For many employers, the financial risk associated with an unfair dismissal claim has, until now, been relatively predictable. There is always a cost associated with Employment Tribunal proceedings, but the value of compensation awarded has been subject to a statutory limit: in the 2025/26 tax year, that compensatory award cap stands at £123,543 (or 52 weeks’ gross pay, whichever is lower).
However, that position is about to change, and in a dramatic way, giving rise to potentially significant financial exposure for employers.
What is changing?
Currently, employees need two years’ continuous service before they can bring an ordinary unfair dismissal claim (Section 108 Employment Rights Act 1996). From 1st January 2027, under Section 25 of the Employment Rights Act 2025:
- The qualifying period for ordinary unfair dismissal claims will reduce from two years to six months.
- The current statutory cap of £123,543 (or 52 weeks’ gross pay, whichever is lower) on compensatory awards will be removed completely.
- Employment Tribunals will continue to assess compensation based on actual financial losses and future projected losses caused by the dismissal.
- Employment Tribunals will still take account of factors such as mitigation of loss, contributory conduct and whether dismissal would have occurred in any event.
What are the implications?
In a word, significant. It is believed that somewhere around 840,000 people earn more than the current compensation cap. Once the cap disappears, employers could face claims worth several years’ lost earnings for senior employees, particularly where it can be proved that the odds of the employee finding another suitable role with equivalent pay are low.
The government’s Employment Rights Act 2025 Economic Analysis January 2026 looked at what might happen as a result of the change.
“The cost of removing the compensation cap for unfair dismissal is likely to be limited at the aggregate. In practice, few awards reach the cap. In 2023/24, there were 646 awards for unfair dismissal in employment tribunals reported, and the median award was £6,746. Fewer than 40 awards (around 6%) in 2023/24 for unfair dismissal were greater than £50,000.” [Page 92]
However, the real effect will be felt by employers in higher-paid sectors. Previously, senior executives, professionals, technology specialists, financial services employees and other highly remunerated individuals have often pursued discrimination, whistleblowing or breach of contract claims because ordinary unfair dismissal compensation was restricted by the cap. Once the cap disappears, unfair dismissal claims become significantly more valuable in their own right and high earners may pivot towards them instead, given the enforceability of uncapped compensatory awards.
The effects: more claims, bigger claims, fewer settlements
The removal of the compensation cap is only one aspect of a bigger problem for employers. The qualifying period is being reduced to six months at the same time, significantly increasing the number of employees who have access to protection from unfair dismissal.
This creates a double challenge for employers:
- More employees will be eligible to bring claims.
- Those claims may be worth substantially more.
Additionally, employers may find that claimants are less willing to settle early if they feel that they have the prospect of getting substantially higher sums at the Employment Tribunal.
Action points for employers
January 2027 seems some way off, and employers may think they have plenty of time yet. This assumption would be a mistake. The time to start preparing is now.
1. Strengthen probationary processes
As the qualifying period for unfair dismissal rights will reduce to six months from January 2027, this means probation periods become far more important. If a new hire is not meeting expectations, then performance assessments, review meetings and decisions will need to be comprehensively documented and processes accelerated so that issues can be identified and dealt with in an appropriate manner. Failure to deal with this inside the six-month window has the ability to cause significant problems for employers.
2. Improve management training
It is important to ensure that all managers are fully up to speed on important matters of process and procedure, as many unfair dismissal claims happen because the process conducted was incomplete or flawed. Ensuring consistency in the application of the procedure and following a fair process will be even more important when the compensation exposure is unlimited.
Training should be sourced on:
- disciplinary procedures
- capability management
- performance improvement plans
- investigation techniques
- comprehensive and clear record keeping
- consultation requirements.
3. Review policies and procedures
With such a significant change in the law, it is time to look again at policies and procedures. A comprehensive review needs to be carried out including:
- disciplinary policies
- grievance procedures
- performance management frameworks
- probationary policies
- dismissal procedures
Do not leave things to chance – involve employment law experts from the outset.
4. Enhance documentation standards
Employment Tribunals place significant weight on contemporaneous evidence when determining claims. Therefore, it should be impressed upon managers that keeping clear, complete and comprehensive records is of paramount importance. Those records will include:
- Any concerns over performance, with details of reviews and assessments.
- Details of the training and support that was provided in light of the performance assessments.
- Investigations into conduct issues – who was involved, what was discussed and when, and the outcome.
- Consultation meetings – again, with details of the people at the meeting and what was covered.
- Details of the decision-making processes involved0 including timeline, personnel and outcomes.
It is crucial that this documentation is accurate and contemporaneous – that is, written at the time that the events happened. Poorly kept documentation, or documents that are drafted or written after the event when both memories and recall of detail fade have the potential to derail even an otherwise sound and justified dismissal.
5. Reassess settlement strategies
Whilst employers may have measures in place to evaluate litigation risk, given the significant legislative changes, they may need to consider assessing and re-evaluating how they assess risk in light of the upcoming changes. The likelihood that after January 2027, a claim involving a highly paid employee may be significantly higher than under current rules may affect decisions made around:
- settlement negotiations and the factors that will now come into play
- mediation services – it will be more important now that the employer has the measures in place to try and resolve matters before they reach the point of a tribunal claim
- incorporating informal resolution avenues, such as internal mediation
- insurance arrangements – whatever an employer’s current insurance cover, it will need to be reviewed, given the prospect of bigger claims in future
- litigation reserves held by the employer to cover such contingencies.
6. Consider the effect on senior hiring
Both boards of directors and HR leaders now need to look at how the reforms will affect both the recruitment and exit management of senior employees.
Employment contracts, exit arrangements and governance processes should be reviewed accordingly, making use of any legal advice that the business can access.
