Settlement agreements: a guide for employers and HR advisers

When a settlement agreement is the right tool

A settlement agreement lets an employer end an employment, or resolve a dispute, on agreed terms in exchange for the employee giving up the claims listed in the agreement. It gives certainty: the leaving date, the payments, the reference and the announcement are fixed, and the risk of a tribunal claim about the matters settled is removed.

It is usually the right tool where a fair process would be long, uncertain or damaging to working relationships, where there is a real risk of a claim, or where both sides would prefer a quick and private exit. Typical situations include a senior employee whose role is no longer working, a performance or conduct problem where the evidence is arguable, and a redundancy where an enhanced package is offered in return for a waiver of claims. Take particular care where the employee has raised a discrimination complaint or is absent because of ill health, because the protection for settlement discussions described below does not extend to discrimination claims.

Acas guidance points out that settlement agreements are not always the best way to deal with problems at work, and that many issues can be resolved through good performance management or fair disciplinary and grievance procedures. It also suggests reviewing who settlement agreements are offered to, because offering them routinely to one group, such as older employees, could be discriminatory.

Weigh the cost of the package against the realistic value of the claims being settled and the cost of defending them. That calculation shifts on 1 January 2027. Where the effective date of termination is on or after that date, employees with six months' service can bring an ordinary unfair dismissal claim and the compensatory award is no longer capped, so the case for settling will often be stronger for employees with between six months' and two years' service and for higher earners.

Protected conversations and without prejudice discussions

Two separate rules can keep settlement discussions out of evidence, and they work differently.

The without prejudice rule is a common law principle. It prevents statements made in a genuine attempt to settle an existing dispute being used as evidence in a court or tribunal, and it can apply to any type of claim. It only applies if there is already a dispute, meaning a claim has been made or one side might reasonably consider making one, and the protection is lost if there is unambiguous impropriety, such as blackmail, fraud, discrimination or threats. Acas guidance says an employer offering a settlement agreement to end employment without warning is unlikely to be dealing with an existing dispute.

Protected conversations come from section 111A of the Employment Rights Act 1996. Evidence of pre-termination negotiations, meaning any offer made or discussions held before the employment ends with a view to ending it on agreed terms, is inadmissible in an ordinary unfair dismissal claim, including a constructive dismissal claim, even if there was no existing dispute. Section 111A does not apply where the employee's case is that the dismissal was automatically unfair, for example because of whistleblowing, trade union membership or asserting a statutory right, and it does not apply to discrimination, harassment, victimisation, breach of contract or wrongful dismissal claims. If a tribunal considers that anything said or done was improper, or connected with improper behaviour, the discussions are inadmissible only to the extent the tribunal considers just.

Question	Without prejudice	Protected conversation (section 111A)
Where the rule comes from	Common law	Employment Rights Act 1996
Is an existing dispute needed?	Yes	No
Which claims it covers	Any claim in a court or tribunal	Ordinary unfair dismissal and constructive dismissal claims only
What removes the protection	Unambiguous impropriety, such as blackmail, fraud or discrimination	Improper behaviour, a wider test that includes undue pressure

The Acas Code of Practice on settlement agreements gives examples of improper behaviour: harassment, bullying and intimidation; physical assault, threats and other criminal behaviour; victimisation; discrimination; and undue pressure, such as not allowing a reasonable time to consider the offer or saying, before any disciplinary process has begun, that the employee will be dismissed if they reject it. It is not improper to explain neutrally why you are proposing a settlement, or to state factually the likely alternatives if agreement is not reached, including starting a disciplinary process where that is relevant.

Prepare what you will say and keep the meeting calm and factual. Make clear that the offer is voluntary, that the employee can negotiate and make a counter-offer, and that the discussion will not form part of any performance or disciplinary process. There is no legal right to be accompanied at a settlement meeting, but Acas describes allowing a colleague or trade union representative as good practice. Follow up with a letter setting out the offer and a draft agreement, and allow at least 10 calendar days for the employee to consider it and take advice.

What makes the agreement valid

An agreement cannot normally stop an employee bringing statutory employment claims. Section 203 of the Employment Rights Act 1996 allows a settlement agreement to do so only if it is in writing, relates to particular complaints or proceedings, and the employee has received advice from a relevant independent adviser on its terms and effect, in particular its effect on their ability to pursue their rights before an employment tribunal. The adviser must have insurance or a professional indemnity in force covering claims arising from the advice, the agreement must identify the adviser, and it must state that the statutory conditions are satisfied. The Equality Act 2010 contains equivalent conditions for discrimination claims.

A relevant independent adviser can be a qualified lawyer, or a certified trade union official or advice centre worker. Nobody who is employed by you, or acting for you in the matter, can advise the employee, and that includes your own solicitor and HR adviser. The agreement has to state the specific claims it covers: the Acas Code notes that a statement that the agreement is in full and final settlement of all claims is not enough on its own. If a condition is not met, the employee can still bring the statutory claims the agreement was meant to settle.

A settlement reached through Acas conciliation and recorded in a COT3 agreement is also binding, and does not need independent legal advice. It can be a useful route where a claim has been threatened or brought, or where the terms are simple.

