Senior Exits In Private Credit Portcos: Navigating The Transition To An Uncapped Unfair Dismissal Regime

Having taken the keys of a troubled borrower from a sponsor, it is not uncommon for the new private credit owner to find that the management team may not be the right people to take the business forward and senior exits need to be contemplated.

With significant changes to employment law on the horizon, now is a good time to consider how those exits can be managed in the next six months and how the position will change from 2027.

Unfair dismissal: the current position and the upcoming changes

Currently employees with two or more years’ continuous service qualify for unfair dismissal protection. If an employee is dismissed unfairly, they can claim additional compensation. In order to dismiss an employee fairly, an employer must (i) have a fair reason for the dismissal (and, in all the circumstances, act reasonably in treating that reason as sufficient for dismissal), and (ii) conduct a fair process prior to the dismissal. The statutory fair reasons for dismissal include capability and performance, but the “fair” process required can be arduous.

Capability dismissals require the employer to give the employee sufficient chance to improve their performance. Typically where no improvement is made, a series of written warnings is given, which can lead to dismissal. However, from start to finish this process can take 4-6 months and requires significant management involvement and supervision. For C-suite employees, the process is even less straight forward. Appropriate target setting, and providing the support and training that an Employment Tribunal would find to be meaningful, can be difficult. This is even more so where the individual in question is performing adequately day-to-day but it has been determined that they are not the right person to lead required changes in the business going forward.

At the moment, compensation for unfair dismissal is capped at approximately £120,000. This allows a commercial decision to be taken so that the “fair” process followed can be shorter or avoided altogether by offering a relatively (when assessed in the context of senior pay) low value settlement.

That cap will be abolished entirely on 1 January 2027. At the same time, the qualifying period of continuous employment required before an employee can bring an unfair dismissal claim will fall from two years to six months. The effect will be significant: for senior, highly paid individuals, the potential value of those claims will be dramatically higher and agreed exits will likely become far more expensive.

How will the approach to performance management for senior employees change in 2027?

Case law has never given a firm answer as to how much performance management is “fair” for senior employees. Employment Tribunals have been reluctant to lay down fixed rules, instead saying that Tribunals need to consider the individual circumstances and be fair both to the business and the employee.

It is clear that C-suite managers are still subject to the same rights and disciplinary/capability policies as more junior members of staff. However, there is no strict legal requirement that a full series of warnings must be given for a dismissal to be fair. There is recognition that senior managers are more likely to be conscious of the lack of satisfaction in their performance and the financial state of the business (especially where the survival of the business is at stake). As a minimum senior employees need to understand how their performance is falling short, be aware their role is at risk, and have an opportunity to meet the criticisms against them, even if this doesn’t follow a typical path of first warning, final warning and dismissal. This means cogent evidence of those shortcomings will be crucial through appraisals and ad-hoc documented feedback. In most exit scenarios, a balance will need to be struck between the commercial imperative to change management quickly to achieve profitability and the unfair dismissal compensation risk.

The potential cost of future dismissals

Compensation for unfair dismissal is assessed by reference to the losses arising from the dismissal for the period of time the Employment Tribunal estimates the employee would have remained in employment. The compensation is designed to put the claimant in the position they would have been in had the dismissal not occurred.

For senior executives this may include significant discretionary bonuses and unvested equity awards along with lost salary and pension contributions. Currently settlement negotiations exist in the framework of the unfair dismissal cap and employees have to look to (sometimes spurious) discrimination or whistleblowing claims to increase their financial ask. Without the cap, the negotiation dynamic is likely to change dramatically: knowing there is unlikely to be appetite to conduct a full-form performance process, senior management will try to leverage their position by arguing they are likely to be out of work for a significant period; trying to bring all forms of remuneration and benefits into account (including any cash or equity awards granted to incentivise growth following the change in control); and by exploiting the statutory uplift mechanism, which can see any procedural errors resulting in compensation increases of up to 25%.

From the employer’s perspective, what will become key in any unfair dismissal defence, aside from carrying out as much process as business circumstances allow, will be evidencing to a Tribunal that, notwithstanding any deficiencies in process, the employee was living on borrowed time, the overall performance of the business was not improving in line with projections underpinning the incentivisation arrangements, and that a departure was inevitable in order to limit (hopefully significantly) the period of recovery.

Practical steps to consider taking now

• Look now at whether any staffing changes should be considered and actioned ahead of 2027, while being alive to any whistleblowing or discrimination risk.
• Ensure there is a paper trail when providing feedback to staff who you are concerned are underperforming.
• Carry out robust performance appraisal meetings, which give sufficiently detailed feedback and set clear targets and expectations.
• Consider revisions to disciplinary and performance policies to permit a shorter-form process where appropriate.
• Incentivise a sensible negotiated exit by linking positive leaver treatment (whether that is “good leaver” treatment or a separate negotiated proposal where the documentation allows it), or a pre-determined exit payment, to the executive signing a settlement agreement. That is obviously easier where new incentive or equity arrangements are being put in place.
• Position exit negotiations by focussing on management’s failings, the impact on their overall performance of the business a whole, the reputational risk those failings carry in the market, and their obligations to try to mitigate loss by finding other work.

Other changes

The expansion of unfair dismissal protection is not the only change to employment law coming in 2027. The law around large scale redundancies, amending employment terms where the changes lead to “firing and re-hiring” staff, and trade union processes is also changing.

Macfarlanes is a pre-eminent law firm advising a global client base across Private Capital, Private Wealth, M&A and Disputes.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.