What is a settlement agreement?
In plain terms, it's a legally binding agreement where an employee agrees to waive their right to bring certain claims against you, in return for agreed terms, usually a payment, sometimes other things like a reference or an extended notice period. For it to be valid, the employee must take independent legal advice on it, and it’s standard practice for you to contribute towards their legal fees in doing so.
Offering a settlement agreement is not an admission of wrongdoing, and it's not automatically the "generous" option or the "aggressive" one. Instead, settlement agreements are a tool which, if used well, gives both sides a clean, certain ending. However, used badly, it's an expensive way to avoid a conversation you were going to need to have anyway.
When to use a settlement agreement
A settlement agreement tends to make sense when:
A working relationship has genuinely broken down and continuing to manage it formally would cost more (in time, morale and risk) than a clean exit.
You're restructuring and know a role or a person won't fit going forward, and want certainty quickly.
You're facing a lengthy performance or conduct process that will be unpleasant for both parties, and a settlement would be more respectful, cost effective and faster for both parties.
You need to manage the timing and messaging of someone's departure carefully, perhaps around a client relationship, a confidential project, or a sensitive team dynamic.
What should the agreement cover?
Beyond the standard terms regarding the waiver of claims, there are a few things worth considering including:
Restrictive covenants and confidentiality obligations post-employment; a settlement agreement is a chance to reconfirm contractual obligations and restrictions so that both parties are clear on what happens after termination.
Announcements and messaging; settlement agreements often include agreed internal and external announcement wording on the reason for the employee’s departure, providing both parties certainty on what will, and will not, be communicated.
References; settlement agreements often include agreed wording for references, which avoids an awkward call from a future employer six months later.
Common mistakes made by employers
Offering a settlement agreement to an employee in circumstances that aren’t “protected”, creating risk of a future Tribunal claim.
Naming a number before taking advice on what "fair" looks like, and once a figure's been mentioned, it's hard to walk back.
Assuming settlement is always cleaner than process, as sometimes a fair, well-documented performance process is quicker, cheaper, and just as final.
Forgetting the employee needs (and is entitled to) independent advice, and without this the settlement agreement won’t be enforceable.
Putting unreasonable pressure on the employee to sign in a short timeframe, which can backfire resulting in the employee refusing to sign or racking up unnecessary legal fees which impacts their view of the compensation being offered, leading to longer negotiations.
Treating settlement agreements as a template exercise; using a generic settlement agreement can result in you missing the things that actually matter to your specific business, whether that's client relationships, confidential information, or team dynamics.
The broader conversation
I’ve managed exits from inside a business, not just advised on them from outside, and so I know the legal terms are only half the job. The other half is timing the conversation and making sure the exit doesn't quietly cost you more in relationships and reputation than it saves in legal risk. That's the part a template can't do for you.
FAQs
Do I have to offer a settlement agreement, or can I just dismiss the person?
You can dismiss without using a settlement agreement, provided you follow a fair process and have a fair reason. A settlement agreement is usually about certainty and speed and so, although they are not a legal requirement, they are an effective option where this is a desired outcome.
How much should I offer?
It depends on the situation, including the employee’s length of service, the strength of any underlying claim, notice entitlement, and what a tribunal process would realistically cost you in time and risk if it didn't settle. There's no fixed formula, and generic online calculators tend to mislead more than they help.
Does the employee have to accept it?
No. They can reject it and, if that happens, you’ll be back to your original options. This is why you should take advice and ensure you have a clear fallback plan before you make the offer, and are not left scrambling for one if they say no.
At New Road we help business owners handle exits properly, from working out whether a settlement agreement is the right tool, through to drafting one that actually protects your business. Get in touch to discuss how we can help.
This post provides general information for business owners, not legal advice on a specific exit. Settlement agreements turn on the individual facts and figures involved, and you should take advice on your specific situation before acting.
