Unfair dismissal shake-up: preparing for unlimited compensation claims?

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UPDATED 11 & 12 DECEMBER 2025

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.

UPDATE: 11 DECEMBER 2025

Don’t leave your seat, anyone: there’s another twist.

Last night the House of Lords rejected the Government’s attempt to remove the cap altogether and inserted an amendment requiring the Government to first consult on the proposal within 3 months of the Bill becoming law. What happens next?

• The Government digs its heels in and sends the Bill back to the Lords again? I think – and so do a lot of others in the market – that this is unlikely. It’ll delay other changes the Government wants to make, perhaps up to a year;
• The Government accepts the amendment, the Bill becomes law by Christmas and we spend January to February consulting. This seems by far the more likely.

What’s the likely outcome of the consultation? The cap gets lifted anyway? I don’t think so. Very few stakeholders are in favour and those who are seem lukewarm at best. Lord Hendy, a real expert in the field and the kind of peer who gives the House of Lords a good name, spoke powerfully against the change in the debate last night. He has been described as “one of the leading figures in the struggle for trade union rights” and has been arguing publicly for months the Bill doesn’t go far enough in other areas. If the Government have lost him, query who their supporters are on this.

My guess is as good as anyone else’s, but FWIW I predict that the 52 week remuneration cap will stay but the £118,233 will go. There will be a change – too much political capital has been invested for any other outcome – but it will be much watered down. Good news for higher earners, bad for employers but not catastrophic – which in my view the outright removal of the cap would have been.

That said, bad news is still bad. There will be much uncertainty, at least until the Spring and possibly later, about what these changes will mean. Whilst we don’t know what this may mean for incentive schemes, it seems highly likely that employers will need to change their approach to the termination of highly-paid executives. Failing to follow statutory process is highly likely to be a lot more expensive.

Anyway, we’ll keep you posted.

UPDATE 12 DECEMBER 2025

You really can’t take you eyes away for a moment. The Government has said it does not accept the Lords’ amendment. It lost the vote by 24. It has appointed 25 new Labour peers (!).

It’s not clear when this is going back to the Lords but there is no sign the Government is backing down. Meanwhile, as my prediction didn’t last 24 hours, I have taken my crystal ball and hurled it into the nearest pond. To be fair both to the sphere and me, I didn’t expect the Government to ditch a manifesto commitment (Day 1 Rights) but fight to the death over something they’d already ditched in Opposition (lifting the cap) and which almost no-one else thinks is a good idea.

Meanwhile, we are already working on mitigation strategies for clients with highly-paid executives, particularly those who participate in global equity-incentive plans.

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.