Settlement agreements: an employers guide

Poorly drafted settlement agreements expose employers to unnecessary cost. Properly drafted settlement agreements allow employers to terminate employment cost effectively without risking claims in the Employment Tribunal. 

In addition to reading this article you may find our recent webinar guide to settlement agreements for employers.

Settlement agreements: Employer protection

A settlement agreement, that used to be termed a compromise agreement, should say it is in full and final settlement. Otherwise it does not serve its purpose.

We define and detail the payments made in full and final settlement. For example, the settlement agreement should separate tax free and taxable payments. We explicitly state what each item represents e.g. outstanding holiday pay to the date of termination.

Settlement payments in instalments

Some employers pay employees in instalments over a prolonged time period. Good agreements require employees to re-state the settlement agreement’s terms before receiving final payment. This is a common belt and braces precaution.  We build the re-statement into the settlement agreement the employee or director signs when their employment terminates.

Employee indemnities

Our settlement agreements ensure the employee indemnifies not just the employer, but directors and officers. This prevents the employee bringing claims against your directors or officers.

Settlement agreement: employer tax issues

HMRC investigations are becoming routine. HMRC want to see the nature of payments made to employees. HMRC  look for PAYE which employers should have operated, but did not.  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 the employment 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.

We review the terms. Often the provisions do not exist, or are out-of-date, or and not enforceable.

However, in many cases the provisions in the employment or director’s agreement either do not exist or are out of date or legally unenforceable. A common error is that the courts determine if the  restriction or covenant is reasonable to be at the time when the employee signed the restrictive covenant, not when the employee leaves.

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

What can be included

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;
  • Protection for trade secrets.

The length and duration of the restriction should be defined and reasonable.


Post termination restriction or restrictive covenant require consideration, i.e. payment. This payment is taxable under PAYE. Current practice is to pay fairly nominal amounts of consideration.

Settlement agreement: settle all claims

It is the employer’s job to set out exactly which claims apply to the particular situation. Employer often make mistakes, e.g. fails to identify the correct claims, or includes irrelevant claims. Then employer risk receiving a claim from the employee despite the employer paying the employee on the terms set out in the settlement agreement.

In a recent case the Employment Tribunal decided that a former employee who had signed a settlement agreement was nevertheless entitled to bring a disability discrimination claim.

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.

TUPE transfer

If TUPE applies, clearly the settlement agreement should address any TUPE specific requirements. The duty to inform and consult is held jointly and severally between the former employer and the new employer after the TUPE transfer.

The settlement agreement could include settlement of the failure to inform and consult under the TUPE regulations. However both sets of employers should enter into the settlement agreement.

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.

Tax payable by the employee on share transfers

In some cases the employee can claim Business Assets Disposal Relief (entrepreneurs’ relief).  But, there can be unforeseen tax consequence, if the following order does not apply:

  • The employee or director transfers shares or the company buys back the shares; before
  • The employment or directorship terminates.


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.

Sunita Sharma

Manages to explain difficult concepts in easy to understand language. In tune with her clients.

Let us take it from here

Call us on 020 7438 1060 or complete the form and one of our team will be in touch.