UK employers are quietly clearing the decks. With the Employment Rights Act set to shake up dismissal rules from January 2027, businesses are expected to front-load redundancies before the year is out — and the clock is ticking.
The trigger? Labour’s decision to scrap the compensation cap on unfair dismissal claims. That one move has turned a manageable legal risk into a potentially eye-watering liability, especially when high earners are involved. Here’s what’s changing, why it matters, and what it could mean for workers at every pay grade.
What’s Actually Changing Under the Employment Rights Act?
The Employment Rights Act cleared Parliament in December after a messy back-and-forth between the Commons and the Lords. The headline change? The removal of the unfair dismissal qualification period — and, crucially, the compensation cap.
Right now, payouts for unfair dismissal are capped at £118,223 or one year’s salary, whichever is lower. Under the new rules, that ceiling disappears entirely.
Why That’s a Big Deal for Employers
When there’s no cap, the numbers can spiral fast. Stefan Martin, partner at Hogan Lovells, put it plainly: “Where that cap is taken off, that could become quite a significant issue where you’re talking about really high earners.”
Think about it — a senior executive on £80,000 a year who struggles to find equivalent work could claim two years’ lost earnings or more. That’s not a redundancy cost anymore; that’s a legal catastrophe.
Labour’s ‘Day One’ Rights U-Turn — and the Trade-Off
This all traces back to a political compromise. Labour originally promised workers ‘day one’ unfair dismissal rights, a flagship manifesto pledge. Under pressure, the government agreed to push that protection back to six months.
To sweeten the deal for unions after backing down, Labour ditched the compensation cap instead.
It’s a classic political trade: delay one protection, turbocharge another. The result is a legal landscape that’s significantly riskier for businesses employing high earners.
The Redundancy Rush: What Businesses Are Planning
Legal advisers are already seeing employers move. Firms are drawing up plans to carry out headcount changes before January 2027 — effectively a pre-emptive “clean up” before the new rules bite.
The logic is straightforward: make difficult staffing decisions now, under the current capped regime, rather than risk unlimited claims later.
What This Means for Lower Earners
It’s not just the C-suite at risk. Ironically, the cap removal could hit lower-paid workers harder in a different way.
Without a cap, tribunals can theoretically award compensation based on how long someone is unemployed. For someone earning £30,000 who struggles to find work for two years, that claim could double their annual salary, a scenario that may make employers more cautious about who they hire in the first place.
The Broader Jobs Picture Isn’t Helping
This legal shake-up lands against an already softening labour market. The latest ONS figures show the UK unemployment rate climbed to 5.2% between October and December — the highest since early 2021, and slightly above what analysts expected.
A rising jobless rate means dismissed employees are more likely to be out of work longer, which directly inflates potential compensation claims. For employers, that’s another reason to act sooner rather than later.
Key Takeaways
The Employment Rights Act removes the unfair dismissal compensation cap from January 2027. Businesses are expected to bring forward redundancies to avoid exposure under the new rules. High earners face the biggest immediate risk, but the knock-on effects could ripple across all pay grades, especially as unemployment continues to tick upwards.
If your business has workforce decisions on the horizon, the time to take legal advice is now, not next year.
FAQ
Q1: What is the Employment Rights Act?
A: The Employment Rights Act is UK legislation passed in December that overhauled worker protections. Key changes include removing the unfair dismissal qualification period and scrapping the compensation cap, effective from January 2027.
Q2: Why are businesses rushing redundancies now?
A: By making staffing changes before January 2027, businesses can operate under the current capped regime — where unfair dismissal payouts are limited to £118,223 or one year’s salary. After that date, there’s no ceiling on what a tribunal could award.
Q3: Who is most at risk from the compensation cap removal?
A: High earners face the largest immediate exposure, since potential claims scale with salary. But lower-paid workers may also feel the effect indirectly, as employers become more cautious about hiring and retention decisions.
Q4: What was Labour’s ‘day one’ rights U-turn?
A: Labour originally pledged workers full unfair dismissal protection from day one of employment. After pushback, this was delayed to six months — but to keep unions on side, the government scrapped the compensation cap entirely.
Q5: How does rising unemployment affect unfair dismissal claims?
A: With the UK unemployment rate at 5.2% — the highest since early 2021 — dismissed workers may find it harder to secure comparable roles quickly. Since compensation is partly calculated on time out of work, longer unemployment spells mean larger potential payouts.
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Effective Date: 15th July 2025
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