Settlement Agreements in the UK (2026): Requirements, Independent Advice and Tax

A settlement agreement is a legally binding contract in which an employee or worker gives up the right to bring certain employment claims in return for a payment or other terms. It's the standard way UK employers agree an exit, end a grievance or close off a dispute without a tribunal. This guide is for small business owners considering offering one and for employees who've just been handed one. It covers the legal requirements, independent advice, "protected conversations", confidentiality and the NDA rules coming in 2027, how the package is taxed — including the £30,000 rule and notice pay — and a worked example in pounds.

Quick answer

A UK settlement agreement is only valid if it's in writing, relates to specific complaints, and the worker has had advice from a named, insured independent adviser — usually a solicitor, often paid for by the employer. Compensation for losing the job is usually tax-free up to £30,000, but notice pay, holiday pay and bonuses are taxed as earnings.

• Acas recommends at least 10 days to consider the offer

• Pre-termination talks are usually inadmissible in unfair dismissal claims — but not discrimination or automatically unfair ones

• Confidentiality can't stop whistleblowing or reporting a crime

• Legal fees paid directly to the employee's solicitor aren't taxed

• NDAs covering harassment or discrimination are set to be restricted from 2027

What a settlement agreement is and when it's used

Most statutory employment rights can't be signed away. Section 203 of the Employment Rights Act 1996 makes most contractual waivers of tribunal claims void, so a simple "I won't sue" in a letter doesn't work. A settlement agreement is one of two exceptions — the other is an Acas-conciliated COT3 — and it's only effective if it meets the statutory conditions. If it does, the worker can't later bring the claims it lists.

Acas says settlement agreements can be made with employees, workers, former workers and even job applicants, though the claims available depend on status: unfair dismissal, redundancy pay and breach of contract are for employees, while discrimination claims can be brought by all of those groups. They're most often used to end employment, but they can also settle a dispute while someone stays — for example a disagreement about an unpaid bonus. Either side can suggest one, and it must be voluntary and reached through negotiation.

Typical terms include a payment, pay in lieu of notice, an agreed reference, an agreed announcement to colleagues, return of company property, confidentiality, and the employee's confirmation that they're waiving specified claims. Employers usually add a tax indemnity and a warranty that the employee hasn't breached their contract in a way that would justify dismissal.

The legal requirements for a valid agreement

Acas summarises the conditions that make a settlement agreement legally effective. It must be in writing; it must relate to a particular complaint or proceedings; the worker must have received advice from a relevant independent adviser on its terms and effect, particularly on their ability to pursue their rights before a tribunal; the adviser must have insurance or an indemnity covering the risk of a claim over that advice; the adviser must be identified in the agreement; and the agreement must state that the statutory conditions regulating settlement agreements are satisfied.

Is the settlement agreement valid?

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• In writing and signed by both parties
• Lists the specific claims being settled — not just 'all claims'
• Employee advised by a relevant independent adviser on its terms and effect
• Adviser named in the agreement and insured
• Agreement states the statutory conditions are satisfied
• Adviser's certificate or letter attached confirming the advice was given

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The "particular complaints" point catches people out. Acas gives the example that wording such as "in full and final settlement of all claims" on its own isn't enough; the agreement should list the claims it covers — unfair dismissal, wrongful dismissal, unlawful deductions, discrimination on each ground, and so on. Well-drafted agreements list them in a schedule and then add a general waiver that works as far as the law allows.

Some things normally sit outside the waiver. Agreements usually carve out accrued pension rights, claims to enforce the agreement itself, and personal injury claims the employee isn't aware of when signing. A worker can't waive claims about things that haven't happened yet, such as a future breach of the agreement.

Who counts as an independent adviser

Acas lists three types: a qualified lawyer such as a solicitor or barrister; a trade union officer, official, employee or member who's been certified in writing by the union as competent and authorised to give advice; or a worker at an advice centre who's certified as competent and authorised. The adviser can't be employed by, or acting for, the employer. In practice almost all advice is given by an employment solicitor, who signs a short certificate attached to the agreement.

Protected conversations and how negotiations start

Settlement discussions often begin with what's called a "protected conversation". Section 111A of the Employment Rights Act 1996 says that offers and discussions about ending employment on agreed terms generally can't be used as evidence in an ordinary unfair dismissal claim. Unlike traditional "without prejudice" protection, Acas notes that no existing dispute is needed, so an employer can raise the idea before any formal process has started.

