Unfair dismissal: removal of the compensation cap under the Employment Rights Act 2025

The Employment Rights Act 2025 contains the most significant reforms to UK employment law in a generation. Among the most impactful changes is the removal of the statutory cap on compensation for ordinary unfair dismissal, alongside a reduction in the qualifying period to bring a claim. Both of these changes come into effect on 1 January 2027.

Together, these changes fundamentally alter the risk profile associated with dismissals, particularly for employers with senior, highly remunerated employees. In our previous article we considered the implications of the reduction in the qualifying period to six months. This article focuses on the removal of the statutory cap, looking at the previous legal position, what is changing, and the key issues and practical steps employers should be considering now.

The position until now: a capped and relatively predictable regime

Under the existing unfair dismissal framework, a successful claimant is entitled to:

• a basic award (calculated in the same way as a statutory redundancy payment); and
• a compensatory award, intended to reflect the employee’s actual financial losses arising from the dismissal.

As things stand, the compensatory award is subject to a statutory limit, set at the lower of 52 weeks’ gross pay or a statutory cap of £123,543 (increased annually). While Employment Tribunals have always had broad discretion in assessing what losses are recoverable, and it is established law that the value of some bonuses, benefits and deferred remuneration can be factored in when assessing loss, the cap has operated as a key constraint on employer exposure and a central reference point when assessing litigation risk or settlement value.

In practice, this meant employers could generally quantify their maximum financial exposure for ordinary unfair dismissal claims at an early stage. For senior or higher paid employees, unfair dismissal was often a comparatively weak remedy when set against contractual claims or uncapped statutory claims such as discrimination or whistleblowing, and, in many cases, was not worth pursuing as a standalone claim.

What is changing under the Employment Rights Act 2025?

From 1 January 2027, the statutory cap on compensation for ordinary unfair dismissal will be removed entirely. Tribunals will be able to award compensation reflecting the employee’s full financial loss, subject to established principles such as mitigation, contributory conduct, and so-called Polkey reductions (where a tribunal finds that a dismissal was unfair for procedural reasons, but it is likely that the employee would have been dismissed in any event, even if a fair procedure had been followed).

Key issues and emerging risk factors for employers

1. Increased exposure in senior and high value exits

The most immediate impact will be felt in relation to senior employees and those with complex remuneration structures. While compensatory awards can already extend beyond base salary, the removal of the cap will mean that the value of other types of remuneration is likely to be more closely examined and will become more significant. This will include:

• bonuses (including discretionary bonuses);
• deferred remuneration;
• long-term incentive plans;
• equity or carried interest arrangements; and
• loss of benefits.

Unfair dismissal claims that were previously unattractive or commercially marginal will now carry greater weight for senior employees. At the same time, the potential scale of liability is likely to influence settlement discussions, with employees expected to push for significantly higher settlement sums.

2. Greater scrutiny of remuneration and incentive design

Tribunals will be required to assess what remuneration an employee would have received had they remained employed. This may well result in closer examination of:

• how discretionary bonuses are awarded in practice;
• how incentives interact with disciplinary or performance processes; and
• whether decision making around incentives is consistent, transparent and evidence-based.

Poorly drafted or inconsistently applied incentive policies will create material litigation risk. In many cases, tribunals will not be used to considering such complex remuneration structures. Remedy hearings will become increasingly important, and parties are likely to need to produce expert evidence to support their position.

3. Increased emphasis on process and evidence

With uncapped compensation, procedural fairness becomes even more critical. Weaknesses in performance management, disciplinary processes or dismissal rationale are more likely to translate directly into higher compensation awards.

Employers should expect more detailed evidence on future loss, career trajectory, and labour market conditions to feature in unfair dismissal litigation and, again, expert evidence may be required.

4. Changed settlement dynamics

The removal of the cap is likely to have a direct effect on settlement strategy and expectations. Employers may face increased pressure in negotiations, particularly where re-employment prospects are uncertain or incentivisation arrangements form a significant part of the total reward. Employers will no longer be confident that they can dismiss senior executives without process, and buy out an unfair dismissal claim by entering into a settlement agreement.

