EMPLOYMENT LAW · BERLIN
Settlement Agreement: What Employees Should Know Before Signing
A settlement agreement can seem like a simple solution at first: the employment relationship is to end by mutual agreement, often with severance pay, a termination date and further provisions on garden leave, vacation or a reference letter.
For employees, however, a settlement agreement is not just a formality. Once signed, it usually brings the employment relationship to a binding end. Unlike a dismissal, the end of the employment relationship is not declared unilaterally by the employer. It is agreed by both sides.
That is why employees should carefully review a settlement agreement before signing it.
What is a settlement agreement?
A settlement agreement is an agreement between employer and employee to end the employment relationship on a specific date.
This means: the employer does not terminate the employment relationship unilaterally. Instead, both sides agree that the employment relationship will end.
Typically, a settlement agreement does not only regulate the end of the employment relationship. It also often covers further points, for example:
• termination date
• severance pay
• garden leave or release from work
• remaining vacation
• outstanding salary
• bonus or commission
• reference letter
• return of work equipment
• company car
• non-compete obligations
• confidentiality
• settlement of all mutual claims
Because many claims are often regulated in one document, employees should not sign too quickly.
Do I have to sign a settlement agreement?
No. A settlement agreement is voluntary.
The employer can offer a settlement agreement. The employee does not have to accept it. If the employee does not sign, the employment relationship initially continues unless it is ended in another way, for example by dismissal.
This is important because employers sometimes set short deadlines or put pressure on employees. A short signing deadline does not automatically mean that the agreement should be signed immediately.
Before signing, employees should clarify:
• What happens if I do not sign?
• Is the employer actually threatening dismissal?
• Would such a dismissal likely be valid?
• Is the proposed package economically reasonable?
• What are the consequences for unemployment benefits, health insurance and taxes?
• Could I lose outstanding claims through a settlement clause?
Written form: a settlement agreement must be signed
A settlement agreement ending an employment relationship must be concluded in written form.
This means: the agreement must be physically signed by both sides. A purely verbal agreement, an email or an electronic declaration is not sufficient to end the employment relationship.
For employees, this is practically important: as long as no validly signed settlement agreement exists, the employment relationship is not ended merely by a verbal statement.
Conversely, once the agreement has been validly signed, it is usually difficult to undo.
Difference from a dismissal
In a dismissal, one side, usually the employer, unilaterally declares that the employment relationship will end. The employee does not have to agree to the dismissal.
A settlement agreement is different. Here, the employment relationship ends by agreement. The employee therefore actively participates in ending the employment relationship.
This distinction is important. In the case of a dismissal, the employee can have assessed whether bringing a dismissal protection claim makes sense. After signing a settlement agreement, this question usually no longer arises in the same way, because the termination has been agreed by mutual consent.
Difference from a separation agreement after dismissal
A settlement agreement must be distinguished from a separation agreement after dismissal.
A settlement agreement ends the employment relationship itself. No dismissal is required.
A separation agreement after dismissal is typically concluded after a dismissal has already been issued. The dismissal is already on the table. The agreement then regulates the consequences of that dismissal, for example severance pay, reference letter, garden leave or waiver of legal action.
Put simply:
With a settlement agreement, the employment relationship ends by contract.
With a separation agreement after dismissal, the employment relationship is intended to end because of a dismissal; the agreement only regulates the consequences.
Is there a right of withdrawal?
A common misconception is that a signed settlement agreement can simply be withdrawn.
This is generally not the case. Settlement agreements usually do not come with a general statutory right of withdrawal like certain consumer contracts.
Withdrawing from the agreement later is only possible in special situations. This may include cases of unlawful threat or cases where the employer violated the duty of fair negotiation during the contract negotiations.
These are exceptions and depend heavily on the individual case. Employees should therefore not rely on being able to undo a signed agreement later without difficulty.
Short deadline: what should I do?
Many employees receive a settlement agreement with the message that they should sign quickly.
This can understandably create pressure. Nevertheless, a short deadline should not lead to signing the agreement without review.
It is important to understand: not every short decision deadline automatically makes the agreement invalid. The decisive question is whether the employee had a fair opportunity to understand the situation and make a free decision.
In practice, this means: especially where the deadline is short, employees should quickly assess what consequences the signature would have and whether renegotiation makes sense.
Severance pay: possible, but not automatic
Many settlement agreements include severance pay. However, there is no general statutory entitlement to severance pay in every case.
Severance pay is usually a matter of negotiation. Its amount depends, among other things, on the strength of the employee’s legal position, the employer’s dismissal risk, the length of employment and the interests of both sides.
It is also important to check when the severance payment becomes due. Often, it is paid only at the end of the employment relationship or together with the final payroll.
Employees should also check whether the severance payment is really compensation for the loss of the job or whether it actually includes outstanding remuneration elements, such as bonus, commission, vacation or salary.