Employers do not have to pay for the employee's advice, although Acas guidance suggests considering it. Offering a contribution helps the process move, because the agreement cannot settle statutory claims until the employee has been advised. Pay it directly to the employee's solicitor under a specific term of the agreement, for legal costs incurred only in connection with the termination, so that it is not taxed as the employee's income.

The terms to include

Most settlement agreements ending an employment deal with the following:

• the termination date and how the employment ends;
• salary, holiday pay and any bonus or commission due up to that date;
• notice pay, garden leave or pay in lieu of notice;
• the termination payment, its tax treatment and when each payment will be made;
• any employer pension contribution and the contribution to legal fees;
• the claims being settled and the statutory statements about the adviser;
• the agreed reference and announcement;
• confidentiality, within the legal limits;
• return of company property and continuing restrictive covenants; and
• warranties and a tax indemnity from the employee.

Warranties usually include confirmation that the employee has not committed an act of gross misconduct, has returned company property and has not accepted another job, with the right for the employer to recover the payment if a warranty proves untrue. A tax indemnity makes the employee responsible for further tax on payments described as tax-free. Acas guidance says it is good practice to pay as soon as possible after the agreement is signed.

Confidentiality clauses need care. A clause cannot prevent a worker making a protected disclosure under whistleblowing law, and any provision that tries to do so is void. It cannot stop a worker reporting a crime to the police, and since 1 October 2025 it cannot stop a victim of crime, or someone who reasonably believes they are one, making the disclosures permitted by section 17 of the Victims and Prisoners Act 2024, for example to a lawyer, a regulated professional, a victim support service or close family. The Employment Rights Act 2025 will also make confidentiality provisions void to the extent that they stop workers speaking about harassment or discrimination, subject to exceptions to be set by regulations. The government's timeline says this will take effect in 2027, and its factsheet says it will only apply to agreements made after it comes into force.

Tax and National Insurance on the payments

A single package usually contains payments taxed in three different ways, and the employer running payroll has to apply the right treatment to each.

Earnings

Salary to the termination date, holiday pay, bonus and commission already earned, and other contractual entitlements are earnings. They go through payroll with income tax and employee and employer Class 1 National Insurance in the normal way, even when they are paid under the settlement agreement. HMRC's guidance on compromise agreements makes clear that describing a payment as being in full and final settlement does not change the treatment of amounts the employee was already entitled to. Any part of the package given in return for a restrictive undertaking, such as a new non-compete, is also taxed as earnings.

Post-employment notice pay

Where the employee does not work their full contractual or statutory notice, calculate post-employment notice pay using HMRC's formula, whether or not the contract has a payment in lieu of notice clause and whatever the agreement calls the payment. The formula uses the basic pay for the last pay period before the trigger date, the number of days in the unworked notice period and the number of days in that pay period, less certain amounts already taxed as earnings. Post-employment notice pay is taxed in full and is subject to employee and employer Class 1 National Insurance.

The termination award

The rest of the compensation for the loss of the job is taxed under the termination payment rules. The first £30,000 is free of income tax, and statutory redundancy pay and genuine redundancy compensation count towards it. All payments connected with the end of the same employment, or of employments with associated employers, share one £30,000 threshold. Income tax is due on the excess through payroll. The employee pays no National Insurance on a termination award at any level, but the employer pays Class 1A National Insurance on the amount above £30,000, at 15% for 2026/27, reported and paid through payroll during the tax year rather than at the end of it.

For example, say an employee earns £48,000 a year and has two months' notice that will not be worked, and you agree a package of £40,000 on top of salary and holiday pay to the leaving date. Roughly £8,000 of the package is likely to be post-employment notice pay under HMRC's formula, taxed in full with Class 1 National Insurance. The remaining £32,000 or so is the termination award: £30,000 is free of income tax, around £2,000 is taxed, and you pay Class 1A National Insurance at 15% on that £2,000, which is about £300. The formula works in calendar days, so real figures will differ slightly.

Pension contributions and legal fees

An employer contribution to a registered pension scheme made as part of the settlement is not taxed under the termination payment rules and does not use up the £30,000. It cannot be used to avoid tax on amounts the employee is already entitled to as earnings unless that entitlement is properly given up first, and it counts towards the employee's pension annual allowance. Your contribution to the employee's legal costs is exempt if the three conditions described above are met.

Running the process step by step

1. Establish the facts and the business reason, and assess the claims the employee could bring and what they might be worth.
2. Decide the package, check the tax treatment with payroll, and get authority to make the offer.
3. Hold the conversation, keeping it neutral and factual.
4. Send the offer letter and draft agreement, allowing at least 10 calendar days.
5. Negotiate in writing, through the employee's adviser once they have one.
6. Agree the final wording, including the adviser's details and the list of claims.
7. Obtain the signed agreement and the adviser's confirmation before paying.
8. Pay through payroll with the correct treatment, including Class 1A where it applies.
9. Diarise the continuing obligations, such as payment dates, the reference and the announcement.

