A practical guide to drafting legally robust settlement agreements
Settlement agreements are a familiar tool for bringing the employment relationship to a clean and legally secure conclusion. When drafted properly, they provide certainty for both employer and employee, minimise risk of future claims, and help avoid lengthy disputes. However, a settlement agreement is only as effective as the provisions it contains. Missing or poorly drafted clauses can create uncertainty, expose employers to unnecessary risk and, in some cases, affect the enforceability of the agreement.
In this guide, our employment law team explains what a settlement agreement is, the statutory requirements for validity, and the key provisions every employer should consider including, together with practical guidance on some of the most common drafting pitfalls.
What Is a Settlement Agreement?
A settlement agreement is a legally binding contract between an employer and an employee under which the employee agrees to waive or settle specific claims, usually in return for a payment and other agreed terms. In the UK, to be valid and enforceable in respect of statutory employment claims, an agreement must satisfy a number of specific statutory conditions.
When Is a Settlement Agreement Legally Valid?
To settle statutory employment rights, the agreement must:
- Be in writing.
- Relate to particular complaint(s) or particular proceedings.
- Confirm that the employee has received advice from an independent adviser (such as a qualified employment lawyer, certified trade union official or certified advice centre worker) about the terms and effect of the agreement and its effect on the employee’s ability to pursue claims.
- Identify the adviser, who must have a current contract of insurance or professional indemnity covering the risk of a claim by the employee in respect of that advice.
- State that the statutory conditions regulating settlement agreements are satisfied.
If any of these elements is missing, the waiver of statutory claims may not be legally effective.
Waiver of Claims: What Can and Cannot be Settled?
The core purpose of a settlement agreement is to resolve specified legal claims. Employers should therefore:
- List the claims being waived with clarity, by reference to statutes and claim types. Typical examples include unfair dismissal, discrimination, whistleblowing detriment, breach of contract (including wrongful dismissal), and unlawful deductions from wages.
- Avoid relying on broad “catch-all” wording. UK law does not generally permit a waiver of unknown or future statutory claims in the abstract. The waiver should be linked to the circumstances known at the time and identified categories of claims.
- Respect legal limits. A settlement agreement cannot:
- Prevent protected disclosures or whistleblowing to prescribed persons or regulators, or reporting suspected crimes.
- Waive accrued rights under an occupational pension scheme in the usual way, although it can settle claims about miscalculation or maladministration.
- Validly waive personal injury claims that are unknown at the time unless they are specifically identified and the employee has, or could reasonably be expected to have, knowledge of the relevant circumstances. Many agreements expressly preserve latent personal injury claims and claims for industrial disease.
- Exclude rights that arise after the agreement in relation to events that have not yet occurred. Careful drafting is needed if the parties wish to cover future claims arising from the termination itself.
Payments and Tax: Getting the Treatment Right
The tax treatment of termination payments depends on their legal nature rather than the label given to them in the settlement agreement.
- Contractual payments. Salary to the termination date, accrued but untaken holiday pay and any contractual payments in lieu of notice are subject to income tax and employee and employer National Insurance contributions (NICs) via PAYE.
- Notice pay and PENP. The post-employment notice pay (PENP) rules deem some or all of a termination payment to be taxable as earnings where notice is not worked or fully worked. The agreement should state the notice arrangements and whether there is a payment in lieu and confirm that tax will be accounted for in accordance with PENP.
- Ex gratia termination sums. Genuine compensation for loss of employment that is not earnings may be eligible for the £30,000 income tax exemption. Amounts above £30,000 are taxable. Employer NICs may be due on certain taxable termination amounts. The agreement should acknowledge that the employer will deduct and account for PAYE where required.
- Tax indemnity. It is standard to include an employee indemnity in favour of the employer for any additional tax, employee NICs, interest and penalties assessed on the employee in respect of the payments, save to the extent arising from the employer’s breach. This protects the employer if HMRC later challenges the treatment.
Confidentiality and Non-Disparagement Clauses
Well-drafted settlement agreements commonly include mutual confidentiality obligations covering both the agreement itself and the circumstances surrounding the employee’s termination, together with mutual non-disparagement obligations.
These clauses should be carefully framed so they do not restrict lawful disclosures, including disclosures to HMRC, medical or legal advisers, a spouse or partner on a confidential basis, or to regulators and law enforcement where permitted or required by law. They must not purport to prevent protected disclosures.
Agreed Employment References
There is no general legal obligation for an employer to provide a reference. Where a reference is agreed, it is usually a short factual reference attached to the settlement agreement, confirming dates of employment and job title and, if appropriate, brief role details.
The agreement should also confirm that any reference provided will be true, accurate and fair, and that the employer will provide only the agreed wording in response to reference requests.
Restrictive Covenants After Employment Ends
Settlement agreements often restate and reaffirm existing restrictive covenants in the contract of employment and remind the employee of continuing obligations (for example, confidentiality and intellectual property).
