A Settlement Agreement (formerly called a compromise agreement) is a legally binding agreement that leads to or follows a person's employment being terminated. Ordinarily it will provide for a severance payment by the employer, and the employee agreeing not to pursue any Employment Tribunal claims.
It is also normal for the Settlement Agreement to deal with the notice element in an employee's contract of employment and may provide for a payment in lieu of this. Settlement Agreements are very common because they offer a mutually convenient arrangement for both parties due to the certainty and tax advantages.
There is usually a period of negotiation and discussion between the employer and employee, or their legal advisers, to ensure that a mutually beneficial compromise is reached.
Settlement Agreements are recognised by statute as being the only way employment claims can be resolved in a binding way without the need for Employment Tribunal proceedings. This is because Settlement Agreements are an exception to the rule that an individual cannot contract out of his or her employment rights.
The Settlement Agreement should be explained to the employee by an independent solicitor before the agreement becomes binding. The solicitor must also sign the agreement to confirm that the appropriate advice has been provided. It is normal practice for the employer to offer a contribution towards the employee's legal fees.
Compensation received under a Settlement Agreement can often be paid tax-free up to £30,000.