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                                                                    EXHIBIT 10.7


                             SETTLEMENT AGREEMENT


          This Settlement Agreement (the "Agreement") is entered into as of
August 16, 1998, by and between William D. Griffin ("Griffin") and Inference
Corporation, a Delaware corporation (the "Company").

                                R E C I T A L S
                                - - - - - - - -

          A.  Effective as of February 1, 1997, Griffin and the Company entered
into that certain Employment Agreement (the "Employment Agreement").

          B.  Griffin desires to resign from all of his executive officer and
director positions with the Company as of the date hereof and to resign his
employment duties with the Company effective August 16, 1998.

          C.  In connection with Griffin's resignation, the parties desire to
enter into this Agreement and amend the Employment Agreement as set forth below.


                               A G R E E M E N T
                               - - - - - - - - -

          NOW, THEREFORE, in consideration of the foregoing, and for other good
and valuable consideration, the receipt and sufficiency of which is hereby
acknowledged, the parties agree as follows:

          1.  Notice of Resignation.
              --------------------- 

              (a)  Griffin hereby provides notice to the Company that he resigns
from his position as the Company's Senior Vice President, Chief Financial
Officer and Secretary as of the date hereof and resigns all of his employment
duties with the Company effective August 16, 1998 ("Employment Termination
Date").

              (b)  Griffin also confirms that he has resigned as a director of
the Company, effective as of August 16, 1998.

          2.  Severance Benefits.  Section 4.3 of the Employment Agreement is
              ------------------                                             
hereby amended and restated to read as follows:

              "(a)  On August 31, 1998, the Company shall pay to Executive as
     severance pay in a lump sum cash payment, $195,000; and

               (b)  The Company shall maintain, at the Company's expense, in
     full force and effect, for the Executive's continued benefit until the
     earlier of (i) 
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     September 30, 1999, or (ii) the Executive's commencement of full time
     employment with a new employer, all life insurance, medical, health and
     accident, and disability plans, programs or arrangements in which the
     Executive was entitled to participate immediately prior to the date of
     termination, provided that the Executive's continued participation is
     possible under the general terms and provisions of such plans and programs.
     In the event that the Executive's participation in any such plan or program
     is barred, the Company shall arrange to provide the Executive with benefits
     substantially similar to those which the Executive was entitled to receive
     under such plans or programs. Subsequent health insurance benefits will be
     in accordance with COBRA."

          3.  Waiver Under Employment Agreement.  Except for the continuing
              ---------------------------------                            
obligations of Griffin under Article III of the Employment Agreement, which
Griffin hereby reaffirms, and the continuing obligations of the Company under
Article IV of the Employment Agreement, as amended hereby, the parties agree
that the Employment Agreement shall be terminated in its entirety as of the
Employment Termination Date and both parties expressly waive any notice periods
for termination of the Employment Agreement.

          4.  Return of Company Property; Expenses.
              ------------------------------------ 

              (a)  Griffin covenants that on or prior to the Employment
Termination Date he shall return all Company property, equipment and documents
in his possession or under his control, including, but not limited to, keys,
credit cards, telephone calling cards, manuals, books, notebooks, financial
statements, reports, samples, pricing lists, and other property of the Company;
provided, however, Griffin shall be allowed to retain (i) the desktop and
notebook computers and monitor currently being used by Griffin in his office and
(ii) the laser jet printer and other related computer equipment in Griffin's
home office.

              (b)  Within five days of the Employment Termination Date, Griffin
shall submit to the Company all outstanding business expenses for reconciliation
and payment. The Company shall reimburse Griffin for business expenses incurred
thereafter only if such expenses are submitted and approved before they are
incurred.

          5.  Stock Options.  Notwithstanding the terms of the Company's Amended
              -------------                                                     
and Restated 1993 Stock Option Plan, as amended, and the Stock Option Agreements
between the Company and Griffin, the stock options which were granted to Griffin
during his employment with the Company and  which  otherwise would be vested on
or prior to September 30, 1999 (109,050 options) (the "Options") shall not be
terminated by reason of the termination of his employee status, and instead
shall remain in place and continue to vest subject to the following (the other
85,849 stock options held by Griffin shall terminate as of the Employment
Termination Date):

              (a)  Termination of Options.  Any Options which have not vested 
                   ----------------------                                   
as of 

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the Option Termination Date (as defined in Section 5(c)) shall expire and become
unexercisable as of the Option Termination Date. All Options which have vested
on or prior to the Option Termination Date shall remain exercisable until ninety
(90) days from the Option Termination Date.

              (b)  Sale or Reorganization.  Upon the dissolution or liquidation 
                   ----------------------             
of the Company, or upon a reorganization, merger or consolidation of the Company
with one or more corporations as a result of which the Company goes out of
existence or becomes a subsidiary of another corporation (other than any
reorganization, merger or consolidation effected to change the Company's state
of incorporation), or upon a sale of substantially all of the Company's property
or a sale of more than eighty percent (80%) of the then outstanding stock of the
Company to another corporation (each a "Terminating Transaction"), Griffin shall
have the right, at such time immediately prior to the consummation of the
Terminating Transaction as the Board shall designate, to exercise his vested
Options to the full extent not previously exercised, and all unvested Options
shall accelerate and become exercisable immediately prior to the consummation of
a Terminating Transaction.

