How Severance Agreements Usually Work

In UK employment law, a severance agreement - more commonly known as a settlement agreement - is a formal written contract between an employer and an employee that sets out agreed terms for ending the employment relationship and settling any legal claims that could arise on termination. The term “settlement agreement” replaced the older phrase “compromise agreement” in statute and practice, but the purpose remains the same: to provide a legally binding resolution that avoids future disputes, including claims to an employment tribunal or court.

Settlement agreements are used when both parties want certainty about the terms of an exit, especially where there might be disagreements or potential legal claims. They are voluntary and negotiated, not imposed unilaterally by either side.

What a Settlement (Severance) Agreement Is

A settlement agreement is a legally binding contract that sets out the terms on which an employee agrees to end their employment and, in return, typically receives a sum of money and other benefits. The employee also normally agrees to waive the right to bring specific legal claims against the employer, such as unfair dismissal or discrimination claims, that are listed in the agreement.

Key characteristics include:

• It must be in writing and signed by both parties.
• It must relate to specific claims the employee might present, not just “all possible claims”.
• The employee must receive independent legal advice from a qualified adviser who has professional indemnity insurance, and the adviser must be identified in the agreement.
• It is voluntary: neither party can be forced into it.

Settlement agreements are distinct from statutory redundancy rights; they are contractual arrangements negotiated between employer and employee and go beyond minimum statutory entitlements.

Why Settlement Agreements Are Used

Settlement agreements serve several practical purposes:

1. Resolve a dispute confidentially without litigation or tribunal claims.
2. Provide certainty for both employer and employee about how and when the employment will end and what payments or benefits will be made.
3. Allow employers to manage risk by avoiding tribunal costs, damage to reputation, and time spent defending claims.
4. Enable employees to secure compensation and a reference on agreed terms, often better than they might achieve through a tribunal.

Settlement agreements are frequently used in redundancy situations, performance or conduct disputes, long-term sickness absence cases, or where there are ongoing grievances.

What Is Typically Included

Although each agreement is tailored to individual circumstances, most settlement agreements contain a set of core elements:

1. Payments

Severance agreements usually break down multiple components of payment:

• Termination payment: A sum offered as compensation for the termination of employment.
• Accrued but unpaid salary, bonuses, and holiday pay: These are contractual entitlements due on termination.
• Notice or payment in lieu of notice (PILON): Either the employee works their notice period or is paid instead.
• Tax treatment: Termination payments under £30,000 are typically tax‑free; amounts above this may be taxable, and the agreement often makes clear how each element is treated for tax purposes.

2. Waiver of Claims

The core feature of a settlement agreement is that the employee agrees to waive specific legal claims against the employer, such as unfair dismissal, breach of contract, or discrimination claims, that are listed in the document. This waiver only applies to the claims expressly included.

3. Confidentiality and Non‑Disparagement

Most agreements include clauses to protect confidential information and restrict the parties from making negative or derogatory comments about each other. These are designed to protect reputations and business interests.

4. References and Announcements

Agreements often specify a reference the employer will provide, and may include how the departure will be communicated to colleagues or clients.

5. Legal Costs

To ensure the employee receives independent advice, employers typically offer to pay or contribute to the cost of legal advice. This is necessary to make the settlement agreement enforceable.

Legal Requirements and Validity

For a settlement agreement to be legally valid:

• The agreement must be written and signed.
• It must detail the specific claims or disputes it covers.
• The employee must have received advice from a relevant independent adviser who is appropriately insured.
• The name of the independent adviser must be included.

If these conditions are not met, the agreement may fail to contract out of tribunal rights effectively.

Settlement discussions can be confidential under section 111A of the Employment Rights Act 1996, meaning that without prejudice offers and negotiations generally cannot later be used as evidence in certain tribunal claims.

Practical Steps in the Process

1. Initial Offer and Discussion

An employer may propose a settlement agreement at any stage, including before formal disciplinary or redundancy procedures. Discussions are usually treated confidentially to encourage open negotiation.

2. Review and Advice

The employee should take the agreement away and seek advice from an independent solicitor or appropriately qualified adviser. The employer often contributes towards this cost.

3. Negotiation

Terms, including the level of compensation, may be negotiated. The employee can reject the offer or suggest amendments. Nothing is binding until both parties sign.

4. Signing and Implementation

Once signed, the agreement becomes binding. The employee will typically receive the agreed payments and benefits at a specified time, and the employment relationship ends under the terms in the document.

Time Limits and Claims

Settlement agreements usually include provisions to waive the right to bring tribunal claims for the matters covered. However:

• Some statutory claims, like certain automatic unfair dismissal reasons (e.g., whistleblowing), may not be covered by confidentiality protections in negotiations.
• Time limits for bringing tribunal claims remain relevant if disputes are not settled by agreement - for example, a claim for unfair dismissal must generally be presented within 3 months of dismissal. (Separate statutory rules apply and readers should consult current tribunal practice.)

Risks and Considerations

For Employees

• Accepting a settlement agreement means giving up the right to pursue certain legal claims. This requires careful assessment and independent advice.
• Tax implications vary between payment elements; employees should understand how severance and contractual payments will be taxed.

For Employers

• Employers must ensure settlement agreements meet legal requirements; otherwise they may not successfully waive tribunal rights.
• Confidentiality clauses must comply with guidance and not unlawfully prevent reporting of serious misconduct or statutory rights.

Key Takeaways

A severance or settlement agreement in England and Wales is a negotiated written contract that ends an employment relationship and provides agreed payments in return for waiving specific legal claims. It must meet statutory requirements - be in writing, identify specific claims covered, and include evidence of independent legal advice - to be legally binding. These agreements are voluntary and often include additional terms such as confidentiality, references, and negotiated compensation. They are widely used to provide certainty and avoid tribunal claims but need careful consideration of legal rights and tax consequences.