Removal of the unfair dismissal compensation cap: what can employers do to prepare?

Blog

13.02.2026

The removal of the unfair dismissal compensation cap is set to become one of the most impactful changes introduced by the Employment Rights Act 2025 (ERA 2025). With the removal of the compensation cap – and unfair dismissal rights set to apply after just six months’ service – employers face a fundamentally different risk landscape from January 2027.

This article explores what is changing, the potential implications for employers, and the practical steps businesses can take now to prepare for the shift.

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What is changing: removal of the compensation cap

The ERA 2025 will remove the existing cap on unfair dismissal compensation. Currently, compensation for unfair dismissal is capped at the lower of one year’s pay or £118,223.

From January 2027, this cap will be abolished entirely. Once the cap is removed, tribunals will be able to award compensation which reflects loss of earnings in full (subject to the duty to mitigate), including in respect of base salary, discretionary bonuses, and long-term incentive plans, such as equity awards and carried interest arrangements.

This was a late and unexpected addition by the government, introduced just before the ERA became law in December 2025. Despite initial plans to consult extensively on unfair dismissal reform, in its updated Factsheet on unfair dismissal, the government confirms that it does not intend to consult on either the change in qualifying period or the decision to remove the compensation cap.

A government impact assessment concludes that the impact of removing the unfair dismissal compensation cap is "likely to be limited", noting that relatively few unfair dismissal awards currently reach the cap (with the median being £6,746 in 2023/24, and only 6% reaching over £50,000). However, it acknowledges the impact will be uneven, with higher‑paid employees and those with limited re-employment opportunities expected to benefit more, and some high‑pay sectors therefore facing greater exposure.

What do these changes mean in practice?

The practical reality is that, without a compensation cap, unfair dismissal awards could increase significantly, particularly for higher‑earning employees.

Currently, senior executives and other high-paid employees have limited incentive to pursue ordinary unfair dismissal claims because the cap is far below their annual remuneration. Once the cap is removed, these individuals may see unfair dismissal as a far more valuable route. Employers may find that senior exits become more complex and financially risky, leading to an increase in the number of unfair dismissal claims being brought. Settlement of such claims may also become harder, with employees having greater leverage in negotiations and increased expectations around exit terms to reflect the potential for uncapped loss of earnings awards.

For further analysis of what these reforms mean for senior executives, see our blog: The Employment Rights Act 2025: key points to note for senior executives.

While exposure may increase, certain factors will continue to limit awards. The removal of the cap does not alter:

the tribunal’s expectation that dismissed employees must mitigate their loss by seeking alternative work; and
the usual factors affecting compensation calculations, including Polkey deductions (where tribunals can reduce compensation to reflect the likelihood that an employee would still have been dismissed, even if a fair procedure had been followed) and contributory fault

However, these legal constraints may not be at the forefront of employees’ minds when bringing or negotiating claims in an uncapped regime. Employers should therefore be prepared for higher expectations and more assertive negotiation positions when managing contested exits.

What can employers do to prepare?

The removal of the unfair dismissal compensation cap will significantly increase financial risk and litigation exposure for employers, especially in respect of what have traditionally been viewed as low-risk dismissals. Here are some practical steps for employers to consider in anticipation of this change:

Use the first six months effectively: with unfair dismissal protection and uncapped compensation applying after six months' service, employers will need to manage probationary periods proactively – setting clear objectives from day one, holding regular review meetings, documenting concerns early and being prepared to take action where performance or conduct issues emerge. As there will be no transition period for unfair dismissal reform, all employees recruited before July 2026 will gain unfair dismissal protection on 1 January 2027. Employers should think about adopting a more rigorous approach now, to ensure early issues are identified and addressed in advance of that happening.
Strengthen performance management and dismissal procedures: with compensation becoming uncapped, procedural errors will carry greater financial risk. Employers may need to become more robust at conducting – or at least commencing – fair processes for performance management, misconduct and redundancy. This may include ensuring greater compliance with employment processes when managing senior executives or other high paid employees, which has not always been the norm up to now.
Plan strategically for senior exits: the potential for uncapped awards is likely to become riskier for high-earning or senior employees and may influence settlement dynamics. Employers should review how senior exits are managed and ensure there are clear internal escalation routes, more scrutiny over contentious exits and better alignment between HR, legal and finance. As part of this, boards and senior leadership should understand the financial and governance implications of uncapped awards.
Assess settlement strategy: settlement agreements, protected conversations, mediation and other forms of alternative dispute resolution may become increasingly important ways to control risk and cost. Employers may need to revisit their typical settlement ranges and prepare for higher expectations from claimants, alongside more complex negotiations.
Review insurance cover: employers should review insurance policies to ensure levels of cover adequately reflect the increased risk of unfair dismissal tribunal proceedings. Premiums may rise as a result of the unfair dismissal reforms, so early engagement with insurers is advisable and certainly should be done well in advance of any sensitive conversations with employees.
Check notice periods: employers should ensure statutory notice is applied correctly to avoid unintended unfair dismissal exposure. Under the Employment Rights Act 1996, giving less than the statutory minimum notice (two weeks for employees with under two years' service) can shift the effective date of termination and inadvertently push an employee over the six-month threshold, triggering unfair dismissal rights. Employers should therefore check notice periods carefully and ensure notice is served in sufficient time to avoid being caught out. Ensure contracts have payment in lieu of notice (PILON) clauses for greater flexibility.

For more information on reforms being made to unfair dismissal, see our blog: How is the law on unfair dismissal changing under the Employment Rights Act 2025?

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.