In Brief
- From 1 January 2027, the Employment Rights Act 2025 will remove the statutory cap on unfair dismissal compensation, fundamentally changing the financial risk profile of employee terminations.
- For employers in sectors where senior employees receive bonus, deferred pay or equity, incentives and remuneration are likely to become central to tribunal claims and settlement negotiations.
- Existing leaver provisions and Micklefield clauses in share plans will not eliminate exposure to statutory unfair dismissal claims: employers should stress-test their arrangements now.
- Employee shareholder status, though no longer tax-advantaged, may merit a fresh look for private equity and financial services businesses seeking to manage this new litigation risk.
- Employers should act now to review high-risk populations, tighten governance and documentation, and plan exits more carefully before the cap is removed.
What is changing
From 1 January 2027, unfair dismissal risk looks very different.
The Employment Rights Act 2025 will remove the cap on compensation for unfair dismissal. That is not just a change for employment lawyers. For employers, particularly those operating in sectors where senior employees are rewarded through bonus, deferred compensation or equity, it is likely to become a significant pressure point for incentives and remuneration too.
In an uncapped regime, the financial consequences of dismissal may increasingly be measured not just by reference to salary and benefits, but by what the employee says they have lost the chance to receive or retain: annual bonus, deferred awards, carried-interest, share incentives and the future upside of equity holdings. These economic interests will soon fall into feasible claim heads of loss and this creates a material financial risk for employers.
That does not mean every dismissed employee will suddenly have a high-value claim. But it does mean that reward structures, leaver provisions and termination processes are likely to come under much closer scrutiny. And in some sectors, that may prompt employers to revisit legal tools and structuring options which had largely dropped out of use, including employee shareholder status.
Why incentives and remuneration now matter more
Once the cap on compensation goes, ordinary unfair dismissal will become far more valuable in cases involving senior executives and investment professionals.
The underlying legal principle for compensation is familiar - the tribunal asks what loss the employee actually suffered as a result of the dismissal, to the extent that loss was caused by the employer's conduct, and awards the amount it considers just and equitable in all the circumstances.
The practical effect is straightforward: if loss flows from the dismissal, it can be compensated.
That does not mean every forfeited bonus or lapsed share award will be recoverable. Questions of causation, mitigation, Polkey (the principle that compensation may be reduced to reflect the chance that a fair process would still have led to dismissal) and contributory conduct will still matter. But it does mean that the value tied up in incentives may now become central to quantum and settlement.
The risk is not simply ‘larger tribunal awards’. The real shift is commercial: once ordinary unfair dismissal is no longer bounded by a statutory ceiling, claim value becomes more fact-driven. That pulls bonus and equity into the core of quantum, settlement dynamics and (in practice) board-level decision-making.
That is particularly important in private equity, financial services and listed businesses where variable remuneration may significantly exceed base salary.
Why this is especially acute in equity-backed and bonus-heavy environments
For many employers, the issue is less about legal theory and more about evidence and valuation: is there a credible reasonable expectation that a bonus would have been paid (and broadly at what level), based on policy, objectives, calibration and communications?
In relation to equity: once unfair dismissal is established, the loss of unvested/forfeited equity can be pleaded as a head of loss - and the hard questions are typically (i) would the award probably have vested / been retained but for the dismissal? and (ii) what is the value of that lost opportunity?
That is where reward design and employment litigation start to overlap much more directly.
Many incentive plans already contain leaver provisions intended to define what happens on termination. But employers should not assume that those provisions will necessarily answer the tribunal claim. Most share plans and Management Incentive Plans have contractual mechanisms to limit entitlements for leavers, but will these be effective to limit a statutory claim? Do Micklefield clauses work to limit liability for unfair dismissal?
The answer is no. Micklefield clauses cannot limit the amount of compensation an individual can claim for unfair dismissal. Such clauses can protect employers from claims for loss of share plan entitlements arising from wrongful dismissal - a contractual claim - but they do not meet the statutory requirements necessary to waive unfair dismissal rights, and so are void to the extent that they attempt to exclude or limit statutory unfair dismissal compensation.
