A settlement agreement (previously called a compromise agreement) is a legally binding contract between an employer and employee that settles employment claims in exchange for a payment. Once signed, the employee cannot bring the claims covered by the agreement to an employment tribunal.
Settlement agreements are used to resolve disputes before or during tribunal proceedings, to manage a difficult redundancy or dismissal, or as an alternative to going through a formal disciplinary process.
Critical requirement: A settlement agreement is only legally binding if the employee has received independent legal advice from a relevant independent adviser — typically a solicitor, a trade union official, or an advice centre worker. The adviser must sign the settlement agreement confirming they have given the advice. Without this, the agreement is void.
The employer typically pays a contribution to the employee's legal advice costs — often £250–£500 plus VAT as a fixed contribution.
A settlement agreement must specifically identify the claims being settled. It can settle:
It cannot settle personal injury claims where the employee is not aware of the injury at the time of signing, or claims relating to accrued pension rights.
| Payment type | Tax treatment |
|---|---|
| Payments in lieu of notice (PILON) | Fully taxable as earnings |
| Holiday pay | Fully taxable as earnings |
| Statutory redundancy pay | First £30,000 tax-free |
| Ex gratia payment for loss of employment | First £30,000 tax-free (combined with statutory redundancy) |
| Payments above £30,000 | Subject to income tax and NI contributions |
Employers can have a “protected conversation” with an employee about ending their employment without that conversation being admissible in an unfair dismissal claim at tribunal. This is known as a Section 111A conversation. The protection does not apply where the employer has behaved improperly in the conversation (threats, harassment, or pressure).
DocPilot employment templates include termination letters, redundancy letters, and settlement-adjacent documents. All updated for the Employment Rights Act 2025.
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