At a Glance
The Employment Rights Act 2025 (ERA 2025) fundamentally reshapes the law around unfair dismissal, potentially radically changing employers’ risks. From 1 January 2027, employees will need just six months’ continuous service to acquire protection from ordinary unfair dismissal, and the compensatory award element for ordinary unfair dismissal will become uncapped. This month, we’re focusing on how this change might impact on exits of senior employees or highly-paid employees with complex remuneration arrangements. Read Part 1 of our series here.
Introduction
From 1 January 2027, unfair dismissal is changing radically. The qualifying period of service required to bring an ordinary unfair dismissal claim will reduce from two years to six months (where the effective date of termination falls on or after 1 January 2027), and the current statutory cap on the compensatory award (the lower of 52 week’s pay or £123,543) will be removed.
This month, we’re focusing on what the removal of that cap on the compensatory award may mean for employers’ approach to dismissals of senior employees, especially where the individual is highly-paid or participates in complex remuneration or incentive arrangements.
Historically, the cap on compensation has meant that standalone ordinary unfair dismissal claims tend to be less common for this cohort, because they are limited in what they can recover as compensation. However, an ordinary unfair dismissal claim may become a much more valuable claim once the reforms take effect.
This may result in more claims, which raise complex issues of remedy involving complex incentive arrangements like share options, carried interest, and beyond. Senior exits may therefore become higher risk and more difficult to negotiate. It will likely take a number of years for the consuetudes of this change to be seen. The removal of the cap does not mean that claims from high earning senior executives will be attractive or straightforward to pursue or that high-value awards are inevitable. Employees will still need to succeed in establishing liability in the first place and will remain under a duty to mitigate their loss.
Why does the removal of the cap matter?
The test used by the employment tribunal to calculate the compensatory award is:
“such amount as the tribunal considers just and equitable in all the circumstances having regard to the loss sustained by the complainant in consequence of the dismissal in so far as that loss is attributable to action taken by the employer.”
This gives the tribunal a fairly broad discretion in making remedy decisions in unfair dismissal cases. The removal of the cap may therefore require employers to assess a wider range of potential losses flowing from the dismissal when evaluating their risk, including:
- annual or discretionary bonuses that may be earned;
- commission payments that may be earned;
- payment of deferred bonuses;
- equity, long term incentive plans or carried-interest style arrangements tied to continued employment, vesting milestones or exit events;
- pension losses (particularly with defined benefit pensions – though they are very rare in the private sector);
- losses of valuable benefits such as private healthcare, income protection, or death in service benefits;
- future loss over a longer period where the employee says comparable re-employment will be difficult to secure.
Of course, with the cap removed, even claims for lost salary may be much higher when the claimant was highly paid.
The main impact for employers is twofold:
- Unfair dismissal claims may become more complex and expensive to litigate. With complex remedy issues possibly becoming more common in unfair dismissal claims, this may have a knock-on effect on the length of hearings and tribunal backlogs, as more judicial time and potentially expert evidence may be needed
- Agreed exits may become more difficult to negotiate if employee expectations become inflated
Historically, tribunals have not had to focus too closely on the meaning of the statutory test for the compensatory award, because high-value claims are not generally litigated as unfair dismissal claims. Tribunals will be experienced in considering complex remedy issues in existing claims where compensation is not capped (such as discrimination claims) but will see an increase in the number of those issues being raised in unfair dismissal claims and may take a different approach to assessing loss. Tribunal delays mean that it may take several years for the tribunal to develop its approach, creating uncertainty for employees and employers in the meantime.
How can employers prepare?
There are a number of options employers can consider exploring to help manage potential exposure. The reality is that there is no magic fix to avoid these new risks, but reviewing strategies for senior exits, relevant documentation and reward arrangements before the reforms take effect may put employers in a stronger position come January next year.
- Review bonus, commission, and incentive arrangements. Consider whether any changes can be made which will assist in defending claims for lost variable compensation. Employers may want to consider, as far as possible, avoiding d any commitment to making future awards and setting out clearly in incentive plans the consequences of termination of employment (such as the forfeiture of unvested awards).
- Review how policies and procedures work in practice when making senior exits. Currently senior exits are often made following a reduced dismissal process. From 1 January, it may become necessary to follow fuller disciplinary or performance management processes.
- Consider whether contractual severance policies, or golden parachutes may help to manage expectations and make a negotiated exit easier. However, be aware of the risk that this may instead create a floor to negotiations.
- Ensure that concerns about an employee are well-documented. Having a strong evidential record to document concerns with, for example performance or conduct, can be helpful to support an argument based on Polkey to reduce the compensation awarded, where the dismissal process is flawed in some way, but dismissal was inevitable. See our article here for more on the importance of Polkey arguments.
- Review potential senior exit issues before the reforms take effect. Employers may want to explore their options where there are existing performance or conduct concerns, including timing of a dismissal. However, this should be approached carefully and employers should be mindful of the need to manage the risks of other claims (such as for discrimination), their collective consultation obligations, and the exact timing of any dismissal. The rules around qualifying service for unfair dismissal are complex, so employers should always take specific advice before taking action.
- Train managers on the changes. Ensure managers understand what the changes mean in practice, including the importance of addressing issues early and documenting concerns.
Ultimately, claims relating to lost share incentives face considerable uncertainty for claimants, which is inherent when dealing with complex remedy issues involving potential future losses. For example, there may be a risk that performance conditions might not have been met in the future, and there is the unpredictability of changes in share values. However, the removal of the unfair dismissal cap may mean that complex arguments about future losses relating to complex remuneration arrangements become much more common.
Please contact your usual Littler contact if you would like any support with preparing for the changes. See here further information on Littler’s manager training offering or contact our Client Training Partner Natasha Adom.