What about valuation challenges?
Valuation is likely to become a battleground in its own right. That is obvious enough in relation to private company shares, growth shares and sweet equity, where there may be no ready market value and where worth may depend heavily on the assumptions made about timing, performance and exit. But valuation issues can also arise in relation to deferred awards, carried interest and bonus opportunities, particularly where the claim is framed as loss of a chance. Employers should expect closer scrutiny of the valuation methodology used at the time of exit, the consistency of treatment across leavers, the extent to which any discount has been applied, and whether the underlying assumptions are supported by contemporaneous evidence. In practice, that means disputes may quickly move beyond plan wording into expert evidence, internal valuation materials and the rationale for how the business priced the employee’s loss on departure.
Could employee shareholder status (ESS) be of use?
ESS, introduced in 2013, was designed to create a new category of employee: someone who received shares in their employer group in exchange for giving up certain employment rights, including the right to claim ordinary unfair dismissal and the right to a statutory redundancy payment.
The attraction of ESS was the significant tax advantages available at the time. Those tax advantages were removed for ESS agreements entered into on or after 1 December 2016. Consequently, the arrangement fell out of use. However, the employment status itself was not repealed.
That is why the removal of the unfair dismissal cap may prompt some employers, particularly in private equity and financial services, to ask whether employee shareholder status deserves another look, as a means to contract out of this litigation risk.
How ESS works
An individual has employee shareholder status only if certain statutory conditions are met. In summary:
- the employer and the individual must agree that the individual is to be an employee shareholder;
- in return, the company must issue or allot fully paid-up shares in the company, or procure the issue or allotment of fully paid-up shares in its parent, with a value of at least £2,000 on the day of issue or allotment;
- the company must provide a written statement setting out the particulars of employee shareholder status and the rights attaching to the shares; and
- the individual must give no consideration other than entering into the agreement.
There are also procedural safeguards. Before the agreement is entered into:
- the individual must receive independent legal advice on the terms and effect of the agreement; and
- at least seven calendar days must pass after that advice is given before the agreement is signed.
The employer must pay the reasonable costs of that advice.
If the arrangement is validly entered into, the individual gives up some statutory rights. Most notably, an employee shareholder cannot claim ordinary unfair dismissal claim or statutory redundancy pay. However, protections remain in relation to most employment rights, including discrimination, whistleblowing and automatically unfair dismissal.
Why revisit ESS now?
In the private equity market, it is standard for senior management in portfolio companies to invest alongside the sponsor and acquire ordinary shares or growth equity with the prospect of real upside on exit. If the investment performs well, the gain can be substantial.
But those same managers may also be required to transfer their shares if they leave before exit, and the price they receive may depend on whether they are treated as a good leaver or bad leaver. In many cases they also lose the ability to share in future value growth after termination.
Currently, the statutory cap has generally limited the scope for unfair dismissal claims to operate as a practical route to recover such losses. Once the cap is removed, that changes. Future upside, forfeited awards and bonus opportunity all become much more likely to feature in the claimant’s case.
That is why ESS may start to look more attractive for employers. If management are receiving a meaningful equity stake as part of the bargain, employers may ask whether it is reasonable to require them to agree not to bring ordinary unfair dismissal claims.
Could private equity and financial services lead the way?
The hardest issue is usually consideration. The legislation requires that the individual gives no consideration other than entering into the employee shareholder agreement. In contrast, PE-backed management teams are often expected to invest their own money so that they have genuine “skin in the game” and to help manage tax exposure on acquisition.
That tension does not necessarily make employee shareholder status unusable. But it does mean the arrangements would need to be designed with care so that the statutory conditions are satisfied without undermining the commercial objectives of the incentive package.
