UK Employment Rights Act 2025 Unfair Dismissal Deep Dive Part 1: Polkey in a World Without Caps

Removal of the Cap on Compensation Awards for Unfair Dismissal

In most cases, there are two elements of compensation that may be payable to an employee who successfully claims for unfair dismissal:

• A basic award – Calculated on the basis of a statutory formula in a similar way to a statutory redundancy payment.
• A compensatory award – Capped at the lower of 52 weeks’ pay or the statutory numerical cap, which is reviewed annually (£118,223 for 2025/2026 and is increasing to £123,543 from April 6, 2026).

The ERA 2025 will remove both elements of the statutory cap on the compensatory award. The basic award will remain unchanged.

The consequences of the removal of the cap for the compensatory award are significant, including:

• The potential financial exposure of an ordinary unfair dismissal claim will be significantly higher than at present, particularly for high earners.
• Calculating the value of a claim for more senior employees is likely to be more complex, requiring consideration of bonus and incentive losses that previously were “capped out.”
• The potential for higher compensation may increase employees’ appetite to litigate unfair dismissal claims (where currently, the cap means claims are not always attractive for high earners).
• Negotiations to settle claims may become more complicated and employee expectations may become higher.

These changes mean that old orthodoxies for employers around how to approach dismissals and attitudes to unfair dismissal risk may need to be revisited and updated.

What is a Polkey Reduction and Why Might it Become More Important Than Ever?

The concept of a Polkey reduction arose from the House of Lords decision in Polkey v AE Dayton Services Ltd [1987] IRLR 503. This is the principle that a tribunal can reduce a compensatory award made to an employee for a successful claim of unfair dismissal to reflect that the tribunal considers that there would have been a fair dismissal in any event.

It may be expressed as a percentage reduction (though a 100% reduction is rare) or as a cap on future loss.

The tribunal might, for example, conclude that a fair process would have taken six weeks and would have resulted in the same outcome – therefore limiting the compensatory award to six weeks’ pay.

When the cap on the compensatory award is removed, Polkey deductions may become a crucial tool in an employer’s arsenal when a tribunal is considering remedy for ordinary unfair dismissal, particularly when dealing with senior exits. With the cap removed, employers have two options when considering a complex senior exit:

1. Ensuring a fair reason for dismissal and carrying out a full process before dismissal, accepting the risks to the business of the employee remaining in post during the process (for example risks to confidential information or competitive behaviour); or
2. Skipping the process, accepting that the dismissal will be procedurally unfair and the compensatory award will be uncapped, but then seeking to deploy arguments for a Polkey deduction.

Being able to credibly demonstrate that a Polkey deduction is likely may also assist in settling disputes early.

However, it is key to remember that this tool is only useful on remedy – and only follows an employer being found liable for a procedural unfair dismissal. It does not help employers to defend against liability.

What Should Employers Do to Have a Chance to Argue a Polkey Reduction?

Polkey relies on the tribunal having the evidence available to it to conclude that dismissal would have happened in any event.

It is key therefore to ensure that employers have strong evidence of the reasons that dismissal was inevitable. Poor documentation or muddled reasoning can undermine this. If employers only think about this after dismissal, it may already be too late, so employers should ensure robust record-keeping so that if Polkey does come into play for any dismissal, there will already be a solid documentary record. 

Take for example a dismissal for poor performance of a senior employee, who has underperformed for a number of years and has lost the confidence of the company’s board of directors. If there are limited historical records showing the extent of that poor performance, succeeding on a Polkey argument will be much more difficult. Clear objective performance metrics and records are key. If underperformance is not known to the employee, a tribunal may find it difficult to conclude that dismissal would have been inevitable.

Polkey is also useful:

• Where the employer can show that a redundancy was inevitable, with documents showing the contemporaneous business case for restructure or redundancy.
• Where the employer can show that misconduct was so serious it clearly justified dismissal, even if a fair process had been followed.

Additional Considerations for Reducing Tribunal Awards

Polkey is just one of a few reasons why a tribunal may reduce a compensatory award. Tribunals may also make deductions for payments already received by the employee as compensation for dismissal, deductions for an employee’s failure to mitigate, failure to comply with relevant codes of practice (such as the Acas Codes of Practice on Disciplinary and Grievance Procedures and on Dismissal and Reengagement) and reductions for any contributory fault on the part of the employee.

Employers should be alive to other evidence that might exist to support arguments that the employee’s behaviour contributed to their dismissal. This might include information that comes to light after dismissal, such as the discovery that an employee had been misusing the company’s confidential information during employment.

Employers should also consider the employee’s likely future employment duration, such as showing that the employment relationship was already fractured, that upcoming redundancies were in the pipeline or that the employee would not have continued in employment indefinitely.

Conclusion

With the expansion of ordinary unfair dismissal expected from January 1, 2027, Polkey is not something employers should view as an afterthought. Instead, it may become crucial to allow employers to navigate and potentially limit the costs arising from unfair dismissal risk.

However, it is only part of the story, and Polkey does not protect against an employer being found liable for a procedurally unfair dismissal. Look out for the next instalment in this deep dive into the ERA 2025’s changes to unfair dismissal.

For further information on the latest developments, see our Reform Hub.

Helping Employers Prepare

With the range of changes coming in under the ERA 2025, employment counsel can help you to:

• Identify and evaluate the specific risks and implications of the ERA 2025 and related reforms for your business.
• Address and prioritise any compliance gaps.
• Create a tailored, pragmatic action plan and advise your business on implementing any necessary changes.

Further information is available via the ERA 2025 Products and Services page on our website.