That protection has firm limits. Acas confirms it applies only to employees' unfair dismissal and constructive dismissal claims. It doesn't cover automatically unfair dismissal, such as whistleblowing, trade union activity or asserting a statutory right like the minimum wage, and it doesn't cover discrimination, wrongful dismissal or unlawful deductions claims. In those claims, a badly handled protected conversation can be produced as evidence.

Protection is also lost if there's improper behaviour. Acas's examples include harassment, bullying and intimidation, physical assault or threats, victimisation or discrimination, and undue pressure — for instance not allowing reasonable time to consider the offer, or telling someone that if they don't accept they'll be dismissed before any disciplinary process has started. On the other hand, explaining the reasons for the offer and setting out the likely alternative, declining to give a reference, not paying for advice, or encouraging the employee to reconsider are not improper.

Acas also says discussions shouldn't affect any performance or disciplinary procedure that's already running. If an employee declines the offer, the employer should carry on with the normal process fairly — and shouldn't treat the refusal as a reason to dismiss.

The process from offer to payment

A settlement usually follows a predictable path. Knowing it helps both sides avoid delays and keeps the employer clear of improper pressure.

From first conversation to payment

1. 1

   Raise the offer

   Explain that the conversation is voluntary and confidential, the reasons for the offer and what's on the table. Follow up in writing.

2. 2

   Allow time

   Acas recommends at least 10 days to consider it and take advice; longer if needed.

3. 3

   Draft the agreement

   The employer's solicitor usually drafts it, including the claims list, payment breakdown, reference and confidentiality.

4. 4

   Independent advice

   The employee meets their adviser, who explains the terms and the claims being waived and may negotiate.

5. 5

   Sign and certify

   Both parties sign; the adviser signs a certificate confirming the advice and insurance.

6. 6

   Pay through payroll

   Pay the taxable elements through PAYE and the tax-free element as set out; issue the P45.

There's no statutory deadline, but Acas recommends 10 days as the minimum time to think it over. Disabled workers may need longer — for example to arrange an interpreter — and refusing reasonable extra time risks being treated as undue pressure.

Employers aren't legally required to pay for the employee's advice, but Acas says they should consider it and most do, because without advice there's no valid agreement. The contribution is a negotiated sum paid directly to the employee's solicitor, often a few hundred pounds plus VAT for a straightforward agreement; there's no official figure. Employers should take their own legal advice on the drafting too.

Once signed, the worker can't bring the listed claims. If either side breaks the agreement — the employer doesn't pay, or the employee breaches confidentiality — Acas says it's treated as a breach of contract claim in the county court in England and Wales or the sheriff court in Scotland.

Confidentiality clauses and the 2027 NDA changes

Most settlement agreements include confidentiality, often covering both the terms and the circumstances of the exit. Acas stresses that confidentiality clauses are voluntary and that some disclosures can't be stopped: a clause can't prevent a worker from whistleblowing, reporting a crime to the police, or sharing information about a crime to get advice and support as a victim in England or Wales. English universities and other higher education providers can't use clauses to stop staff disclosing sexual misconduct, abuse, harassment or bullying.

From 6 April 2026, Acas confirms that disclosing sexual harassment counts as a qualifying disclosure under whistleblowing law, so employees who report it are protected from automatically unfair dismissal and detriment, even if the harassment happened before that date.

The bigger change is still to come. The Employment Rights Act 2025 makes void any term in an agreement between an employer and a worker — including settlement agreements, contracts and COT3s — that prevents the worker making allegations or disclosures about harassment or discrimination, or about how the employer responded. Agreements that meet conditions to be set in regulations, known as excepted agreements, can still include such terms. The government consulted until 8 July 2026; proposals include written independent advice, a written statement of the worker's preference and a cooling-off period. Mills & Reeve and other commentators expect the rules to take effect in 2027, but no date is confirmed. Until then, keep confidentiality clauses narrow and include an express list of permitted disclosures.

How settlement payments are taxed

Tax is where most confusion arises, and the label in the agreement doesn't decide it. GOV.UK sets out the rules, and our termination payments guide explains them in depth.

The key rule is post-employment notice pay (PENP). If the employee doesn't work their full notice, the basic pay they'd have earned during the unworked notice is treated as earnings and taxed in full, even if the agreement calls the whole sum "compensation". Only the balance — the relevant termination award — can use the £30,000 exemption. GOV.UK adds that if PENP exceeds the severance payment, you're only taxed on what you actually receive.

