What is a settlement agreement?

What is a settlement agreement?

A settlement agreement is a legally binding contract between an employer and an employee under which the employee waives specified statutory employment claims, usually in return for a payment. It is valid only if the section 203(3) Employment Rights Act 1996 conditions are met.

This is not a PAYE Settlement Agreement. A PAYE Settlement Agreement is a separate arrangement HMRC offers employers to settle tax on certain expenses and benefits; it has nothing to do with ending someone's employment.

The two share a name because both use the word "settlement" to describe an agreed, final arrangement with HMRC or with an employee, but they are governed by entirely different law and serve entirely different purposes. The rest of this guide covers the employment kind: the one you sign to end a job.

What are the section 203(3) conditions for a valid settlement agreement?

Under section 203(3) of the Employment Rights Act 1996, a settlement agreement is only legally valid if it meets all six of the following conditions:

1. The agreement must be in writing.
2. It must relate to the particular complaint or proceedings, not a blanket waiver of every possible future claim.
3. The employee must have received advice from a relevant independent adviser on the terms and effect of the agreement, and in particular its effect on their ability to pursue a claim before an employment tribunal.
4. The adviser must be identified in the agreement, usually by name and firm.
5. The adviser must have a current contract of insurance, or professional indemnity cover, in force against the risk of a claim by the employee arising from that advice.
6. The agreement must state that the conditions regulating settlement agreements under the relevant legislation are satisfied.

If any of these six conditions is missing, the agreement cannot validly waive your statutory employment rights, even if you have signed it. The adviser certificate your solicitor signs alongside the agreement is how the advice condition is evidenced in practice; the certificate itself is standard practice rather than one of the statutory conditions.

Who pays for the advice on a settlement agreement?

Because a settlement agreement is not valid unless you have taken independent legal advice, market practice is that the employer contributes a fixed sum toward the cost of that advice, set out as a legal-fees clause in the agreement itself. This is paid directly to your adviser rather than to you, and sits separately from your compensation.

See how our pricing works for what that means in practice when you instruct us to review or negotiate your agreement.

How long do you get to consider a settlement agreement?

There is no strict statutory deadline. The ACAS Code of Practice on settlement agreements gives guidance that 10 calendar days is a reasonable period for an employee to consider an offer and take advice on it. That is guidance, not a legal requirement, but an employer who imposes a materially shorter deadline without good reason risks that being held against them later, for example on the question of whether you were put under undue pressure.

In practice, many employers set a deadline of 7 to 14 days in the covering letter. If you need more time to instruct a solicitor and take proper advice, ask in writing. Most employers agree to a short extension rather than risk an argument that the process was rushed.

Why was it renamed from a "compromise agreement"?

Settlement agreements were called compromise agreements until 29 July 2013, when section 23 of the Enterprise and Regulatory Reform Act 2013 renamed them. The legal function is unchanged: the same conditions under section 203 of the Employment Rights Act 1996 still apply, and older references to a "compromise agreement" mean the same document as a modern settlement agreement. See our dedicated page on what the 2013 rename changed for the full detail, or our guide on what to do after you receive one for what happens next once you have it in hand.

Is this the same as a PAYE Settlement Agreement?

No. A PAYE Settlement Agreement, usually abbreviated PSA, is a completely separate mechanism that HMRC offers to employers. It lets an employer settle the income tax and National Insurance on certain minor, irregular, or hard-to-value expenses and benefits given to employees, such as staff entertaining or small gifts, in one annual payment to HMRC, rather than reporting each item individually on every affected employee's payslip or P11D.

A PSA is arranged between the employer and HMRC, applies collectively across a workforce, and has nothing to do with any individual employee's job ending, waiving a claim, or receiving independent legal advice. If you have been sent an employment settlement agreement to sign, a PAYE Settlement Agreement is not the document you are looking at, and nothing about your employer's PSA arrangements affects the validity or tax treatment of your settlement agreement payment.

What happens if you do not sign?

A settlement agreement is a voluntary contract. You are free to refuse it, and your employer cannot force you to sign. If you refuse, you keep your existing employment rights and remain free to pursue a tribunal claim if you believe you have one, subject to the usual time limits.

What happens next depends on why the offer was made. The offer itself may be withdrawn once you decline it. If it arose from a redundancy or disciplinary process, that process will usually continue, and the employment may end anyway, but without the agreed reference, the ex-gratia payment, or the other terms that were on the table. Your solicitor can help you weigh the realistic value of the offer against the risk, time, and uncertainty of not signing and pursuing a claim instead.

Where to go next

This page covers what a settlement agreement is and when it is valid. For the practical steps that follow, see:

• Just received a settlement agreement? What to do first
• Expecting a settlement agreement? Signs and preparation
• How much should your settlement agreement be worth?
• Negotiating a settlement agreement: what actually works
• Glossary of settlement agreement terms for definitions of specific words and clauses

Frequently asked questions