If an employer wishes to introduce new or extended post-termination restrictions, fresh consideration must be provided, and the restrictions must remain reasonable in duration, geographical scope and overall effect if they are to be enforceable. Payment expressly allocated as consideration for new restrictions is typically included and should be identified.
Return Company Property and Protecting Confidential Information
The agreement should include clear obligations requiring the employee to return all company property, data and confidential information by a specified date. Where appropriate, employees should also confirm that employer data has been deleted from personal devices and acknowledge the continuing obligation to protect confidential information. Where relevant, include assignment or confirmation of ownership of intellectual property created during employment.
Internal and External Communications
To reduce the risk of future disputes, employers should consider including an agreed internal announcement and, where appropriate, an agreed external statement about the employee’s departure. The agreement should clarify that nothing in the announcement limits lawful disclosures to regulators or law enforcement.
Who Pays the Employee’s Legal Fees?
It is common for employers to contribute to the employee’s legal fees incurred in obtaining the independent legal advice required for a valid settlement agreement. Although there is no statutory obligation to pay those fees, where a contribution is offered the agreement should specify the amount, whether VAT is included, whether payment is payable directly to the adviser, and whether the contribution is conditional upon signature.
Employee Warranties and Repayment Provisions
Employers commonly include warranties confirming that the employee:
- Has not already received or accepted alternative employment that would affect payments under the agreement
- Has not committed undisclosed gross misconduct that would have justified summary dismissal
- Has disclosed any relevant outstanding disciplinary matters where appropriate
Employers may also wish to consider a clawback provision requiring repayment of termination sums if the employee breaches key obligations such as confidentiality, non-disparagement or restrictive covenants, subject to reasonableness.
Bringing Internal Processes to an End
The agreement should confirm that all internal grievances, appeals and complaints have been withdrawn, that no further internal proceedings will be pursued, and the identified statutory and contractual claims are fully settled.
Where litigation has already commenced, the settlement agreement should clarify the process and timetable for staying or withdrawing proceedings.
Managing the Process and Timing
A settlement agreement should clearly record:
- The termination date
- Any period of garden leave
- Outstanding holiday entitlement
- When benefits will cease
- The timing of termination payments
Employees should be given a reasonable opportunity to obtain independent legal advice and consider the terms before signing. Employers should specify when the settlement offer will expire. A short cooling-off period can be considered but is not mandatory.
Common Settlement Agreement Mistakes Employers Should Avoid
Common pitfalls include:
- Vague waivers: Failing to link the waiver to specific claims and legislation risks unenforceability.
- Overreaching confidentiality clauses: Drafting that purports to prevent protected disclosures or reporting to regulators is likely to be void and can attract regulatory and reputational risk.
- Incorrect tax treatment: Rebranding taxable earnings as compensation does not change their tax status and invites HMRC challenge.
- Failure to consider post-employment notice pay (PENP): Omitting PENP calculations can leave employers exposed to tax liabilities and interest.
- Introducing new restrictive covenants without consideration: Extending or adding restrictions without clear consideration may undermine enforceability.
- Omitting adviser detail: Not identifying the independent adviser and their insurance in the agreement can invalidate the waiver of statutory claims.
Settlement Agreement Checklist for Employers
Every settlement agreement should be tailored to the individual circumstances of the employment relationship and the issues being resolved. However, the following checklist provides a useful starting point when preparing or reviewing an agreement.
- Parties, background and effective date of termination.
- Statutory validity statements and adviser details.
- Waiver of specified claims with statutory references and appropriate carve-outs.
- Payments schedule, tax and NIC treatment, PENP, and tax indemnity.
- Confidentiality and non-disparagement with lawful disclosure carve-outs.
- References and announcements, with agreed wording attached.
- Restrictive covenants, whether reaffirmed or newly introduced with consideration and reasonableness.
- Return of company property, data and confidentiality obligations and intellectual property provisions.
- Employee warranties, undertakings and any repayment provisions.
- Withdrawal of proceedings and procedural steps to conclude disputes.
- Legal fee contribution (if any) and payment mechanics.
- Entire agreement clause, governing law and jurisdiction.
Final Thoughts from Our Employment Law Team
A clear, carefully drafted settlement agreement delivers certainty and reduces risk. Focus on statutory validity, precise waivers, accurate tax treatment, and proportionate protections. Where in doubt, refine the drafting and keep a clear audit trail of the rationale for each clause.
Where more complex circumstances arise, obtaining legal advice at an early stage can help ensure that the agreement achieves its intended purpose. Our previous guide, ‘The Employment Rights Act 2025: Key Changes for Employers’ provides other useful employment law information.
Need Advice on a Settlement Agreement?
Whether you are preparing a settlement agreement, negotiating its terms or responding to an employment dispute, obtaining legal advice at an early stage can help protect your business and reduce legal risk.
Our Employment Law team advises employers and employees on settlement agreements, workplace disputes, disciplinary and grievance procedures, restrictive covenants and employment litigation.
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Disclaimer
This blog was prepared and published in July 2026 for general information purposes only and does not constitute legal advice. Specific advice should be taken on particular facts and circumstances before any action is taken.