Employment Rights Bill stalls over unfair dismissal cap issue

Late last month, the government dropped its plans to provide employees in Britain with rights to claim unfair dismissal from ‘day one’ of their employment while proposing to reduce the period that would apply before they qualify for unfair dismissal protections from two years to six months, applicable from January 2027. At the same time, the government announced plans to ‘lift’ the current compensation cap that applies to unfair dismissal claims – a year’s pay or £118,223, whichever is lower”. In fact, the government opted to remove the cap altogether.

The changes in government policy were framed as a compromise to address the respective interests of both business groups and trade unions and followed a meeting the government convened between representatives on both sides. The government subsequently tabled amendments to the Employment Rights Bill with a view to giving effect to the changes and achieve the bill’s passage through the final stages of the parliamentary process.

However, on Wednesday, peers in the House of Lords rejected the government’s proposals on removal of the cap. They voted to approve a motion the effect of which is designed to trigger further debate on whether the government ought to undertake a review of the compensation limits before they are abolished, before the bill is finalised.

The motion was tabled by Conservative peer Lord Sharpe of Epsom. Speaking in the Lords, he accused the government of “constitutional impropriety”, on the basis that it had brought substantive amendments to the bill at a late stage in the parliamentary process. Lord Sharpe described his motion as seeking a “modest and responsible safeguard” and pointed to the fact that previous changes made to the compensation cap over the past 30 years were consulted on first by previous governments.

Lord Sharpe’s amendment seeks to ensure that the Secretary of State conducts a review of the limit imposed on the amount of the compensation awarded or compensatory award made, within three months of the Bill passing, and before the limits are abolished. He questioned the utility of the government’s promise to conduct an impact assessment after its proposed lifting of the cap is written into law.

Lord Sharpe also highlighted “possible practical consequences” of removing the compensation cap, adding that the government had appeared “not to have considered even the most basic scenarios”.

“For example, what happens when a board is faced with an underperforming CEO on £1 million or more?” Lord Sharpe said. “Today, many boards reach a clean exit. Notice is given, a payment to cover the maximum unfair dismissal award is made and a swift settlement is agreed. It allows the organisation to move on. But under an uncapped regime, the entire risk changes. Will a board now be expected to conduct a full six-month performance improvement plan, offer formal warnings, objectives, documented support and staged reviews, simply to reduce the risk of defending a seven-figure tribunal sum? …The incentives have now changed, so we would expect behaviour to change. They will now be incentivised to use the tribunal system, even if they were not in the past.”

The Employment Rights Bill will now return to the House of Commons on Monday for consideration of the Lords message. Time has also been allocated for the bill to be debated by MPs on Wednesday too, if required for consideration of any further Lords message. The last day that MPs will sit in parliament before the house rises for Christmas recess is Thursday 18 December 2025. MPs return from recess on Monday 5 January 2026.

Public policy expert Scott Wright of Pinsent Masons said: “Given the government had already made concessions on the cap, the unexpected changes to the bill by the Lords has been viewed by some as an attempt to frustrate passage of the government’s landmark legislation. However, with additional stages of ‘ping-pong’ to take place next week, we would expect the government to consider concessions on the compensation limit, particularly around additional consultation to get the bill passed before Christmas recess and onto the statute book.”  

Employment law expert Anne Sammon, also of Pinsent Masons, said: “Removing the cap on unfair dismissal compensation would be a seismic shift in UK employment law. It fundamentally changes the risk profile for employers, particularly in sectors where salaries and bonus structures are substantial, such as sports or financial services.” 

“While the six-month qualifying period before a claim can be brought in a 'standard' unfair dismissal case offers some certainty, uncapped awards could make dismissal decisions far more complex and costly. Employers really do need to revisit their recruitment strategies and ensure robust performance review and management processes are in place from day one,” she added.