Upon consummation of any Terminating Transaction, all vested Options will
terminate.

              (c)  Termination Date.  The term "Termination Date" shall mean the
                   ----------------                                             
following:

                   (i)   September 30, 1999; or

                   (ii)  If Griffin materially breaches the terms of Article III
of the Employment Agreement, the date upon which Griffin receives notice from
the Company of such breach.

          6.  Release of Claims.
              ----------------- 

              (a)  (i)   In consideration for the Company's payment of the
severance benefits and the extension of the stock option exercise period, except
for the Company's obligations under Section 4.3 of the Employment Agreement, as
amended hereby, Griffin, for himself and his heirs, representatives, executors,
successors, and assigns does hereby forever release, absolve, acquit, and
discharge the Company and the Company's present and former officers, directors,
affiliates and affiliated entities, employees, agents, shareholders, and the
heirs, representatives, executors, successors, and assigns of the Company or of
any of the foregoing individuals or entities, of and from any and all known or
unknown claims, demands, causes of action (whether at law or equity), debts,
disputes, controversies, damages, losses, lawsuits, costs and expenses
(including attorneys' fees), or liabilities whatsoever (whether based upon
alleged tort, alleged contract, or any other legal theory of recovery) which
Griffin may now have or may have in the future against the Company or any of the
foregoing individuals or entities relating to, arising out of, or based upon any
act or omission concerning Griffin's employment or association 

                                       3
<PAGE>
 
with the Company and the termination of such employment and association,
including without limitation any of the foregoing claims (1) under the
California Fair Employment and Housing Act, Older Workers Benefit Protection
Act, the Fair Labor Standards Act of 1938, the Equal Pay Act, the Employee
Retirement Income Security Act, the California Labor Code, or any other
applicable anti-discrimination or other federal, state, or local employment or
labor law, rule, or regulation; (2) by reason of any breach of contractual
(whether express or implied) duties or obligations owed or alleged to be owed to
Griffin by the Company; or (3) by reason of any tortuous wrongful termination of
employment.

                   (ii)  Except for Griffin's continuing obligations under
Article III of the Employment Agreement, the Company, for itself and its
successors and assigns, does hereby forever release, absolve, acquit, and
discharge Griffin and his heirs, representatives, executors, successors,
assigns, agents, and attorneys of and from any and all known or unknown claims,
demands, causes of action (whether at law or equity), debts, disputes,
controversies, damages, losses, lawsuits, costs and expenses (including
attorneys' fees), or liabilities whatsoever (whether based upon alleged tort,
alleged contract, or any other legal theory of recovery) which the Company may
now have or may have in the future against Griffin or any of the foregoing
individuals or entities relating to, arising out of, or based upon any act or
omission concerning Griffin's employment and association, including without
limitation any of the foregoing claims by reason of (i) any breach occurring
prior to the date hereof of contractual (whether express or implied) duties or
obligations owed or alleged to be owed to the Company by Griffin; or (ii) any
breach occurring prior to the date hereof of fiduciary or employment duties owed
or alleged to be owed to the Company or any shareholder of the Company.

          (b) The parties acknowledge that they may hereafter discover facts
different from or in addition to those they now know or believe to be true with
respect to the claims, demands, causes of action, obligations, damages and
liabilities of any nature whatsoever that are the subject of the releases set
forth in Section 6(a), and they expressly agree to assume the risk of the
possible discovery of additional or different facts, and agree that this
Agreement is and shall remain effective in all respects regardless of such
additional or different facts.

          (c) The parties hereto acknowledge that this Agreement is a settlement
of possible past, present and future differences, disputes and claims and is not
an admission of liability by any of the parties hereto.

          (d) Each party represents, warrants, and agrees that such party has
not made any assignment, and will not make any assignment, of any claim, cause
of action, right of action or any right of any kind whatsoever which are the
subject of the releases set forth in Section 6(a), and that no other person or
entity of any kind (other than as expressly mentioned above) had or has any
interest in any of the demands, obligations, actions, causes of action, debts,
liabilities, rights, contracts, damages, attorneys' fees, costs, expenses,
losses or claims referred to herein.

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          (e) Each party represents and warrants that no complaints, charges, or
lawsuits have been filed by or on behalf of such party against the other party
or any of the individuals or entities associated or affiliated with such other
party as set forth in Section 6(a).

               (f) Section 1542 of the California Civil Code provides as
follows:

          A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE 
          CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR 
          AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY 
          HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH 
          THE DEBTOR.

Each party expressly waives the provisions of Section 1542 of the California
Civil Code and all claims heretofore arising, known or unknown, and voluntarily
and expressly releases each person released from liability by such party under
Section 6(a) from all liability on claims arising out of any such matters.