Keep the number of people who know about the discussions small, keep settlement correspondence separate from the employee's personnel file, and make sure the manager who holds the conversation understands what they can and cannot say.

Common drafting and process mistakes

Mistakes with settlement agreements tend to fall into two groups: those that affect whether the agreement binds the employee, and those that create tax or other liabilities for the employer.

On the process side, the risks are presenting the offer as take it or leave it, giving a deadline of a day or two, telling the employee they will be dismissed if they refuse before any process has started, relying on section 111A when the employee has already raised discrimination or whistleblowing concerns, and paying before the agreement has been signed and the adviser has confirmed the advice. Starting a disciplinary process straight after a rejected offer is not unlawful in itself, but the offer and discussions cannot form part of that process, and a tribunal may look closely at the timing if a claim follows.

On the drafting side, the common errors are a general waiver of all claims without listing them, an adviser who is not named or not independent, a confidentiality clause that ignores the statutory limits, treating contractual pay or notice pay as tax-free, missing post-employment notice pay or Class 1A National Insurance, leaving payment dates open, and forgetting to deal with bonus or share scheme rules, company property and continuing covenants.

HR consultancies and payroll bureaus are well placed to spot these early. Involve the payroll provider before the figures are offered, so that the package can be paid in the way the agreement describes. We draft settlement agreements and advise employers and their HR advisers on protected conversations, tax treatment and negotiation, and we agree the scope and cost of the work in writing before we start. For the employee's side of the process, see our guide to settlement agreements for employees.

Frequently asked questions

What is a protected conversation?

A protected conversation is an offer or discussion, before employment ends, about ending it on agreed terms. Under section 111A of the Employment Rights Act 1996, evidence of it cannot normally be used in an ordinary unfair dismissal claim, even where there was no existing dispute. The protection does not cover discrimination, whistleblowing or other automatically unfair dismissal claims, and a tribunal can admit the evidence to the extent it considers just if there was improper behaviour, such as undue pressure.

Can I offer a settlement agreement without starting a disciplinary process?

Yes. A settlement agreement can be proposed at any stage of the employment, including where no formal process has started and there is no dispute. Section 111A keeps the discussions out of evidence in an ordinary unfair dismissal claim, provided there is no improper behaviour. Do not tell the employee they will be dismissed if they refuse, because saying that before any disciplinary process has begun is an example of undue pressure in the Acas Code.

Do employers have to pay for the employee's legal advice?

No. Acas guidance says employers do not have to pay for the employee's independent advice but should consider offering to, and a contribution helps the process move because the agreement cannot settle statutory claims until the employee has been advised. If it is paid directly to the employee's solicitor under a specific term of the agreement, for legal costs incurred only in connection with the termination, it is not taxed as the employee's income.

Is employer's National Insurance due on a settlement payment?

It depends on the payment. Salary, holiday pay, bonuses and post-employment notice pay are subject to employer Class 1 National Insurance in the normal way. The termination award is free of National Insurance up to £30,000, but the employer pays Class 1A National Insurance on any amount above £30,000, at 15% for 2026/27, reported and paid through payroll during the tax year. The employee pays no National Insurance on the termination award.

How long should we give an employee to consider a settlement offer?

The Acas Code of Practice on settlement agreements says a reasonable period depends on the circumstances, but as a general rule at least 10 calendar days should be allowed to consider the formal written terms and take independent advice, unless the parties agree otherwise. A disabled employee may need longer as a reasonable adjustment. Not allowing a reasonable time is an example of undue pressure, which can make the discussions admissible in an unfair dismissal claim.

Can a settlement agreement include a confidentiality clause?

Yes, but it must respect the legal limits. It cannot stop a worker making a protected disclosure under whistleblowing law or reporting a crime to the police, and since 1 October 2025 it cannot stop a victim of crime making the disclosures permitted by the Victims and Prisoners Act 2024. Further restrictions on clauses covering harassment and discrimination are due in 2027 and, according to the government's factsheet, will apply only to agreements made after they come into force.

What happens if the employee rejects the settlement offer?

The employment continues. If the underlying problem remains, deal with it through the appropriate route, such as performance management, a disciplinary or grievance procedure or mediation, and follow that process fairly. You cannot rely on the settlement offer or the discussions as part of that process. Encouraging the employee to reconsider is not improper in itself, but any further approach should stay within the limits the Acas Code sets on undue pressure.

Sources & further reading

• legislation.gov.uk — Employment Rights Act 1996, section 111A
• legislation.gov.uk — Employment Rights Act 1996, section 203
• Acas — Code of Practice on settlement agreements
• Acas — Settlement agreements: confidentiality
• HMRC — NIM13201: Class 1A National Insurance on termination awards
• HMRC — EIM13880: post-employment notice pay formula
• HMRC — Rates and thresholds for employers 2026 to 2027
• legislation.gov.uk — Victims and Prisoners Act 2024, section 17

This article is general information, not legal advice. The law changes and depends on your circumstances — always take advice on your specific situation before acting. Last reviewed 17 September 2026. Buzz Solicitors is a trading name of AD Solicitors Limited, a recognised body regulated by the SRA (no. 8011228).