidential pre-termination settlement discussion that cannot be used in an ordinary unfair dismissal claim, even where there is no existing dispute — though it does not protect discussions tainted by improper behaviour, and it does not cover discrimination or automatically unfair dismissal claims. These rules let both sides explore a settlement frankly without fear that the conversation will be used against them, but their limits matter, which is why it is wise to understand the basis on which a settlement is being discussed.

Claims you can and cannot waive

A settlement agreement can waive most employment claims — unfair dismissal, wrongful dismissal, discrimination, unpaid wages, and many others — provided they are specifically identified, which is why these agreements list the claims in detail. However, some things cannot be validly waived: accrued pension rights are usually excluded; claims for personal injury that the employee does not know about at the time are generally preserved; and the agreement cannot stop the employee enforcing the settlement agreement itself or exercising rights that the law says cannot be excluded. Future claims that have not yet arisen can be more difficult to settle and need careful drafting. The breadth of the waiver is a key point of any settlement: employers want it as wide as possible, while employees should understand exactly what they are giving up and what is preserved.

Negotiating a settlement agreement

Settlement agreements are negotiable, and both sides have levers. The size of the payment usually turns on the strength of the employee’s potential claims, the cost and risk of litigation, and the employee’s length of service and seniority. Other terms are often just as important: a good agreed reference can be worth a great deal to an employee’s future; confidentiality and non-derogatory terms protect both sides; and the treatment of restrictive covenants, outstanding bonuses and benefits all feature. The employee’s adviser will assess whether the offer is fair given the underlying claims. A sensible negotiation focuses not just on the headline figure but on the whole package — payment, reference, confidentiality, covenants and tax treatment — because the right combination often matters more than the number alone.

Worked example

An employee with a potential unfair dismissal and discrimination claim is offered a settlement agreement after a dispute. The employer offers an ex-gratia payment of £25,000, an agreed reference, and payment of the employee’s legal fee for advice. Because the £25,000 is a genuine termination payment within the £30,000 exemption, it is received tax-free, while the employee’s separately calculated notice pay and accrued holiday are taxed as normal. The employee takes independent legal advice, which confirms the formalities are met and assesses whether £25,000 is fair against the strength of the claims; after negotiation the reference wording and confidentiality terms are improved. Both sides sign, the claims are waived, and the matter is resolved without a tribunal. The example shows how payment, tax, advice and the other terms come together in a typical settlement.

How much should a settlement be?

There is no fixed formula for a settlement payment, because it reflects a commercial assessment of risk rather than a set entitlement. The starting point is what the employee is contractually owed — notice, accrued holiday, any due bonus — which would be paid anyway. On top of that sits the settlement element, which compensates the employee for giving up their claims and provides an incentive to agree. The size of that element depends mainly on the strength and value of the potential claims: a strong unfair dismissal or discrimination claim, with significant potential compensation, justifies a larger settlement, while a weak claim justifies less. Length of service, seniority, the likely cost and time of litigation, and how much each side wants a clean break all feed in. As a rough guide, many ordinary settlements add a few months’ pay to the contractual entitlements, but strong discrimination claims — which are uncapped — can command much more. The employee’s adviser will assess whether a particular offer is fair against the realistic value of the claims, which is exactly why taking advice on the merits matters before agreeing a figure.

Settlement agreement versus an employment tribunal

Deciding between accepting a settlement and pursuing a tribunal claim is a balance of certainty against potential. A settlement gives a guaranteed payment now, a clean break, confidentiality, an agreed reference, and no stress or delay — but the employee gives up the chance of a larger tribunal award. A tribunal claim offers the possibility of a higher award (and, for discrimination, an uncapped one) and a public finding, but it carries real risk, cost, delay (often many months), and no guarantee of success or of recovering the money even if you win. Most employment disputes settle precisely because certainty is valuable to both sides and litigation is unpredictable. The right choice depends on the strength of the claim, the gap between the offer and the realistic tribunal value, and the employee’s appetite for risk and delay — which is why an honest assessment of the merits, with advice, is the foundation of the decision.

