A settlement agreement (previously known as a compromise agreement) is a legally binding contract, which records the terms on which an employer and employee agree to terminate the employment relationship by consent.

It is a neutral agreement under which an employer pays the employee a sum of money in exchange for their agreement not to pursue any claims arising out of their employment or its termination.

The agreement effectively settles any disputes or potential claims against the employer regarding the employment.

An employer’s perspective of settlement agreements

A settlement agreement is often put forward by the employer as an alternative option to a disciplinary or redundancy process but can be used to settle almost any employment dispute.

The main advantage for an employer is that once both parties sign the settlement agreement, they will have peace of mind that the employee will not pursue any legal claims arising out of their employment or its termination.

Terminating employment under a settlement agreement can also save the employer the time and resources required for going through a disciplinary or consultation process.

Main drawbacks of settlement agreements

Although settlement agreements can be useful in certain circumstances, the main drawback for the employer is the cost as they will need to make a termination payment to the employee in return for their agreement not to pursue any claims.

The employer will also be responsible for the legal fees associated with drafting the agreement and a contribution towards the employee’s legal advice. Nonetheless, the employer is in control the amount and the cost of entering into a settlement agreement is likely to be less than the cost of defending any legal proceedings, which may arise following a dismissal.

A settlement agreement is presented on a without prejudice basis, meaning that if negotiations breakdown and the parties do not enter into the agreement, the offer remains ‘off the record’ and cannot be relied on in legal proceedings (except in limited circumstances).

If an employee rejects a settlement agreement, an employer should ensure that they comply with their legal obligations before deciding to dismiss an employee.

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