Unfair dismissal shake-up: preparing for unlimited compensation claims

Getting your Trinity Audio player ready...

In a move with huge implications for UK businesses, the Government is looking to remove the cap on compensation for unfair dismissal at the same time as reducing the qualifying service period to six months. This could become law within weeks and subsequently come into force effectively within months. Businesses must act right now if they want to try to influence the political process to prevent the change. If, as expected, it becomes law, then businesses may only have a few months to get ready.  Incentive schemes and performance management processes will all need careful review and may no longer be fit for purpose.

At the moment, the cap for senior executives is £118,233. Consequently, the majority of employers and senior executives give little consideration to unfair dismissal rights when managing terminations. The money is found elsewhere, sometimes in the contract of employment and sometimes in a so-called ‘ex gratia’ payment to ease the passage. The sums of money are large, but affordable.

Remove the cap and suddenly exiting employees can start claiming compensation for: carried interest they would otherwise forego; shares that would otherwise vest, perhaps years in the future; discretionary bonuses they say they would have earned. It does not matter whether those incentives are held outside the UK, in a Delaware LLP for example, or if they are governed by English law. Employment tribunals will still be able to take prospective, foreseeable losses into account. In the ‘right’ circumstances, claims could be worth many millions of pounds.

This is a real shock for employers and practitioners alike. The situation has arisen as a result of legislative challenges, with the Government’s flagship Employment Rights Bill yet to pass through the House of Lords. The main stumbling block has been so-called ‘day-one rights’ – the removal of the qualifying service period altogether. Although this was a manifesto commitment, the Lords have blocked it repeatedly.

To break the impasse, it is believed the Government struck a deal with employers’ organisations. In any event, the Government are dropping ‘day-one rights’ in favour of a six-month qualifying period. They are also proposing to lift the cap on unfair dismissal compensation altogether.

Although Labour previously considered this proposal while in opposition, it was ultimately not included in their manifesto, similar to the approach taken by the Blair government. In reality, most unfair dismissal cases result in compensation awards that fall well below the statutory cap. Consequently, the removal of the cap is likely to benefit primarily high earners rather than the broader workforce.

So, to say it was a shock when it came out on Friday would be an understatement. Lifting the cap was trailed the previous week but most practitioners thought that was likely to refer to the secondary definition, which is 52 weeks’ pay if lower than £118,233. It made sense to remove that to benefit lower earners in the rare circumstances where they might otherwise be able to claim for higher amounts than a year’s money.

The market is still working through the implications. For example, tribunals can award a 25% uplift for failure to follow an ACAS procedure on termination. A £4 million claim could become a £5 million because someone forgets to pencil in a meeting.

It is uncertain whether tribunals will adjust their expectations to take account of the mega-awards they might now have to make.  However:

• It is crucial to review incentive schemes to identify vulnerabilities; and,
• Employers will want to tighten up performance management processes in particular.  These are always very hard to get right at a senior level, because the legislation was never designed for them.  It is nearly 60 years old and largely reflects practice in the manufacturing sector of the 1960’s not the service economy of this decade.

Most importantly, now is the time for business to be telling Government what this might mean for them. There are still five clauses in dispute between the House of Commons and the House of Lords, but the pressure is mounting for the Bill to be passed soon.

To get more detail on this, and other legislative changes set out in the Employment Rights Bill, take a look at our Employment Essentials tracker, where we’re staying on top of the latest developments and how they will affect your business.

If you would like to discuss the content of this blog further or need guidance on the latest updates from the Employment Rights Bill, please get in touch with Jonathan Chamberlain, Hannah Swindle or your usual contact at Gowling WLG.