Settlement agreements in redundancy

Settlement agreements are especially common in redundancy situations. An employer running a redundancy may offer an enhanced package — more than the statutory redundancy entitlement — in return for the employee signing a settlement agreement and waiving claims, giving the employer certainty that the redundancy will not be challenged as unfair. For the employee, this can mean a better financial outcome than a bare statutory redundancy, plus an agreed reference and a clean exit. It is important to understand how the figures fit together: the settlement may roll up statutory redundancy pay, notice and an extra ex-gratia sum, with the tax treatment differing between the elements. Our guide to redundancy explains the underlying entitlements, while this guide covers how a settlement agreement packages and finalises them. Where a redundancy is offered with a settlement agreement, taking advice on whether the package is fair — and whether any claims are being given up cheaply — is well worth it.

If you are offered a settlement agreement

If your employer offers you a settlement agreement, work through these steps:

• Do not feel rushed — you are entitled to reasonable time to consider it and take advice.
• Understand why it is being offered — redundancy, a dispute, performance, or an exit.
• Get independent legal advice — it is a requirement, and the employer usually contributes to the cost.
• Assess the payment against the realistic value of any claims you have.
• Check the tax treatment — what is within the £30,000 exemption and what is taxable.
• Negotiate the whole package — figure, reference, confidentiality and covenants.
• Check the confidentiality terms comply with the rules on harassment and whistleblowing.
• Only sign once advised and satisfied the formalities and terms are right.

A settlement agreement is voluntary and negotiable, so understanding your position before you respond puts you in the strongest place.

What we see in practice

In our advisory work, the settlement agreements that cause later regret are rarely the ones with the wrong number in them — they are the ones signed before the employee understood what they were giving up. The most common pattern we see is an agreement presented as a fixed “take it or leave it” package with a tight deadline, when in reality both the figure and the wording are routinely negotiable. We also see confidentiality and “derogatory comments” clauses drafted far more widely than the situation needs. Taking the independent advice the law already requires, and using it to test the waiver wording rather than simply sign it off, is what turns a settlement from a risk into a clean break.

Common mistakes to avoid

• Skipping the formalities. Without independent advice and the statutory conditions, the waiver is invalid.
• Focusing only on the headline figure. The reference, confidentiality and covenants matter too.
• Misunderstanding the tax. Only the genuine termination element up to £30,000 is tax-free; notice pay is taxable.
• Over-broad confidentiality. A clause silencing harassment or discrimination is now void.
• Signing under pressure. Take proper advice and time; do not be rushed into a waiver of rights.
• Vague waiver wording. Claims should be clearly identified, and preserved rights spelled out.

London employers and employees: a quick note

Settlement agreements are especially common in London, with its concentration of senior roles, higher salaries and frequent restructures — and the higher the salary and the stronger the potential claim, the larger and more carefully negotiated the settlement tends to be. London’s professional and financial-services sectors in particular use settlement agreements routinely on exits. For both employers and employees in London, the priorities are the same: get the formalities right so the waiver is valid, negotiate the whole package rather than just the figure, structure the payment tax-efficiently within the rules, and ensure confidentiality terms comply with the law on harassment and whistleblowing.

How Hayhills can help

Advising on the commercial side of settlement agreements is not a reserved legal activity, so Hayhills can help you directly. For employers, we help you decide whether a settlement is the right route, structure the package and terms, and ensure the agreement and any protected conversation are handled correctly. For employees, we help you understand the strength of your position and negotiate the package — payment, reference, confidentiality and covenants. Because the formal independent-adviser sign-off that validates the waiver must be given by an appropriately qualified and insured lawyer, we work alongside and introduce a qualified solicitor to provide that certified advice, and refer larger tax questions to a specialist. Explore our employment advisory service or speak to Hayhills today.

This article is for general information only and does not constitute legal or accountancy advice. Hayhills Limited, trading as Hayhills Legal Advisory, provides non-reserved legal advisory services. Always check current requirements at GOV.UK.

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