What should employers be doing now?

Although the reforms do not take effect until 2027, employers should be planning proactively. Recommended steps include:

1. Review dismissal risk at an organisational level

The removal of the compensatory cap significantly alters the scale and predictability of potential liability. Decisions to dismiss, restructure or manage underperformance at senior level may expose the organisation to material financial risk, particularly where remuneration includes bonuses, deferred incentives or long‑term awards. As a result, unfair dismissal should be factored into employers’ risk assessments, alongside other regulatory, financial and reputational risks.

With unfair dismissal protection applying after six months, performance and conduct issues must be identified, documented and addressed promptly. Employers will no longer have the same margin for delay without inadvertently increasing exposure.

In practice, this means ensuring that concerns are raised promptly, expectations are clearly articulated, and any formal performance management or disciplinary processes are commenced and progressed without undue delay.

2. Audit bonus and incentive policies

Employers should review whether incentive documentation clearly addresses:

• the impact of disciplinary and performance processes – incentive documentation should clearly explain how bonuses and long‑term incentives are affected where an employee is subject to disciplinary action or formal performance management, including whether awards may be reduced, deferred or withheld, and on what basis;
• the interaction between incentives and termination – employers should ensure that policies are explicit as to how incentive awards are treated on termination of employment, including distinctions between different reasons for dismissal (for example, misconduct, capability or redundancy) and whether awards lapse automatically or remain subject to discretion;
• the extent of discretion and how it is exercised in practice – where incentive arrangements confer discretion, this should be clearly defined and exercised consistently, with documented decision‑making that reflects how discretion is applied in reality, rather than relying solely on broad or theoretical policy wording.

Alignment between policy wording and real‑world application will be critical, particularly in an uncapped compensation regime where tribunals will scrutinise whether incentives would, in practice, have been paid but for the dismissal.

3. Invest in manager capability

Line managers and senior leaders will play a central role in creating the evidence on which unfair dismissal decisions are ultimately judged. In an uncapped compensation regime, the quality of managerial decision‑making and documentation will be critical to defending both the fairness of a process and the scope of any alleged loss.

Training should therefore focus not only on legal principles, but on practical application, including procedural fairness, consistency of treatment, and contemporaneous record‑keeping. Managers must understand how day‑to‑day actions, written communications, and informal discussions are likely to be scrutinised in tribunal proceedings months or years later.

4. Revisit settlement and insurance strategies

Employers may wish to reassess settlement approaches, budgeting assumptions, and (where applicable) employment practices liability insurance in light of uncapped exposure. The cumulative effect of the upcoming changes to the unfair dismissal regime is likely to be a larger number of tribunal claims, and increased costs – both legal costs in defending complex claims, and the value of compensatory awards in successful ones.

The senior executive perspective

For senior executives, the removal of the cap changes the risk-reward assessment when an exit is disputed. Unfair dismissal will become a more economically meaningful remedy, particularly where termination affects bonuses, deferred remuneration or long term incentive arrangements.

While this does not mean that litigation will necessarily be pursued, the availability of uncapped compensation is likely to influence how executives approach exit discussions. Where the potential value of a claim materially exceeds what would previously have been recoverable, executives may be less inclined to accept early or heavily discounted settlements, and more willing to explore formal legal options where they perceive weaknesses in the process.

In practical terms, this could well alter the dynamics of senior exits. The manner in which performance concerns are documented, discretion over incentives is exercised, and dismissal decisions are justified will play a progressively important role in shaping whether disputes are resolved pragmatically or become contested.

Conclusion

The removal of the cap on unfair dismissal compensation marks a decisive shift away from a predictable, quantifiable risk model towards open-ended financial exposure. For many employers, particularly those with senior or highly remunerated employees, or those with complex remuneration structures, unfair dismissal claims will increasingly be a strategic and board level issue, and for senior executives, those claims will have a renewed appeal.