Termination date and notice period
The termination date is one of the most important points in a settlement agreement.
Even though the parties to a settlement agreement are not necessarily bound by the notice period, observing the applicable notice period can be very important in practice. An earlier termination date can affect unemployment benefits.
Employees should therefore check:
• Which notice period would apply to the employer?
• Does the employment relationship end earlier under the settlement agreement?
• Will salary be paid until the end?
• Is there paid garden leave?
• Is the reason for termination documented clearly in the agreement?
Unemployment benefits: brief, but important
A settlement agreement can affect unemployment benefits.
Two issues in particular must be distinguished: a possible blocking period and a possible suspension due to severance pay and a shortened notice period.
These questions should not be examined only after signing. The specific wording of the agreement, the termination date, the notice period and the stated reason for termination can be important for the social security assessment.
Garden leave and vacation
Many settlement agreements provide that the employee is released from work until the termination date.
It should be checked carefully whether the release is revocable or irrevocable. It should also be clearly regulated whether and during which period remaining vacation is taken.
This is not just a formality. Garden leave, vacation and other earnings can have significant economic consequences.
Important questions include:
• Do I still have to be available during garden leave?
• Can the employer call me back?
• Is remaining vacation credited?
• Are overtime hours compensated?
• May I start a new job before the termination date?
• Will income from a new job be offset?
Especially if a new job is already in sight, an early exit clause can be important. It may allow the employee to leave the employment relationship earlier and receive an additional payment.
Reference letter
A settlement agreement should also regulate the employment reference letter.
This is not only about whether a reference letter will be issued at all. The type, content and grade of the reference letter can also be important.
A useful provision may state that the employer will issue a qualified favourable reference letter with a specific performance and conduct rating. In some cases, it is also agreed that the employee may submit a draft reference letter.
This should be regulated as clearly as possible to avoid disputes after the employment relationship has ended.
Settlement clause: review carefully
Many settlement agreements contain a settlement clause at the end.
Such clauses often state that, once the agreement has been fulfilled, all mutual claims arising from the employment relationship are settled.
This can have far-reaching consequences. It may mean that outstanding claims can no longer be asserted.
Before signing, employees should therefore check whether there are still open claims, for example:
• salary
• overtime
• bonus
• commission
• vacation
• expenses
• company car claims
• variable remuneration
• occupational pension
• stock options or long-term incentives
If such claims exist, they should be expressly regulated or excluded from the settlement clause.
Typical risks for employees
A settlement agreement can make sense. But it can also have significant disadvantages.
Employees should be particularly careful if:
• the employer demands a signature at very short notice,
• no severance pay or only a low severance payment is offered,
• the termination date is very early,
• the notice period is not observed,
• it is unclear whether unemployment benefits are at risk,
• outstanding salary or bonuses are not regulated,
• the agreement contains a broad settlement clause,
• special dismissal protection may apply,
• the reason for termination is not documented clearly,
• the employer threatens extraordinary dismissal,
• the agreement is difficult to understand.
In such cases, the agreement should be legally reviewed before signing.
What should be checked before signing?
Before signing a settlement agreement, employees should in particular check:
1. Why does the employer want to end the employment relationship?
2. Is the employer actually threatening dismissal?
3. Would such a dismissal likely be valid?
4. Is the employer’s applicable notice period observed?
5. Is the termination date economically reasonable?
6. Is severance pay provided and when is it due?
7. Are garden leave, vacation and overtime clearly regulated?
8. Are there outstanding salary claims, bonus or commission?
9. Is the reference letter sufficiently regulated?
10. Does the agreement contain a settlement clause?
11. Are there risks for unemployment benefits?
12. Are there tax or social security issues?
13. Is there an early exit clause or the possibility to start a new job earlier?
14. Are company car, work equipment, loans or non-compete obligations regulated?
These points show: a settlement agreement should not be assessed only by looking at severance pay. What matters is the overall package.
Should I sign a settlement agreement?
That depends on the specific case.
A settlement agreement can make sense if the employment relationship is going to end anyway, the conditions are fair and the economic and social security consequences have been clarified.
It can be disadvantageous if the employee gives up protection rights, remuneration or other claims without sufficient compensation.
The general rule is: do not sign too quickly. Review first, decide afterwards.
Conclusion
A settlement agreement ends the employment relationship by mutual consent. That makes the employee’s signature particularly important.
Unlike in the case of a dismissal, the employee actively agrees that the employment relationship will end. Once signed, the agreement usually cannot simply be withdrawn.
Before signing, employees should review the termination date, notice period, severance pay, garden leave, vacation, reference letter, outstanding remuneration, settlement clause and possible consequences for unemployment benefits.
A fair settlement agreement can be a sensible solution. An unchecked settlement agreement, however, can lead to significant disadvantages.