That raises a number of practical questions:
- which shares are being issued for the purposes of ESS;
- how those shares sit alongside any wider management investment arrangements;
- how value is established and evidenced;
- whether the written statement and advice requirements have been properly dealt with; and
- what tax consequences follow from the overall structure.
PE and FS were the most prolific users of ESS in its original form but any business which awards equity to senior employees could explore whether ESS might be used as part of the remuneration architecture. Financial services businesses have an interest where deferred compensation, co-invest or equity-linked remuneration forms a significant part of total reward.
Listed companies are likely to face more complexity. Many listed company plans do not involve up-front share ownership at all, instead using options, RSUs or conditional awards. There are also corporate governance code requirements, remuneration policy constraints and shareholder expectations to navigate. That will not necessarily make employee shareholder status impossible, but it may make it less straightforward.
Even where the regime is not used, the wider lesson remains the same: uncapped unfair dismissal will force a closer look at how incentives are designed, documented and operated on termination.
A note of caution
None of this means ESS is a silver bullet. The obvious challenge is that employee shareholder status no longer carries the tax advantages which originally made it attractive. That means the case for using it now has to be commercial. In practice, that is likely to limit its appeal to senior individuals who are being offered meaningful equity upside and who are prepared to treat the loss of ordinary unfair dismissal rights as part of the wider bargain. For those employees, the key question is likely to be whether the value of the shares, the broader remuneration package and any negotiated contractual protections make that trade-off worthwhile.
ESS only removes certain rights. It does not prevent claims for discrimination, whistleblowing detriment, automatically unfair dismissal and many other statutory rights. There is a political angle too. If the regime began to be used more visibly to manage termination risk for highly-paid executives, it is possible that the Government could repeal it.
And finally, implementation matters. If the statutory conditions are not met, the arrangement may fail, leaving the employer with the complexity but without the protection.
What should employers do now?
Even for employers with no interest in ESS, the removal of the cap should now trigger a review of incentives and termination processes.
In particular, employers should consider:
- Review high-risk populations
Identify employees whose remuneration includes significant bonus, deferred pay, carried-style economics or equity upside. These are the cases where dismissal risk is likely to increase most sharply.
- Stress-test leaver provisions
Check whether plan rules, bad leaver/good leaver mechanics and bonus forfeiture provisions are fit for purpose, and whether they are likely to support the employer’s factual case on termination.
- Tighten governance and improve the evidence trail
Where incentive outcomes depend on discretion, employers should make sure decision-making is properly documented and consistent. Where incentive plans have broad bad-leaver triggers, narrow good-leaver treatment and wide discretion, the vulnerability is governance and evidence. There should be a clear protocol for Remuneration Committees to follow.
- Join up HR, legal and reward teams
This is not just an HR issue and not just a reward issue. Internal alignment will matter more where bonus and equity may feature in a tribunal schedule of loss.
- Plan exits more carefully
The removal of the unfair dismissal cap is likely to make incentives and remuneration a much more prominent feature of employment disputes. In some cases, that may simply mean more detailed arguments about bonus and equity loss. In others, it may prompt more fundamental questions about how reward arrangements are structured in the first place. With the Employment Rights Act 2025 due to double the time limits to bring most statutory claims (six months instead of three), employers should assume more extensive pre-claim activity: grievances, DSARs, valuation challenges, comparator requests and harder negotiation around settlement. The answer is not necessarily more process for the sake of it, but better decisions and better records, earlier.
ESS is unlikely to become mainstream overnight. It remains technically demanding, no longer carries the tax advantages that originally drove interest in it, and may not suit many businesses. But for some employers, particularly in private equity and financial services, it may prove to be a regime worth dusting off.
At the very least, uncapped unfair dismissal gives employers a timely reason to revisit the connection between reward and exit risk. For those with equity-heavy remuneration models, that exercise should start now.
How Mishcon de Reya can help
Our Incentives team advises employers on all aspects of incentives and remuneration structures. As the removal of the compensation cap approaches, we can help you review your arrangements. If you'd like to discuss the impact of these changes on your, please get in touch.