Unfair dismissal reform: What PE firms and their portfolio companies need to do now

Changes effective 1 January 2027 – practical implications for PE firms and portfolio leadership teams

The Employment Rights Act 2025 represents one of the most significant shifts in UK employment law in decades. Whilst many reforms will be phased in between 2026 and 2027, two changes to unfair dismissal law coming into force on 1 January 2027 will have a particularly profound impact on Private Equity firms and their portfolios: (i) the reduction of the qualifying period for unfair dismissal from two years to six months; and (ii) the removal of the statutory cap on unfair dismissal compensation. Taken together, these reforms materially alter the risk profile of hiring, managing and exiting executive teams, requiring earlier planning and tighter processes across PE-backed businesses.

A shorter runway: six-month qualifying period

From 1 January 2027, employees will acquire unfair dismissal rights after six months’ service rather than the current two-year threshold. In practice, this will affect employees hired from 1 July 2026 onwards. For PE-backed businesses often operating in phases of accelerated growth and transitional change, this significantly shortens the period for assessing new hires before any unfair dismissal risk crystallises.

Key implications for portfolio companies

• Robust recruitment processes are essential: poor hiring decisions will crystallise into legal risk much earlier.
• Increased importance of probationary periods: three-month probationary periods (with limited extension) should be actively managed with documented objectives, regular review meetings and clear decision-making.
• Consider collective consultation risk if multiple probationary dismissals may occur within a 90-day period, particularly where different non-disciplinary exits are being run in parallel.
• Paper trails matter: even at an early stage, employers will need evidence of performance concerns or conduct issues to defend potential claims and to minimise potential collective consultation risk.

The end of the compensation cap: a step change in exit risk

From 1 January 2027, the statutory cap on unfair dismissal compensation (currently the lower of £118,223 or one year’s salary) will be removed. Compensation will instead be assessed by reference to actual loss i.e. the sums that the employee would reasonably have expected to receive had they remained employed.

Why this matters for PE-backed businesses

For senior executives, ‘actual loss’ may extend far beyond base salary and notice pay. Tribunals, with little experience in this area, may be required to grapple with complex remuneration structures and the calculation of financial loss, including:

• Bonuses, including discretionary bonuses where there is a reasonable expectation of payment.
• Deferred incentive awards, such as deferred compensation and earn-outs.
• Share options, growth shares, LTIPs and MIPs, including the loss of unvested or forfeited equity.
• Loss of future opportunity within long-term incentive structures, which are common in PE-backed management teams.

Importantly, contractual drafting will not necessarily be determinative of when payments will need to be made. Tribunals will instead focus on whether the employee would, in reality, have received the relevant remuneration, including bonuses and/or equity payments, if they had not been unfairly dismissed, creating new commercial leverage for senior executives in any exit negotiations.

Increased leverage, slower litigation

These reforms land at a time when the employment tribunal system is already under a huge amount of pressure. Employment tribunal hearings are being listed into 2029 in some regions and backlogs are expected to worsen. In addition, the ACAS early conciliation period has been (temporarily…) extended to 12 weeks and limitation periods in most claims are to be extended from three months to six months in October 2026, giving employees a much longer period in which to bring claims.

For PE firms, this creates:

• Settlement leverage for senior executives: uncapped compensation, particularly involving equity, will materially increase claim value and settlement pressure.
• Management distraction: complex disputes are likely to sit in the system for longer, increasing cost, uncertainty and senior management time commitment.
• Greater process sensitivity: if employers get the process wrong, unfair dismissal risk is crystallised with any uncapped award being further increased by up to 25% if the ACAS Code on Disciplinary and Grievance Procedures was not followed.

What PE firms should be doing now

Although the reforms do not take effect until January 2027, preparation needs to begin well in advance. Practical steps include:

• Audit probation and performance management processes across portfolio companies.
• Train managers on early-stage performance management and documentation.
• Review the level of financial information given to founders on projected remuneration – consider whether such information increases risk of 'actual loss' exposure post-completion if relationships break down.
• Identify legacy risks through due diligence where dismissals post-completion could attract uncapped exposure. Factor potential costs into any post-acquisition or value creation strategy. Revisit timing assumptions for management changes, transformation programmes and integration plans.
• Review executive remuneration structures to stress test against unfair dismissal risk to understand potential ‘actual loss’ exposure, particularly where value is heavily back ended.
• Consider governance and decision-making frameworks and criteria so that the business is in the best possible place to counter arguments that bonus, equity or other incentive payments would have been received.
• Executive exits will require earlier legal input and more robust evidence-based decision-making. Build unfair dismissal risk into exit planning, particularly for senior hires made from mid-2026 onwards.
• Increased focus on fair dismissal rationale and process at an early stage so employers control the narrative and counter senior executive unfair dismissal arguments, increasing employer leverage in settlement discussions.
• Engage early with legal advisers on senior exits to mitigate uncapped compensation exposure.
• Identify any employee performance, conduct or other issues and manage exits before the end of 2026, particularly where employees have less than two years' service, to minimise potential unfair dismissal risk and financial exposure. Equally, implement any restructuring programmes prior to the changes coming into effect on 1 January 2027.

Final thoughts

The unfair dismissal reforms mark a fundamental shift in employment risk for PE-backed businesses. Shorter qualifying periods and uncapped compensation will require more disciplined workforce planning, earlier intervention and closer alignment between HR, legal and deal teams. For PE firms, the message is clear: employment risk is no longer a back-end issue. Those who plan early will be better placed to protect value and avoid costly disputes as the new regime comes into force.

How we can help: We can support with due diligence, portfolio risk and compliance audits, value creation strategy and planning, post-acquisition integration, exit strategy planning for senior executives and key hires, and management training. Please contact Claire Holland for further details.