How strong is the case for compensated no-fault dismissal?

In March, the coalition Government issued a call for evidence on making the dismissal process simpler, with a view to introducing compensated, no-fault dismissals for businesses with fewer than 10 employees.  

The aim is to give small businesses the confidence to hire new staff, or find a way to dispense with underperformers, without facing the prospect of a costly unfair dismissal claim and valuable business hours lost to dealing with red tape. Under the proposed system, employers could dismiss a worker, where no fault had been identified on the part of the employee, by paying of a set amount of compensation.

The Department for Business, Innovation and Skills (BIS) has issued a report looking at how similar legislation has affected employment levels and dismissal claims in other countries. We look at what it reveals.

Germany: Rise in temporary workers to avoid claims

Just like the UK, the majority of German businesses are small and medium-sized enterprises, with these companies employing around 16% of the total workforce. In 2004, the German Government amended its unfair dismissal regulations to exempt any business with fewer than 10 employees (prior to this it had been just five). The aim was to release small businesses from the burden of regulation.

Under its main piece of employment legislation, the Protection against Dismissal Act, employers can dismiss staff if the reason is “socially justified”: this includes any breach of duty where the employee is at fault; urgent business requirements (such as if the role is abolished and the employee cannot be redeployed); and other personal circumstances such as illness.

A trend worth noting in Germany is how many businesses, in order to avoid the costs of a dismissal, rely on the use of fixed-term contracts, with a fixed start and end date. Germany has also introduced the concept of the “mini job”, where employers of part-time workers earning less than €400 per month are exempt from having to pay tax or social security.

In terms of new business and job creation, the evidence suggests that the change in the regulations has not encouraged small businesses to expand more quickly. The number of micro-businesses (with one to nine staff) in Germany between 2000 and 2007 remained relatively stable across all sectors. At the same time, temporary employment levels increased, thanks to an earlier relaxation of temporary worker protection, which allowed businesses to hire someone for a fixed term of up to two years and repeatedly employ someone in a temporary role.

Australia: Tightening the rules has mixed results

Employment regulation reform is fairly recent in Australia, where, in June 2009, the newly elected Labour Government introduced the Fair Work Act (FWA). Before the FWA, businesses with fewer than 100 employees were exempt from unfair dismissal regulation; under the new regulations, businesses with fewer than 15 staff now have a different set of regulations to follow. Here, the impact of changing legislation has to be interpreted as a tightening of the law rather than a relaxation.

Unlike in other countries, the new legislation was not introduced to stimulate growth in micro businesses or provide greater flexibility. Rather, it was a means to address its legal predecessor, the Workplace Relations Amendment Act (also known as Work Choices), which was so unpopular it provoked protests and is thought to have been a contributing factor in the Labour party ousting the incumbent Government in the last election.

Under the FWA, small businesses must adhere to the Small Business Fair Dismissal Code, which provides a 10-question checklist for them to follow. The checklist has no legal status, however, so the employer could still be held liable. Businesses with fewer than 15 staff also have a longer qualifying period before staff can claim for unfair dismissal: one year as opposed to six months for larger businesses.

According to research by the Australian Human Resources Institute, the majority (58%) of firms surveyed believed there to be an increase in labour costs following the implementation of FWA, while more than two-thirds (72%) reported no change in hiring practices. Only 3% reported a growth in employment as a result of the new legislation.

Spain: Compensated dismissals become the rule rather than exception

In Spain, the latest round of employment regulation reform – the 45/2002 Act – was not targeted at small businesses. Instead, employers of any size are not explicitly exempt from unfair dismissal regulations and instead have the power to dismiss an employee at will, providing they pay a substantial severance payment – not a million miles away from the proposed compensated no-fault dismissal scheme here.

Like in the UK, the policy was intended to reduce dismissal costs for employers and also rebalance power in their favour. It also intended to reduce the proportion of temporary workers, which in 2002 accounted for more than 35% of the workforce. As in Germany, Spanish employers had favoured fixed-term contracts at the expense of permanent staff under the previous regulations.

The introduction of the 45/2002 Act has significantly changed the way dismissals are managed in Spain. The use of compensated unfair dismissals accounted for the majority of dismissals (around 65%) in 2009, and has increased in volume since 2002. Employers seem to find it more profitable to dismiss an employee based on “disciplinary” grounds and pay a high severance payment (under 45/2002) as opposed to on “economic” or “objective” grounds, which could lead to an unfair dismissal claim and significant court costs.

In response to this, in September 2010, the Spanish Government introduced a further reform to provide a new definition of dismissal for economic reasons. This means that employers can still use the compensated dismissal route, but only pay the severance payment they would pay for a dismissal made on economic grounds.

So what does the impact of the introduction of alternative dismissal routes for smaller businesses mean for the UK? In both Germany and Australia, allowing employers to release staff without the same level of red tape as larger businesses has not led to a significant increase in new business or employment. In Spain, meanwhile, compensated no-fault dismissals have become the favoured route for all types of business – so much so that experts suggest that the original intention of the legislation has been distorted. In all three examples, the impact of the slowing in the economy from 2008 onwards could have had just as much impact on employment levels as increased regulatory flexibility.

What is clear from BIS’s research is, as the Government gathers evidence on the viability of these reforms, their original intention – to stimulate enterprise and the employment market – may be a million miles away from what actually transpires.

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