When Should You Consider A Settlement Agreement?

A settlement agreement, also known as a compromise agreement or termination agreement, is a legally binding contract used to mutually end an employment relationship or settle an employee dispute.

The contract outlines the terms of the agreement and stops employees from bringing claims against their employer, typically with the employee receiving financial compensation from their employer in return.

Redundancy (whether compulsory or voluntary redundancy) is when an employer has to let an employee go from the company for a reason that is unrelated to their job performance or their behaviour at work, such as a recession, company closure, or the employee’s position being terminated.

Settlement agreements, on the other hand, are presented due to a very specific reason, which we will explore in the next section.

Click here to read our guide to redundancy pay and severance pay.

Even though settlement agreements are traditionally proposed at the end of an employee’s relationship with their employer — in an attempt to help the relationship end on good terms — they can also be used to settle disputes at any point in the relationship.

Some of the most common examples of settlement agreement scenarios include:

A common reason why you may need to move forward with a settlement agreement is due to a dispute involving unpaid wages. For example, if an employee does not receive payment for overtime they’ve worked, a bonus they’ve earned, or even their standard paycheque.

In this case, the settlement agreement would focus on the employer paying out an agreed-upon sum of money to the employee. That said, this may not necessarily result in the employment relationship ending, although the relationship may worsen due to the experience.

If an employee believes they were terminated without rightful cause, they or the employer can propose a settlement agreement.

Moving forward with a settlement agreement is likely the most appealing option for both parties. That’s because it would resolve the dispute quickly and for a lower cost than going through a tribunal or legal process.

If an employee’s position has been made redundant, their employer may present them with a settlement agreement. Again, this helps everyone avoid the lengthy process that is typically involved when dealing with redundancy procedures. Letting go of an employee due to redundancy can be quite difficult in its own right, as the employee hasn’t really done anything to earn a dismissal.

Click here to read our full guide to the redundancy consultation process.

To make up for this, employers will typically try to go the extra mile to make the process as smooth as possible for their employees by including a higher payment in their settlement agreement or providing services to help them find a new job.

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When an employee experiences unfair treatment, misconduct, or discrimination from their manager, supervisor, or leadership team, they may propose legal action or request a tribunal.

A settlement agreement is often proposed instead to avoid litigation and instead reach a swift resolution of the issue. Although it’s not as common, companies and organizations can also offer settlement agreements to individuals who aren’t their employees. For example, if an applicant was interviewed for a position and believed they were turned down for a discriminatory reason and threatened legal action.

In this case, the employer may propose a settlement dispute to avoid the legal process and associated PR problems the dispute may cause.

When an employer is faced with a dispute involving harassment, racism, discrimination, or misconduct, their reputation is on the line. Settlement agreements will often include a clause prohibiting the involved employee from discussing the matter publicly or slandering the company.

When an employee has worked beyond their probation period but is no longer a good fit for the company due to lack of skill, interoffice relationship issues, or personality fit, a settlement agreement is often used to end the working relationship cleanly and avoid a wrongful dismissal suit. Although this is a difficult situation to navigate, the employer can include a letter of recommendation as part of the settlement agreement to improve the situation and help the employee find a better fit.

Settlement agreements should not be the first choice when trying to resolve a workplace dispute. Rather, the company’s HR and legal team should first try to resolve the issue through mediation, discussion, and disciplinary action, only using a settlement agreement once those approaches have failed.

Settlement offers can either be proposed verbally or in writing. The most appropriate course of action to take depends on the contents of the settlement agreement. For example, if the agreement is for a dispute that could result in legal action, a written proposal is likely the best step to take, whereas a minor dispute may be handled verbally.

No matter the dispute, both parties must thoroughly understand why the offer is being presented and must be clear on the accepted proposal.

While settlement agreements are usually proposed by the employer, an employee can also propose a settlement agreement to their employer.

Settlement agreements are voluntary and are typically reached after a negotiation process wherein all other dispute resolution options have been tried.

They are also used as a way to avoid a tribunal, but should not be used excessively or without going through due process beforehand.

The employee doesn’t have to accept the settlement offer, but they could still lose their job without the benefits the settlement offer could bring them, and they might not get a better offer. The terms of the settlement agreement must eventually be agreed upon by both parties.

All settlement agreements will differ depending on the employee, the situation, and the employer’s goals.

Does the employee want to receive financial compensation? Does the employer want to help them find their next job? Does the employee wish to stay or be reinstated in their role?

To design an effective settlement agreement, here are some common terms that you should include:

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