Settlement agreements: an employers guide

Last Updated: December 7th, 2022

Settlement Agreements for employers

Offering an employee a settlement agreement is a common way to avoid potential disputes, save time and possibly some money avoiding disciplinary process, significantly reduce the risk of an aggrieved employee acting unlawfully such as stealing confidential data and overall is a clean way to mutually agree to terminate employment.

Settlememt agreements are very standard documents and this is because, to have legal effect, they must comply with the legislation which created settlement agreements. Whilst very standard there are areas where employers vary in what to include which are typically whether to include any post employment restrictive covenants, policy on references and for senior employees, possibly what happens to any share options.

We advise employers on settlement agreements and draft agreements for employers. We also of course advise on any underlying employment law issues such as redundancy.

How does a Settlement agreement protect the employer?

A settlement agreement results in mutual agreement to terminate employment and the employee waives the rfighst to make almost all claims against the employer. The main exception to this is any personal injury claims, which cannot be contracted out of.

Settlement agreements are also a useful way for employers to include post termination rerstrictions on the employee. However, care is needed when including any form of employment restrictive covenants as if they are too wide ranging they may not be enforcerable.

HMRC tax free compensation payments to employees

HMRC investigations are becoming more common. HMRC can ask questions about the nature of termination payments made to employees. HMRC will  look at PAYE and whether employers have deducted all PAYE they should have.  Employers are liable for interest and penalties, if they fail to operate PAYE in accordance with the regulations.

In most cases, the employer is liable for the tax. HMRC is not overly concerned that employers may have difficulties recovering tax from employees. HMRC can pursue the employee for tax. In practice they pursue employers.

Settlement agreement tax indemnity

We include a good tax indemnity that makes it clear that the employee is liable for all tax on the payments made. However, the tax indemnity does not absolve the employer from the duty to operate PAYE.  Nevertheless, it creates a contractual right to recover the tax the employer pays under PAYE.

Enforcing the indemnity may be difficult if the ex-employee cannot be traced or pleads poverty. In such cases tax retention can help the employer. If the employer retains tax,  then we set out the details in the settlement agreement.

Settlement agreement restrictive covenants

Employers usually have workable, enforceable non-compete and post-termination restrictions in an employment contract for a senior employee or director’s service agreement. In which case, unless the employee has breached the terms, the terms may not need repeating in the settlement agreement.

Sometimes restrictive covenants were not included in the employment contract for a member of staff who was junior when they started but is now in a senior position or are out-of-date, or not enforceable.

A settlement agreement provides an opportunity to create fresh restrictive covenants when an employee leaves.

The post termination restrictions or restrictive covenants can cover a range of anti-competitive behaviour.  Typical requirements prevent the employee:

  • Joining a competitor;
  • Using the employer’s confidential information;
  • Poaching customers, clients and staff;

Protect employers property

Usually employers manage the return of company property such as  documents, phones, computers, etc. However, many forget to obtain passwords, and company property stores on employees’ devices, e.g. memory sticks and home computers. With no passwords, managers then waste considerable time accessing employees emails and hard drives.

The settlement agreement should include an undertaking from the employee to permanently delete any information belonging to the company from employee owned devices. Such clauses make it easier to enforce breaches by the ex-employee. This gives the settlement agreement more teeth.

Reputation management

It will not always be possible for an employee to take down his or her personal social media sites which may include references to the employer. However, the employer may well want references to the employment replaced. Increasingly, well drafted settlement agreements will include an undertaking from the employee to remove any references to the employer by the termination date.

Another angle is the risk of a dismissed employee seeking to damage the employer’s reputation. The settlement agreement should include a clause whereby the employee promises not to directly or indirectly make any derogatory or disparaging comments about the company or any of its employees.

Employee references

An employer has no legal obligation to provide an employee or former employee with a reference. However the reference is a powerful tool in the employer’s armoury. The possibility of a bad or no reference usually brings an employee to the negotiating table.

Employers have a duty to ensure the reference is truthful and reasonable. To protect themselves from claims, many employers just provide simple, factual references.

Simple reference

Settlement agreements often include an agreed form for the reference, that just confirm the:

  • Employee worked there;
  • Duration of employment; and
  • Employee’s job title.

Amending the reference

Employers can reserve the right to amend the agreed terms of the reference should information later come to light rendering the reference inaccurate.  This type of provision can help to stop the former employer making for example derogatory comments or using company information improperly.

Share rights

Often employees or directors must transfer shares when their employment terminates.  There can be additional tax risks if shares are linked with the employment agreement. Best practice is to manage share transfers under a separate share sale agreement.


Usually options lapse to the extent not exercised on cessation of employment.  This general rule applies to unapproved options as well as EMI options and HMRC CSOP options.

Alex Kennedy

I know that when the noise dies down there is a solution to be found. I set about that task as quickly as possible.

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