Do employers need legal advice for settlement agreements?

Most employers know that an employee must get legal advice before signing a settlement agreement. What’s less well understood is the consequences of an employer not seeking legal advice, and the risks involved in using a potentially out-of-date template.

A poorly drafted settlement agreement can leave you exposed to tribunal claims and disputes that cost far more to resolve than the agreement was ever worth. In this blog, our employment lawyers explain what you need to know.

What is a settlement agreement?

A settlement agreement, sometimes called a ‘severance agreement’, an ‘exit package’ or a ‘compromise agreement’, is a legally binding contract between an employer and an employee that brings the employment relationship to an end or resolves a specific dispute on agreed terms. Within a settlement agreement, an employee is offered a sum of money in exchange for the employee waiving their right to bring certain claims against their employer.

To be legally valid, a settlement agreement must be in writing.

Settlement agreements are commonly used when:

• An employer wants to make an employee redundant to avoid the redundancy process
• The employer considers the employee is under-performing and needs to manage a ‘performance exit’
• An employee has expressed significant dissatisfaction with their role or the company
• There is a disciplinary situation
• There is a grievance
• There is simply a clash in personalities

Used incorrectly, they can give both the employee and employer a false sense of security.

Do employers have to take legal advice for a settlement agreement?

Not necessarily. There is no statutory requirement for employers to take legal advice for a settlement agreement. However, the absence of a legal obligation simply means you won’t be penalised for skipping it. It doesn’t mean you’ll be protected if something goes wrong, such as an employee making a future unfair dismissal claim.

As an employer, you are responsible for ensuring the settlement agreement is properly drafted, legally sound and fit for purpose, and that’s hard to achieve without an employment lawyer.

The benefits of seeking legal advice for a settlement agreement include:

• A lawyer can help ensure the agreement accurately reflects the terms agreed between the employer and employee
• They can include specific ‘pro-employer’ terms, such as confidentiality clauses and other post-termination obligations
• Peace of mind that the agreement meets the statutory, compliance and legal requirements for validity
• Customisation beyond a generic template to protect your business against future claims
• It provides the best chance of reducing the risk of future employment claims

It’s especially important to seek employment law advice if:

• The employee is senior (i.e. has more complex contractual entitlements)
• There are existing discrimination or whistleblowing allegations
• TUPE applies
• There is a dispute over any financial calculations, e.g. equity or commission
• The employee or their solicitor is negotiating and trying to make significant amendments to the agreement

Even if you do seek guidance from a solicitor, if your employee fails to take legal advice, the settlement agreement will not be legally binding. It is therefore important to remind your employee of their legal obligation.

What happens if an employer doesn’t take legal advice?

Even if you have what appears to be a robust template, such as one of these from Acas, most issues arise when an employer tries to navigate specific elements of a settlement agreement, such as the terms and restrictions. Common issues include:

• Drafting errors, e.g. failure to identify specific clauses. Or it’s too vague and doesn’t clarify that the employee cannot make certain claims, e.g. discrimination or breach of contract. This is a particular risk when relying on a standalone template or using AI to draft a settlement agreement.
• Post-termination restrictions aren’t enforceable: if you want to protect your business’s confidential information, including non-disclosure agreements (NDAs), or prevent your employee from joining a competitor, these restrictions must be carefully drafted and reasonable in scope. Standard templates rarely cover all bases.
• A flawed process. A settlement agreement doesn’t automatically neutralise an unfair dismissal or discrimination claim (or remove the risk of further action being taken) if the process leading up to this point was not handled properly and in line with your legal obligations.
• Failure to consider tax implications for payouts. Generally, the first £30,000 is tax-free, but this doesn’t apply to all payments. Salary and benefits are subject to tax and National Insurance as usual, but also, payments in lieu of notice are taxable in full, which employers don’t always realise.

While employers have no obligation to seek legal advice for a settlement agreement, employees are required to have a lawyer review the agreement before it can become legally binding.

What should a settlement agreement include?

A robust settlement agreement will typically include:

• A clear termination date
• A financial settlement offer which should include or account for:
  • A clear outline of the payments being made and how these will be treated for tax purposes
  • Any deductions that need to be made
  • The employee’s tenure
  • How long it may take the employee to find a new job (and backfill their role)
• The reasons for the settlement agreement and any potential liabilities if the agreement isn’t reached
• Specific identification of the types of claims being waived
• Any confidentiality obligations (on both the employee and employer), e.g. an NDA
• Whether you will provide a reference
• Post-termination restrictions (if applicable)
• How the employee will exit the business (considering handovers and Garden Leave)

No matter how simple or complex you think matters are, there is no real one-size-fits-all settlement agreement. It’s important to seek legal advice before finalising any draft.

Can an employer and employee use the same solicitor?

No, an employer and employee cannot use the same lawyer when drafting or negotiating a settlement agreement. This would signal a conflict of interest, and so each party is legally required to seek legal advice from separate solicitors.

When should and shouldn’t I use a settlement agreement?

If you are in doubt as to whether a settlement agreement is appropriate or whether an alternative is more suitable, an employment solicitor can advise you. However, settlement agreements are commonly used when an employer wants certainty, a ‘clean break’ and wishes to bring a matter to an end without the risk of formal claims.

Examples of when a settlement agreement can be used include:

• There are performance or conduct concerns
• There is a complex redundancy situation (especially with long-serving and/or senior employees)
• There has been a grievance or dispute

You should not offer a settlement agreement if there has been:

• You are attempting to deal with serious issues such as sexual discrimination or harassment claims
• A personal injury claim, e.g. employer’s liability or an accident at work
• A claim following a business transfer

A settlement agreement should not replace proper procedures.

Read more about when a settlement agreement can and cannot be used here.

Speak to our employment law solicitors

Settlement agreements can be a practical and effective way to manage difficult exits, but only when they are done properly. Seeking legal advice from the outset offers the best chance of protecting your business and limiting the risk of issues later down the line.

If you are considering offering a settlement agreement or you’ve received a request from an employee who wants to enter one, get in touch. Call our employment lawyers on 0117 325 2929 or fill out our online enquiry form.