A settlement agreement (previously called a compromise agreement and sometimes called a severance agreement) is a legally binding agreement between an employee and employer to end an employment relationship or to resolve an ongoing workplace dispute. It is most often used to bring an employment relationship to an end with the employee and employer agreeing to settle a potential employment tribunal claim in return for an agreed financial sum, thereby allowing the parties to avoid litigation.

To be legally binding, a settlement agreement: must be in writing; it must relate to a particular complaint or proceedings; the employee must have received advice on it from a relevant independent adviser; the independent adviser must have a current contract of insurance or professional indemnity insurance; and the agreement must identify the adviser, and state that the applicable statutory conditions regulating settlement agreements has been satisfied.

The relevant independent adviser will usually be an employment lawyer but could also be a certified trade union official or a qualified legal executive.

The agreement will include the amount of the sum to be paid to the employee and details of the legal claims to be waived by the employee in return. The agreement may also include a confidentiality clause and provide for a fee contribution by the employer for the advice given to the employee.

Settlement agreements are negotiated between the parties “without prejudice”, ie they are inadmissible as evidence before an employment tribunal or other court proceedings.

The agreement will provide that the employer must pay the agreed settlement sum within a specified time and both parties must continue to abide by the agreed terms. Failure to do this may allow the disadvantaged party to bring a claim for breach of contract and claim damages in the county or high court.

Currently up to £30,000 can be received under a settlement agreement free of income tax and national insurance contributions. But payments that would otherwise have been received in employment and taxed, eg pay, remain taxable.

The employee will be unable to bring any associated employment tribunal claim relating to the terms of the agreement (with some exceptions, including accrued pension rights).

Claims settled via the Advisory and Conciliation Service (ACAS) may use a Central Office of Tribunals, form 3 (COT3) agreement rather than a settlement agreement. Once the parties agree a settlement sum in principle, ACAS will usually provide a standard form COT3 settlement agreement for approval. The agreed COT3 settlement wording forms a legally binding agreement.

Co-Operative Legal Services (Co-Op) offer detailed information on settlement agreements and other aspects of employment law such as constructive dismissal.