          7.   Transition; Assistance/Cooperation with Litigation.
               -----------------------------------------------------

          (a)  Griffin agrees to assist the Company in effectuating a smooth
               transition of his responsibilities and to provide such
               consultation and advisory services as reasonably requested by the
               Company through September 15, 1998. In consideration for such
               services, Griffin shall receive a consulting fee of $24,975.

          (b)  In connection with the Company's participation in pending or
               future litigation relating to events which occurred during
               Griffin's employment or about which Griffin has information,
               Griffin agrees to cooperate fully and devote all time which may
               be reasonably required in the preparation, prosecution or defense
               of the Company's case, including, but not limited to, the
               execution of truthful declarations or providing information
               and/or documents requested by the Company; provided, however,
                                                          --------
               that such assistance does not interfere with Griffin's other
               business commitments; and provided further, that Griffin shall be
                                         -------- -------
               reimbursed for all reasonable expenses incurred in providing such
               assistance, which must be discussed with the Company before they
               are incurred.

          8.  Legal Representation.  Griffin has been advised to consult with an
              --------------------                                              
attorney prior to executing this Agreement.  Griffin has had the opportunity to
receive the advice of independent legal counsel prior to the execution of this
Agreement, and Griffin understands the terms and provisions of this Agreement
and its nature and effect.

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          9.  Notices.  All notices, requests, or other communications
              -------                                                 
(collectively "Notices") which are given with respect to this Agreement shall be
in writing and shall be personally served or deposited in the United States
mail, registered or certified, return receipt requested, postage prepaid,
addressed as set forth below, or such other address as such party shall have
specified most recently by written notice.  Notice shall be deemed given on the
date of service if personally served.  Notice mailed as provided herein shall be
deemed given on the third business day following the date so mailed.

          To Company:    Inference Corporation
                         100 Rowland Way
                         Novato, California 94945
                         Attn: President

          To Griffin:    William D. Griffin
                         c/o Inference Corporation
                         100 Rowland Way
                         Novato, California 94945

          10.  Governing Law.  This Agreement shall be governed by, and
               -------------                                           
construed and enforced in accordance with, the internal laws of the State of
California applicable to agreements made and to be performed wholly within the
State of California.  The sole forum for resolving disputes arising under or
relating to this Agreement shall be the Municipal and Superior Courts for the
County of Marin, California, or the Federal District Court for the Northern
District of California and all related appellate courts, and the parties hereby
consent to the jurisdiction of such courts and agree that venue shall be in
Marin County, California.

          11.  Modifications, Amendments, Waivers, and Extensions.  This
               --------------------------------------------------       
Agreement may not be modified, changed or supplemented, nor may any obligations
hereunder be waived or extensions of time for performance granted, except by
written instrument signed by both parties to this Agreement or as otherwise
expressly permitted herein.  No waiver of any breach of any agreement or
provision of this Agreement shall be deemed a waiver of any preceding or
succeeding breach thereof or of any other agreement or provision contained in
this Agreement.  No extension of time for performance of any obligations or acts
shall be deemed an extension of the time for performance of any other
obligations or acts.

          12.  Attorneys' Fees. In the event any action in law or equity is
               ---------------                                             
brought for the enforcement of this Agreement or in connection with any of the
provisions of this Agreement, the prevailing party shall be entitled to receive
from the other party all costs and expenses, including reasonable attorneys'
fees, reasonably incurred in connection with such action.

          13.  Assignment.  This Agreement may not be assigned or delegated by
               ----------                                                     
either party without the prior written consent of the other party.  Any
attempted assignment of this Agreement made without the prior written consent of
the other party shall be void.  

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Notwithstanding the foregoing provisions of this Section, the Company may assign
this Agreement to any entity controlling, controlled by, or under common control
with the Company without the prior written consent of Griffin.

          14.  Partial Invalidity.  Any provision of this Agreement which is
               ------------------                                           
found to be invalid or unenforceable by any court in any jurisdiction shall, as
to that jurisdiction, be ineffective to the extent of such invalidity or
unenforceability, and the invalidity or unenforceability of such provision shall
not affect the validity or enforceability of the remaining provisions of this
Agreement.

          15.  Miscellaneous.  This Agreement:
               -------------                  

               (a) constitutes the entire agreement and supersedes all prior
written or oral, and all contemporaneous oral agreements, understandings, and
negotiations between the parties with respect to the subject matter of this
Agreement;

               (b) may be executed in counterparts, each of which shall be
deemed an original and all of which shall constitute one and the same
instrument; and

               (c) is not intended to confer upon any person other than the
parties to this Agreement any rights or remedies under this Agreement.

          IN WITNESS WHEREOF, the parties have executed this Agreement as of the
day and year first above written.

                              "COMPANY"

                              INFERENCE CORPORATION, a Delaware corporation


                              By:   /s/ Charles W. Jepson
                                    ------------------------------------------
                                    Charles W. Jepson, Chief Executive Officer



                              "GRIFFIN"


                              /s/ William D. Griffin
                              ------------------------------------------------
                              William D. Griffin


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