Employment Rights Act 2025 – will 2026 be a year of “living dangerously” for employers and those on the job market?

The Employment Rights Bill has been passed, receiving its Royal Assent on 18 December 2025.

Following a last-minute amendment made by the government, which led to a prolonged ‘ping-pong’ process between the House of Commons and House of Lords, employers now have clarity over forthcoming changes to the law.

While most of the bill had been finalised, one important amendment relating to the government’s proposal to remove the compensation cap on unfair dismissal payments remained the subject of disagreement between the Commons and Lords.

The government insisted that these proposals had been discussed with business leaders, however the House of Lords expressed concerns at such a significant change being made to the bill at a late stage in the parliamentary process.

The Lords finally removed their objections to the amendment earlier this week, and the government has committed to publishing an impact assessment before implementing the unfair dismissal parts of the Act.

Concession on day-one rights

The government had already conceded on the House of Lords’ opposition to ‘day one rights’, which would have allowed unfair dismissal rights to take effect from the first day of an employment contract. Instead, a six-month qualifying period will now be required before unfair dismissal rights come into effect. The current qualifying period is two years.

The ‘trade off’ for moving from day-one rights to a six-month qualifying period was to bring forward implementation of the new law to 1 January 2027.

This new qualifying period will be ‘locked in’, meaning that it can only be changed by an Act of Parliament, rather than by secondary legislation, suggesting that the proposed six-month qualifying period may be in place for the longer term.

A similar concession on removing the cap on unfair dismissal was unlikely. The Lords’ position was that the cap should remain in place, but with a statutory duty on the part of the government to review the level of the cap within three months of the Act coming into force.

The House of Commons voted to remove the cap on Monday, 15 December by an overwhelming majority. On the same day, it published an open letter from six business organisations to the Secretary of State for Business and Trade, Peter Kyle MP, expressing the view that the bill should pass.

The House of Lords finally removed its objections to the amendment on 16 December, following a government pledge to conduct an impact assessment, that will examine the implications of removing the cap.

What is an unfair dismissal award?

An unfair dismissal award consists of two parts:

• A basic award, which is calculated in the same way as a redundancy payment, and
• A compensatory award, which is designed to compensate the person being unfairly dismissed in a ‘just and equitable’ manner

The latter award changes every year, and currently the cap is the lower of £118,223 or 52 weeks of gross pay.

What this means for employers

The government believes that the current compensatory cap acts as an incentive for claimants to construct cases which allege discrimination, because discrimination awards are uncapped.

However, the removal of the cap means that employers will face a higher financial exposure.

While the new law will not come into effect until January 2027, employers will need to make decisions in 2026 with this new landscape in mind, and it is likely to have an impact on hiring and performance management practices, especially at senior level.

Practical steps for employers to take now

From 1 July 2026, the period of continuous employment required to claim unfair dismissals is reduced from two years to six months. So, an employee starting employment on 1 July 2026 will be able to gain protection from 1 January 2027. This also means that employers will have a much shorter period within which to determine whether an employee is a good fit for their business and it is likely that probation periods will be far more aggressively assessed.

The potential for uncapped compensation after six months presents employers with the risk of higher claims, particularly within the financial services sector and will require not just a far greater focus on recruitment practices and onboarding, especially for mid- and senior-level roles but also active performance management. The days of using the statutory cap under a settlement agreement as an effective method of “buying out” unfair dismissal rights for those on high and/or variable remuneration are set to end.

Performance management

This will need to become more strategic, with clear standards and objectives in place. Pro-active performance management will become a key initiative for all businesses but is likely to become its own specialist HR industry within well remunerated industries.

Managers should be trained on policies and HR systems, to ensure appraisals are regular and properly documented, particularly during the probationary period, and performance improvement plans are likely to be implemented earlier and more aggressively for those whose performance may be viewed as on the cusp of what is deemed acceptable.

Bringing forward dismissals and more discrimination and whistleblowing claims?

The new six-month qualifying period may prompt employers to review the timing of dismissals and possibly bring them forward to avoid the new qualifying period of employment. Whether this results in more discrimination and whistleblowing claims being made as a result, remains to be seen.

A shift to temporary and self-employed contractors?

While the bill has been hailed by trade unions as a victory for workers’ rights, in the longer term, job seekers may find that they face a more rigorous recruitment process as the removal of the cap looms.

Employers may also be tempted to use temporary, agency and self-employed contractors instead to minimise their employment risk.

A lot of the bill’s measures still require secondary legislation before they come into effect.

However, this is still a good time to review internal processes and policies especially in relation to recruitment and performance standard setting, in readiness for the most dynamic and profound changes in employment law for half a century.