Settlement agreement

What it means

A settlement agreement is a contract in which the parties, through mutual concessions, settle disputed or uncertain rights and obligations, such as the amount of damage, the scope of work done or the sum due under a complaint. It is governed by the Civil Code and is also used in business relationships.

The settlement replaces the original claims with new obligations under the agreement. Once it is concluded, the parties can no longer pursue what was in dispute, only performance under the agreement, so the claims being settled must be defined precisely.

It helps avoid a lawsuit, which is costly, slow and uncertain. Settlements often follow negotiations, mediation or arise during proceedings when the parties realise a compromise is better than continuing the dispute.

How it works in practice

A good settlement agreement precisely describes the disputed claims, the mutual concessions, the new amount and due date, how it will be paid and a statement that once performed the parties have no further claims. With instalments, it is worth agreeing that the whole sum falls due on default.

If the dispute is already in court, the parties can conclude a court settlement approved by the court, which is directly enforceable. With an out-of-court agreement, non-payment requires a lawsuit to enforce the agreement, unless the debtor acknowledged the debt in a notarial deed with an enforceability clause.

For tax purposes, it must be assessed what the settlement payment represents. If it is a price reduction for a supply, the VAT base and revenue are corrected; if it is compensation for damage, the consequences differ. Whether the payment is deductible for the payer is assessed in the same way.

What to watch out for

A settlement may affect limitation. Acknowledging the debt in the agreement usually starts a new limitation period, while negotiations alone do not stop it running. Anyone negotiating for a long time should watch the deadlines and file a lawsuit in time if necessary.

When settling with a director or shareholder, make sure the company's concessions are not a hidden gift or harm to the company. Waiving part of a receivable may be a non-deductible expense, and disproportionate concessions can trigger the director's liability.