Huge Changes to Unfair Dismissal Law on the Horizon

Unfair dismissal is a cornerstone of employment law and rightly so. It is the simple concept that an employer should not be able to end employment arbitrarily – they must be fair about it.

A brief history of unfair dismissal law

Most individuals and businesses see the sense in the law on unfair dismissal and indeed it has been a feature of workplace law for over 50 years. It has always had two important conditions. First, the employee must have a minimum level of service to benefit from the protection. Second, the amount of compensation which can be claimed has been subject to a limit.

Over the decades, the minimum qualifying period of employment has been varied by government.  Labour governments tend to reduce it, and Conservative governments tends to increase it. For a brief time in the mid-1970s it was six months. Since 2012 it has been set at two years.

In other words, in the first two years of employment, the employer can end the working relationship without first following a fair process or ensuring that they have a fair reason for their decision.

An aggrieved individual might be able to bring a different type of claim – such as discrimination or whistleblowing – where a qualifying period is not required, but an ordinary unfair dismissal claim is not an option until at least two years of service have been accrued.

Accordingly, unless another viable claim exists, an employee can be treated unfairly by their employer in the first two years and there is nothing that can be done about it. For employers it means a great deal of flexibility to use that time to assess whether or not someone is right for the business and let them go if they are not.

If an unfair dismissal claim succeeds, the amount of compensation which can be recovered is currently capped at either a year’s pay or £118,223, whichever is lower. This amount has increased each year in line with inflation.

What is changing?

The current Labour government made an election commitment to make unfair dismissal a “day one” right, i.e. by taking the unprecedented step of removing the qualifying period altogether. They are not going to make good on that promise and instead the period will be reduced to six months.

However, the government is removing completely the cap on the compensation which can be awarded. This is very significant for high earners or those who employ them, as discussed below.

When is the unfair dismissal law changing?

We are told that the government intends to commence the package of changes on 1 January 2027.

This means that those who start employment on or after 1 July 2026 (or potentially a few days later due to a quirk in the rules) will be protected from unfair dismissal if their employment ends on or after 1 January 2027.

What does it mean for employers?

There are two main takeaways.

The first is that managers will be best advised to take more care over the recruitment process and to decide whether or not someone is right for their team within the first six months of employment. Of course, ending the relationship after six months is possible but it could be a lot more time-consuming and costly.

Take the example of a new recruit who is under-performing. The business will be able to terminate their employment in the first six months with no fear of an unfair dismissal claim.

After they have acquired unfair dismissal protection, dismissing on performance grounds is not usually a quick or straightforward process. An employer is expected to set action plans, offer training and support, and issue successive warnings before dismissal is likely to be considered fair by an Employment Tribunal. Each case is different, but it can take many months.

If the employer can point to either redundancy or misconduct, it can be easier or quicker to dismiss, but those circumstances must be present.

It’s also possible that businesses will see an erstwhile eager-to-impress colleague taking a more relaxed approach to their work after the first six months, whereas they would be well-advised against that approach for the first two years at the moment.

The second point is that, without any cap on compensation, the potential liability for claims could be very substantial.

Let’s continue with the example above of an underperforming employee. The employee is paid a basic annual salary of £250,000, can earn a bonus of up to £100,000 a year, and would have been entitled to equity in his employer’s business after a year, which could be worth several million pounds.

Under the current rules, even if the individual has unfair dismissal protection, it is an option for an employer to dismiss them without following a fair process or identifying a fair reason for it. That would give the employee a strong unfair dismissal claim but the primary compensation available to the employee would be capped at £118,223. That limit would anchor the value of the claim and any settlement discussions. In addition, the employer would save the cost, time and stress associated with a performance management process which could run for several months.

Indeed, the government has acknowledged that this is an approach some employers take. In a factsheet released last month, it said:

“It is important that when there is a finding of unfair dismissal at tribunal, the claimant is fairly compensated for any loss they have suffered. By lifting the cap, this will deter employers from treating the cost of dismissing employees unfairly as part of business as usual.”

Under the new rules, an employer will have to be very careful about deploying such a tactic. The well-remunerated employee in our example could have a claim for several hundreds of thousands of pounds.

When claiming unfair dismissal compensation, a claimant is under an obligation to take all reasonable steps to mitigate their losses by trying to find another job. If another role is found soon after dismissal the value of the claim could be modest, but a high earner could accrue significant losses very quickly.

By contrast, in the case of someone who has an annual salary of less than the current cap, there should be little difference in practical terms. That’s because in many – but not all – cases, an individual will be able to find another job within a year, meaning that their losses are no more than a year’s pay in any event. That said, compensation for much longer will be available to them if they can establish to an Employment Tribunal’s satisfaction that it should be awarded.

Finally, it is suggested – by the government and others – that the new rules will reduce the number of complex claims brought in relation to discrimination or whistleblowing, as such claims are often alleged because they allow for uncapped compensation or do not have qualifying periods. With no cap on unfair dismissal compensation, there should be less need to bring other claims and we are told that this will make dealing with claims quicker and simpler as a consequence. Whether or not this will prove to be the case remains to be seen, as most should still want to give themselves the best chance of success by advancing all viable claims.

What does it mean for employees?

It should mean greater job security, which is one of the government’s aims.

Many employers will carry out more rigorous interview processes and review a new team member’s suitability for employment in the first six months much more closely than before. However, many will either choose not to take stock at that early stage, or they may simply miss the short timeframe, in our view.

As things stand, it’s good advice to tread carefully during the first two years of a job, given the limited legal protections, but arguably that will be the case for only six months when the law changes.

It’s also good news for those who are being bullied or treated poorly in some other way by their employer or a manager or colleague. In such cases, it’s an option for the individual to treat themselves as constructively unfairly dismissed, but only if they have the requisite service.

Those who earn more than, say, £125,000 to £150,000 or enjoy generous bonuses or equity arrangements will benefit the most from the right to uncapped compensation. Under the present regime, it can be said that unfair dismissal protections are almost irrelevant for the very well-paid but that will be the case no more. Recovering six or even seven figures in compensation could be possible and it will make an individual’s negotiating position much stronger in any severance or exit negotiations.

Need advice on what this means for you? Reach out to Anthony Purvis.