Timing matters too. Taxable elements are normally paid through the final payslip. If a payment is made after the P45 has been issued, the employer must use a 0T code on a non-cumulative basis, which usually overtaxes the payment; the employee can reclaim through HMRC or Self Assessment. Employers usually include an indemnity making the employee responsible for any further tax due on the tax-free element.

Worked example: a settlement package in pounds

Sophie is a sales manager at a 40-person software reseller in Reading. She's 38, has six years' service, earns £52,000 a year (£1,000 a week) and has a three-month contractual notice period. After a dispute about her performance review she raises a grievance, and the company proposes a negotiated exit. It doesn't want her to work her notice. After two weeks of negotiation through her solicitor, they agree:

Sophie's settlement package

Element	Amount	Tax treatment
Pay in lieu of three months' notice	£13,000	Taxed as earnings with Class 1 NI
Six days' accrued holiday	£1,200	Taxed as earnings with Class 1 NI
Compensation for loss of employment	£25,000	Tax-free — within the £30,000 exemption
Contribution to legal fees, paid to her solicitor	£600 + VAT	Not taxed
Agreed reference and announcement	—	—
Total gross package	£39,200 + legal fees	£14,200 through PAYE; £25,000 tax-free

Pay in lieu of three months' notice

Amount

£13,000

Tax treatment

Taxed as earnings with Class 1 NI

Six days' accrued holiday

Amount

£1,200

Tax treatment

Taxed as earnings with Class 1 NI

Compensation for loss of employment

Amount

£25,000

Tax treatment

Tax-free — within the £30,000 exemption

Contribution to legal fees, paid to her solicitor

Amount

£600 + VAT

Tax treatment

Not taxed

Agreed reference and announcement

Amount

—

Tax treatment

—

Total gross package

Amount

£39,200 + legal fees

Tax treatment

£14,200 through PAYE; £25,000 tax-free

Because notice is paid in full as PILON, the PENP for the unworked notice is already accounted for; the £25,000 is the relevant termination award and sits inside the exemption, so there's no employer Class 1A. Sophie pays income tax and Class 1 National Insurance on £14,200 via her final payslip, and the employer pays employer NI on that sum.

Now change one thing. Suppose the agreement had paid a single £45,000 "compensation" lump sum with no PILON, and Sophie still didn't work her notice. HMRC's PENP rules would treat £13,000 as notice pay and tax it as earnings anyway. The remaining £32,000 would use the £30,000 exemption, leaving £2,000 taxable, and the employer would owe Class 1A at 15% on that £2,000 — £300. Labelling doesn't avoid tax; structuring the package correctly does.

Why would the employer pay £25,000 on top of notice? Because Sophie has more than 2 years of service and an open grievance, and the business wanted certainty, a quick exit and confidentiality rather than the cost and time of a possible unfair dismissal or discrimination claim. See our unfair dismissal guide for how tribunal awards are worked out.

Settlement agreement or COT3?

A COT3 is the Acas alternative. It's recorded by an Acas conciliator, usually during early conciliation after the employee notifies Acas of a potential claim, or after a claim has been filed. Acas says a COT3 is legally binding, the case is closed with no hearing, and both sides must keep to it once terms are agreed, even before signing. It doesn't need independent legal advice, which makes it quicker and cheaper for simple disputes.

Settlement agreement vs COT3

	Settlement agreement	COT3
Who records it	The parties (usually the employer's solicitor)	An Acas conciliator
Independent advice needed	Yes — named, insured adviser	No
Typical timing	Before any claim, often at exit	During early conciliation or after a claim
Effect	Listed claims can't be brought	Case closed; claims settled
Tax treatment	Same termination payment rules	Same termination payment rules

Who records it

Settlement agreement

The parties (usually the employer's solicitor)

COT3

An Acas conciliator

Independent advice needed

Settlement agreement

Yes — named, insured adviser

COT3

No

Typical timing

Settlement agreement

Before any claim, often at exit

COT3

During early conciliation or after a claim

Effect

Settlement agreement

Listed claims can't be brought

COT3

Case closed; claims settled

Tax treatment

Settlement agreement

Same termination payment rules

COT3

Same termination payment rules

A settlement agreement suits a negotiated exit before any claim exists, a package with several elements such as a reference, restrictive covenants or pension terms, and situations where the employer wants the reassurance that the employee has been advised. A COT3 suits a dispute that's already gone to Acas. The tax rules are the same for both.

Common mistakes and how to avoid them

Using a blanket waiver. "All claims" isn't enough. List the specific claims in the agreement.

