Settlement agreements: How they work and when to consider them

25 June 2026

A settlement agreement is a legally binding contract between an employer and an employee that ends the employment relationship on agreed terms.

For employers, it can offer a clean and controlled way to part ways with a member of staff.

How a settlement agreement works

A settlement agreement typically involves the employee giving up their right to bring certain claims against the employer, usually in exchange for a financial payment.

For the agreement to be legally binding, the employee must receive independent legal advice before signing, which the employer will usually contribute towards.

Once signed, the agreement draws a clear line under the employment relationship and significantly reduces the risk of future claims relating to the matters covered.

When employers should consider a settlement agreement

Settlement agreements can be useful in a range of situations, including:

• Redundancy situations where a swift, agreed exit is preferred
• Performance or conduct issues where a tribunal claim is a real risk
• Long-term sickness absence where a return to work is unlikely
• Restructuring or business changes
• Disputes where both sides want to avoid the cost and uncertainty of a tribunal

What to include

A well drafted settlement agreement should cover the financial settlement, any reference to be provided, confidentiality terms and the return of company property.

Getting the detail right at this stage helps avoid disputes further down the line.

A word of caution

Settlement agreements must be handled carefully. Protected conversations and without prejudice discussions have specific rules attached and getting this wrong can undermine the protection an employer is trying to achieve.

Our employment team regularly advises businesses on drafting settlement agreements and managing the conversations that lead up to them. Get in touch today for expert advice on settlement agreements.