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Settlement Agreements: When and How Employers Should Use Them

2nd April 2026

Navigating a difficult staffing issue can feel overwhelming, especially when you want to resolve matters quickly, fairly, and without disruption to your working environment.

We understand how important it is for employers to feel in control, informed, and confident about the steps they take. That’s why we make the process around settlement agreements clear and straightforward, helping you protect your business while treating employees with dignity and respect.

Mike Hornsby, specialist in employment law, sets out what settlement agreements are, when they’re appropriate, and the key steps employers should follow to achieve a fair, legally compliant outcome.

What Is a settlement agreement?

A settlement agreement is a legally binding contract used to formally and mutually end an employment relationship.

It must be in writing, is entirely voluntary, and is commonly used to resolve workplace disputes or bring employment to a close on agreed terms.

For an agreement to be legally valid, it must meet the statutory conditions set out in Section 203 of the Employment Rights Act 1996. When handled properly, a settlement agreement provides certainty for both parties and offers a clean break, often avoiding lengthy procedures or the risk of future disputes.

When should employers consider a settlement agreement?

Settlement agreements can offer a fair, lawful, and practical resolution.

Employers commonly consider them when:

• Redundancy, particularly where enhanced payments are being offered
• Breakdown of working relationships where the situation cannot be repaired
• Performance or capability concerns where a lengthy process would be disruptive
• Grievance or disciplinary matters that may escalate into conflict or tribunal risk
• Situations where both parties prefer to avoid the stress and uncertainty of litigation

What Is a protected conversation?

In some situations, employers may want to explore the possibility of an agreed exit before starting a formal procedure.

A protected conversation, under Section 111A of the Employment Rights Act 1996, allows employers to have confidential discussions about a potential settlement agreement. These discussions usually cannot be referred to in an ordinary unfair dismissal claim.

However, the protection is limited. It does not apply to discrimination or whistleblowing claims, and it may be lost if undue pressure is applied, for example, insisting an employee makes a decision immediately.

How much time should an employee get to review a settlement agreement?

The Acas Code of Practice recommends giving employees at least 10 calendar days to consider the proposed agreement and obtain independent legal advice.

Providing reasonable time:

• Supports fairness.
• Reduces allegations of coercion or undue pressure.
• Helps protect the validity of the agreement.

Employers can offer longer than 10 days when appropriate, particularly in complex or sensitive cases.

What terms are usually included in a settlement agreement?

A settlement agreement will usually set out:

• The financial package being offered
• How notice, holidays, bonuses, or benefits will be treated
• The employee’s waiver of specific claims
• Any agreed reference wording
• Confidentiality terms and post‑employment obligations

Confidentiality clauses cannot prevent employees from whistleblowing, reporting a crime, or seeking professional advice or support.

How are settlement agreement payments taxed?

Some termination payments may fall within the £30,000 tax exemption, but Post‑Employment Notice Pay (PENP) rules require any payment relating to notice to be taxed as earnings.

Getting this calculation right is essential to avoid issues with HMRC.

What’s the difference between a COT3 agreement and a standard settlement agreement?

Although both are settlement tools, they are used in different situations:

COT3 (via Acas)

• Used during Acas conciliation, often when a tribunal claim is active or anticipated
• Independent legal advice is not legally required
• If payment is not made, employers may face government‑backed enforcement routes, including the EX728 fast‑track system

Standard Settlement Agreement

• Negotiated directly between employer and employee
• Must meet the statutory conditions set out in employment legislation
• Typically used before a claim is brought

Understanding the distinction helps employers choose the right route depending on timing and risk.

Need expert guidance? We’re here to help

Settlement agreements can be an effective, respectful, and legally robust way to resolve workplace issues, provided they’re used appropriately and drafted with care.

If you’re an employer and want clear advice on settlement agreements, protected conversations, or managing an employee exit, our employment law specialists across The MAPD Group, are ready to support you with practical, commercially focused guidance.

Give us a call or make a quick enquiry online we’re here to help you move forward.