Combined with the reduction in the qualifying period for unfair dismissal claims from two years to six months, the reforms are expected to increase both the number of claims and the financial consequences where employers get dismissal decisions wrong.
For employers, now is the time to review policies, procedures and employment practices to ensure they are prepared for the new landscape.
Why the removal of the compensation cap matters
At present, compensatory awards for conventional claims of unfair dismissal are limited to the lower of one year's gross pay or £123,543. This provides employers with a degree of certainty when assessing the financial risk of a potential claim.
From January 2027, that cap is expected to be removed. While Employment Tribunals will still assess compensatory awards based on the employee's financial losses, there will no longer be an upper limit restricting awards.
This change is particularly significant for businesses employing senior executives or highly paid professionals. According to HMRC data obtained through a Freedom of Information request, around 840,000 PAYE taxpayers earned more than the current compensation cap during the 2025/26 tax year. Those employees could potentially seek substantially higher compensation if they successfully bring an unfair dismissal claim.
However, the impact is not limited to high earners. Employees on more modest salaries may also receive larger awards where they experience lengthy periods out of work or lose valuable contractual benefits, such as enhanced pension arrangements or other long-term incentives.
Increased financial risk for employers
The removal of the compensation cap is likely to affect how employers approach dismissal decisions and Employment Tribunal claims.
For many businesses, the current cap provides a framework for assessing whether to defend or settle a claim. Without that limit, disputes involving senior employees could become significantly more expensive and commercially complex.
Claims involving highly paid employees often include disputes over issues such as:
- Bonuses and commission
- Deferred remuneration
- Share incentive schemes
- Long-term incentive plans
- Pension losses and other contractual benefits.
These additional factors can substantially increase the value and complexity of a claim.
For smaller businesses in particular, a successful claim involving a senior employee or a lower paid employee who has faced difficulty securing new employment (whether at all or on comparable terms), could have a significant financial impact.
More claims expected from January 2027
The removal of the compensation cap is only one part of the Employment Rights Act reforms.
From January 2027, employees will also gain the right to bring an ordinary unfair dismissal claim after six months' service instead of the current two-year qualifying period.
Together, these changes are expected to increase both the volume and value of Employment Tribunal claims.
The Employment Tribunal system is already experiencing significant delays. Research from the Employment Lawyers Association indicates that the number of outstanding Employment Tribunal cases has increased from around 32,000 in autumn 2022 to almost 60,000 today.
Longer waiting times can increase compensation awards where employees have been unable to find replacement work for extended periods, adding further uncertainty for employers involved in litigation.
What employers should be doing now
Although the reforms do not take effect until January 2027, employers should begin reviewing their employment practices well in advance.
Areas to consider include:
- Dismissal procedures and decision-making processes
- Redundancy procedures and consultation processes
- Probationary periods and performance management
- The use of fixed-term contracts
- Record keeping and documentation supporting dismissal decisions
- Manager training to ensure procedures are applied fairly and consistently.
Taking proactive steps now can help reduce the risk of costly disputes once the new rules come into force.
How TWM can help
Our Employment Law team advises employers of all sizes on managing dismissals, redundancies, disciplinary procedures and Employment Tribunal claims.
Preparing for Employment Rights Act 2025 changes? Explore our Employment Rights Act Hub for practical guidance, key implementation dates and the steps employers should be taking now – or get in touch with our Employment Law team.