Settlement agreements: when to use one and when not to

Employers often reach for a settlement agreement as a default response to any difficult employment situation. In many cases that is the right decision. In others it is an unnecessary cost, or the wrong tool for the circumstances. Knowing the difference protects the business and avoids agreements that either fail to achieve their purpose or create new problems.

Situations where a settlement agreement adds clear value

• A process that has gone wrong. Where a disciplinary or redundancy process has procedural weaknesses that could be exploited at tribunal, a settlement agreement allows the employer to draw a line at a known cost rather than face unlimited exposure at a hearing.
• A senior exit where confidentiality matters. When a director or senior individual leaves, protecting client relationships, commercially sensitive information and the employer’s reputation is often as important as the financial settlement. A well-drafted agreement addresses all of these.
• A discrimination or whistleblowing allegation. These claims carry uncapped compensation. Where the employer has exposure, resolving the matter at an early stage is often significantly less costly than proceeding to a full hearing.
• A redundancy where selection is arguable. Where the selection process has weaknesses, a settlement agreement with an enhanced payment provides certainty and closes off potential claims.

Situations where a settlement agreement may not be necessary

Not every difficult situation requires a settlement agreement. Where the employer has followed a fair process, applied the correct procedure and kept clear records, proceeding to a legitimate conclusion is often the stronger and less expensive position. Offering a settlement agreement prematurely can signal a lack of confidence in your own process and invite a higher demand than would otherwise arise.

The October 2026 consideration

From October 2026, employment tribunal time limits for most claims double from three months to six months. Employers will need to factor in that employees have a longer window to bring a claim after their employment ends. Where there is any realistic exposure, addressing it by agreement sooner rather than later remains the more cost-effective approach.

The tax position matters more than many employers realise

The financial terms of a settlement agreement need to be structured correctly, not just agreed. Payments above the £30,000 tax-free threshold are subject to income tax and employer National Insurance Contributions. Notice pay, whether paid as payment in lieu or during garden leave, is taxable in full. Getting the tax position wrong exposes the employer to HMRC liability and can create disputes about the net sum the employee actually receives.

Post-termination protections: the clause employers overlook

Settlement agreements routinely deal with the financial terms of departure but frequently give insufficient attention to what happens after the employee leaves. Non-solicitation, non-dealing and non-compete clauses need to be reviewed in the context of the specific exit. Where no restrictions exist in the contract, a settlement agreement may be the last opportunity to put them in place. At Davenport Solicitors, we advise employers on settlement agreements across all sectors and at all levels of seniority. Call us on 020 7903 6888 or email contact@davenportsolicitors.com