Legal opinion: New limits on unfair dismissal compensation

With effect from 29 July 2013, a new limit on the unfair dismissal compensatory award is to be introduced. It will be the lower of £74,200 (the current limit) or 52 times the ex-employee’s “week’s pay”. The Government’s intention is clearly to reduce maximum compensation to about one year’s pay, but there are potentially some wrinkles because of the definition of a “week’s pay”. Solicitor Nick Ralph looks at the implications of the new cap.

Calculating a “week’s pay”

A “week’s pay” is calculated rigidly under provisions in the Employment Rights Act 1996. It is either remuneration payable under the contract for working normal hours in a week or, where the remuneration varies with the amount of work done, the average remuneration payable “under the contract of employment” over the 12 weeks prior to dismissal.

This can throw up a few anomalies:

“Remuneration” does not normally include benefits in kind – pension, car, health cover and so on – and so employees with packages with more benefits may be limited to significantly less than one year’s package if unfairly dismissed.
If bonuses are discretionary, they may not be considered to be payable “under the contract of employment” and so may be excluded.
The statutory definition of “week’s pay” does allow annual contractual bonuses to be apportioned in a “just” manner in respect of the 12-week period. But for a dismissal in April, for example, the last bonus may have been payable in respect of the period to the previous 31 December, and it may well not be possible to quantify the bonus that would be payable for the period to the following 31 December. Case law has required that, in order to be included, the pay needs to be capable of being computed at the relevant date.
It is also arguable that bonuses should not be taken into account where the amount of work is stable and the amount of the bonus depends on the results of that work rather than the amount of it. Arguably, the averaging mechanism should not apply in such cases.
In order to save national insurance contributions, some employees sacrifice salary for employer pension contributions. Such sacrificed salary may well not be included within the definition of a “week’s pay”.
The money received by employees for work done outside of “normal” hours as overtime is usually calculated at a higher rate. However, under the strict rules in the legislation, in computing the average “week’s pay”, although overtime hours may be included, the rate applied may be that applicable to “normal” hours – an obvious disadvantage for those who regularly work overtime.
Where employees work and are paid for more hours at certain times of the year, their “week’s pay” will be lower if dismissed during one of the quieter periods.
If pay has been reduced by agreement – for example, because the company was facing financial difficulty – this could reduce a “week’s pay”.

The effect of the new unfair dismissal cap

In the past, the cases relating to the “week’s pay” have concerned matters such as statutory redundancy pay and holiday pay where the anomalies may have represented smaller amounts in monetary terms – for example, because of the cap (currently £450 per week) in relation to statutory redundancy pay and because holiday pay is typically in respect of just a few days or weeks. The fact that the unfair dismissal cap magnifies the definition of a week’s pay by a factor of 52 may make points more prone to be litigated over.

In addition, the amendment to the cap is going to be another factor causing dismissed higher paid employees to look to their “protected characteristics” (sex, race, age and so on) because claims for unlawful discrimination do not have a cap on the level of compensation.

Clearly, even though employees may raise legal challenges in relation to the points referred to above (and others no doubt), the likely overall impact of the change will be to reduce the level of unfair dismissal awards because employees will not be able to get more than 12 months’ pay.

Nick Ralph is a partner at Archon Solicitors Limited

FAQs on unfair dismissal compensation from XpertHR

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