Settlement contract after termination: pros and cons

A settlement contract (Abwicklungsvertrag) defines the conditions that are important for the termination of the employment relationship after termination. These include, for example, the agreement of a severance payment, the amount of the payment, or the return date of the company car. A settlement agreement can be useful for regulating the consequences of termination in detail and avoiding possible disputes. This often makes sense for the employer in particular. Employees, on the other hand, need to be careful – especially with regard to a possible waiting period for unemployment benefits. The following blog article contains the most important tips for employees.

What does a settlement agreement regulate?

A settlement agreement (also: ‘settlement contract’) is an agreement between the employer and the employee. It is concluded after the termination of the employment relationship. The aim is to regulate the terms of the termination by mutual agreement. Unlike a termination agreement, the settlement agreement does not directly terminate the employment relationship. It clarifies the consequences of an already issued termination.

Typical subjects of a settlement agreement may include the following:

• Severance pay (in particular, the amount of the severance pay)
• ‘Sprinter clause’
• ‘Employment certificate’
• ‘Exemption’
• Handling of remaining leave and overtime
• Timing and modalities of return of a company car
• Waiver of a claim for protection against dismissal
• Confidentiality agreements

Difference between a termination agreement and a settlement agreement

A termination agreement mutually ends the employment relationship itself – without any prior notice of termination. In the case of a settlement agreement, however, notice of termination (or a termination agreement) has already been given. The employment relationship is therefore officially already terminated. At least if the termination is effective.

The focus of the settlement contract is therefore on simplifying the settlement of the termination after the termination (or cancellation agreement) has taken place, avoiding disputes and regulating the consequences of the termination. Typical provisions include severance payments, the issuance of a favourable employment reference or compliance with confidentiality agreements (see above).

• A mutual “Termination Agreement” (German: Aufhebungsvertrag or Auflösungsvertrag) ends the employment relationship by mutual consent. Employer and employee agree to terminate the contract on a specific date. They often include terms regarding severance pay, remaining vacation, and the provision of a reference letter. It ends the employment and replaces a dismissal.  
• A “Post-Termination Settlement Agreement”  (German: Abwicklungsvertrag — often called also a “Severance Contract”, a  “Separation Agreement” or a “post-termination agreement”) is only concluded after the dismissal. Here, the employment has already ended. Therefore, the agreement only regulates the consequences of termination. Such as severance payments, final settlements, or the return of company property. 

Differences between a termination agreement and a notice of termination

A notice of termination ends the employment relationship by means of a unilateral declaration. No consent of the other party is required. A settlement contract, on the other hand, requires the consent of both parties and is agreed upon by a joint agreement. The most important differences are:

• Unilateral nature: A notice of termination is declared unilaterally, whereas a settlement contract is a mutual, ‘consensual’ agreement
• Purpose: A notice of termination is used exclusively to terminate the employment relationship. A settlement contract regulates the consequences of this termination, such as severance payments or release from duty.
• Timing: Settlement contracts are usually concluded after a notice of termination. But they can also be useful for fixed-term contracts that are about to expire.

In summary, the notice of termination ends the employment relationship itself, while a termination agreement regulates the framework conditions of an impending or planned termination due to an already issued notice of termination.

Why a Settlement Agreement (Post-Termination)?

A settlement agreement (post-termination) can offer advantages to employees in several areas:

1. Severance pay: The agreement often includes severance pay. Fringe benefits, like the use of the company car, can be part of the settlement agreement as well.
2. Clarification of disputes: A termination agreement quickly clarifies the professional future. This can help to alleviate the psychological pressure and uncertainty that often come with protracted disputes. Employees know exactly when and under what conditions their employment will end.
3. Employment references: Employees have the opportunity to influence the content of their employment references. A positive and qualified reference can still be a factor when looking for a new job.

What are the risks of a severance agreement?

Even though a settlement agreement (post-termination) can offer advantages, there are some risks that employees should be aware of, depending on the contents of the respective contract:

• Waiting period for unemployment benefits: If the contract is considered by the employment agency to be a mutually agreed termination, there is a risk of a waiting period of up to 12 weeks. This can often be avoided.
• Unfavourable terms: Without legal scrutiny, there is always risk that the settlement agreement (post-termination) is designed unilaterally in favour of the employer.

What should employees look out for?

A good termination agreement can avoid many problems. However, some key points should be considered:

1. General information. We generally recommend that a lawyer review the contract to ensure that it does not contain any ‘pitfalls’. For instance with regard to a waiting period for unemployment benefits). This applies not only to questions regarding the waiting period for unemployment benefits. But also, in particular, to the ‘fair’ amount of a severance payment.
2. Formulations regarding blocking periods: Certain clauses can help to avoid a blocking period for unemployment benefits. These are formulations where every word counts and should therefore be checked carefully.
3. Employment reference: If an employee wants an employment reference, they should make sure that the contract contains an obligation for a specific, ‘very good’ and detailed regulation on the employment reference. It is helpful if the wording of the reference is specifically defined in the contract.
4. Confidentiality and competition clauses: Employees should ensure that post-contractual non-competition clauses, confidentiality clauses, and similar agreements, some of which extend far into the future, are checked by a lawyer and are appropriately remunerated. A competition clause that is too broadly defined can significantly restrict your professional future.

What are typical clauses in a settlement agreement (post-termination)?

A settlement agreement (post-termination) often contains several standardised clauses:

• Severance payment: This regulates the amount and the date on which the severance payment is to be made. The exact wording should be clear and binding.
• Exemption: An exemption clause clarifies whether and under what conditions the employee is released from their work obligation until the end of the contract. It is important that the period of exemption is paid.
• Issue of references: The contract should ensure that a qualified employment reference is issued. Employees can request that wording be agreed in advance.
• Return of work equipment: Employees should clarify which work equipment, such as laptops, mobile phones, or company cars, must be returned in order to avoid disputes.

Benefit blackout period due to settlement agreement?

A particularly critical point in a settlement agreement (post-termination) is the question of blackout periods for unemployment benefits. The Federal Employment Agency can view such an agreement as an indication of a mutually agreed separation, which could lead to a blackout period. Employees can avoid this if they observe the following:

• Wording of the notice of termination: the contract should make it clear that the termination was initiated by the employer alone. This can be a decisive factor in avoiding a blocking period.
• Appropriate severance pay: Have your legal advisor look into this; the amount of severance pay can cause trouble with the agency.
• Get help: Expert advice helps to avoid legal pitfalls and minimise the impact on unemployment benefits.

Frequently asked questions (FAQ)