Earlier this year, the Government confirmed that as part of the upcoming changes under the Employment Rights Act 2025, the cap which currently applies to unfair dismissal compensation will be removed entirely. This change, coupled with the fact that employees will gain unfair dismissal rights after just six months of employment (down from two years), greatly increases the litigation risk for employers terminating employees’ employment. According to the government’s latest factsheet on the reform, no further consultation on this point is intended. With this in mind, it is worth considering now how to prepare for this seismic shift.
Current unfair dismissal compensation
As things currently stand, compensation for successful ordinary unfair dismissal claims is capped at a statutory maximum of £118,223 (which increases annually), or a year’s gross pay, whichever is lower. Therefore, the financial risk associated with removing an employee on perhaps slightly spurious grounds, or with minimal (or no) process, is limited no matter how high an earner the individual is (provided there are no other issues such as discrimination or whistleblowing at play, of course).
What is changing
The Employment Rights Act 2025 will remove the existing cap on unfair dismissal compensation entirely from 1 January 2027. This will mean that Employment Tribunals can award compensation reflective of the individual’s full loss of earnings, regardless of how high their remuneration package (including bonus and long term incentives) might be.
Some elements of compensation assessment will remain the same. These include: contributory fault, where an employee’s own conduct, actions, or omissions partially caused or contributed to their dismissal; the duty on the employee to seek to mitigate their losses; and the application of Polkey deductions where the tribunal considers the employee would still have been dismissed regardless of a fair process having been followed.
Despite the aforementioned factors, we consider that the removal of the unfair dismissal compensation cap is very significant, particularly for senior exits and in sectors with a lot of high earners. Not only will these individuals see an unfair dismissal claim as a far more valuable route, but they will also have much higher expectations (and increased leverage) when it comes to negotiating an exit given the potential of securing uncapped loss of earnings if they were to pursue a claim in the Tribunal.
On the other hand, this change may result in fewer spurious claims of, inter alia, discrimination or whistleblowing detriment given that these types of claims are no longer the only route to securing uncapped losses.
What can you do to prepare?
- Implement effective processes for managing probation periods: Since employees will have protection against unfair dismissal after just six months from their start date, the initial months of employment, which is usually a probation period, should be carefully managed. Processes should include early objective setting, and careful monitoring of feedback and of whether objectives are met. Concerns should be documented, and where appropriate, action should be taken promptly.
- Ensure your employment contracts have PILON – payment in lieu of notice – clauses to allow for flexibility in dismissals and avoid late service of notice inadvertently tipping an employee over the six-month threshold so that they obtain unfair dismissal rights.
- Beware of technicalities – In calculating whether an employee has the requisite level of service to bring an unfair dismissal claim, notice rules add on the statutory minimum notice where a dismissal takes effect immediately (e.g. because an employer has paid in lieu of notice). Do not therefore leave matters to the last minute in making decisions about whether an employee has not passed their probation period i.e. just before their six-month anniversary.
- Carefully review and where necessary, improve, your capability, conduct and redundancy procedures and train staff accordingly in view of the increased costs risks. Adherence to fair processes will become especially important when managing high earners.
- Consider settlement strategies to manage the increased risk of costly unfair dismissal claims. Ex-gratia payments are likely to need to be higher than before to incentivise departing employees to waive their potential claims given the changed compensation landscape.