Forgetting the adviser's certificate. Without the named, insured adviser and the statement that the conditions are met, the waiver isn't valid.

Pressuring the employee. Short deadlines and threats of dismissal can make the discussions admissible. Give at least 10 days and write down that the offer is voluntary.

Mislabelling notice pay. If notice isn't worked, PENP applies. Show the notice, holiday and compensation elements separately.

Paying legal fees to the employee. The exemption only covers fees paid directly to the solicitor for advice on the termination.

Over-wide confidentiality. Clauses that appear to stop whistleblowing or police reports are unenforceable and look bad if challenged; from 2027 harassment and discrimination NDAs will need to be excepted agreements.

Missing the time limit. If talks fail, employees still have only 6 months from dismissal to start a claim. Negotiating doesn't stop the clock; notifying Acas does.

Official links

• Acas: settlement agreementsRequirements, offers and confidentiality
• Acas: early conciliation and COT3The Acas alternative
• Termination payments and tax£30,000 rule, PENP, legal costs
• HMRC: post-employment notice payEmployment Income Manual
• Employment Rights Act 1996, section 203Statutory conditions
• Employment Rights Act 1996, section 111APre-termination negotiations

What to do next

If you're an employer, decide what you're trying to achieve, prepare a fair fallback process, and take advice before the first conversation. Use the notice period guide and termination payments guide to cost the package, and the redundancy process guide if the exit is really a redundancy. If you're an employee, don't sign anything until an independent adviser has gone through it with you, check the tax split line by line, and diarise the tribunal deadline in case talks break down.

This is general information, not legal or tax advice — confirm on the official source or with a professional.

Frequently asked questions

What makes a settlement agreement legally binding?

It must be in writing, relate to the particular complaints or proceedings it settles, and the worker must have received advice on its terms and effect from a relevant independent adviser who is insured and named in the agreement. The agreement must also state that these statutory conditions are met. Without them, the worker can still bring the statutory claims the agreement tries to waive.

Is a settlement agreement payment tax free?

Partly. Genuine compensation for loss of employment is usually tax-free up to £30,000, combined with any statutory and enhanced redundancy pay. Pay for unworked notice (post-employment notice pay), holiday pay, unpaid wages and bonuses are taxed as earnings, whatever the agreement calls them. Legal fees the employer pays directly to the employee's solicitor are not taxed.

Does my employer have to pay for my legal advice?

No. Acas says employers should consider paying for the worker's independent advice but aren't required to. In practice most employers contribute, paying the adviser directly. The contribution is tax-free if it's paid straight to the solicitor for advice on the termination.

How long do I have to consider a settlement agreement?

There's no statutory deadline, but Acas recommends giving at least 10 days to consider the offer and take advice, and longer where a disabled worker needs it. Putting someone under undue pressure, for example by refusing reasonable time, can count as improper behaviour and remove the confidentiality of the discussions.

Can a settlement agreement stop me reporting harassment?

Not entirely. Confidentiality clauses can't stop whistleblowing, reporting a crime to the police or seeking support as a victim of crime. Under the Employment Rights Act 2025, clauses that stop workers speaking about harassment or discrimination will become void unless they're excepted agreements, with the rules expected to take effect in 2027.

What's the difference between a settlement agreement and a COT3?

Both are binding ways to settle employment claims. A COT3 is recorded by an Acas conciliator, usually during early conciliation or after a claim is filed, and doesn't require independent legal advice. A settlement agreement is drawn up by the parties and is only valid if the worker has had independent advice.

Sources & verification

Figures on this page were checked against the sources below when it was last reviewed on 13 October 2026. Each rate and limit is stored once with its own official source and review date, and official update channels are monitored daily so changes are picked up. How we verify

1. 1.Settlement agreements — Acas · accessed 13 October 2026
2. 2.Settlement agreements: making a formal offer — Acas · accessed 13 October 2026
3. 3.Settlement agreements: confidentiality — Acas · accessed 13 October 2026
4. 4.Settlement agreements: discussing and negotiating an offer — Acas · accessed 13 October 2026
5. 5.Termination payments and tax when you leave a job — GOV.UK · accessed 13 October 2026
6. 6.How early conciliation works — Acas · accessed 13 October 2026
7. 7.What does the future hold for non-disclosure agreements? — Mills & Reeve · accessed 13 October 2026
8. 8.EIM13876 — Post-employment notice pay — HMRC · accessed 13 October 2026