The Employment Rights Act 1996: section 104K and Flexible Labour Markets – by Hugh Collins

Image by AymaneJed from Pixabay

1. Introduction

In Kemi Badenoch’s Speech to the CBI of 28 November  2025, the leader of the opposition declared that the Employment Rights Bill then before Parliament

“is a 330-page assault on flexible working written in the TUC’s headquarters designed to drag Britain back to a world where unions call the shots and employers carry the blame.  For thirty years, flexible labour markets have been one of Britain’s real strengths.  They allowed us to create millions of jobs after the financial crisis.”

Among the measures that in her view amounted to an assault on flexible labour markets (that she elides with flexible working, which in fact the legislation promotes), the leader of the Conservative party lists ‘day one’ rights for unfair dismissal, which did not happen, and the ‘de facto ban on seasonal and flexible work’, which, though it is an obscure reference, is presumably about the tentative controls over zero hours contracts.  She also added to this list of assaults on flexible labour markets the right of unions to gain access to employees at their place of work, and lower thresholds for strike ballots; neither of these changes seem relevant to flexible labour markets, but no doubt her attack on trade unions went down well with the audience of business leaders.  Oddly, she omitted from that list a provision that is surely the fiercest assault on flexible labour markets in half a century. This is contained in section 28 of the Employment Rights Act 2025 (ERA 2025), which inserted a new section 104K into the Employment Rights Act 1996 (ERA 1996).  

It is possible that the significance of section 104K ERA 1996 was missed by most Members of Parliament, including not only the leader of the opposition, but also the ministers who proposed it. So far it seems to have escaped the attention it deserves.  Indeed, I have been unable to find any discussion of it on the internet or in Parliament. The section was slipped in as a last-minute government amendment in July 2025, when the Bill was before the House of Lords.  It was not expressly mentioned in the Labour Manifesto. It crept into the legislation under the cover of a blizzard of proposed amendments from all quarters. The new section was agreed without discussion in both Houses of Parliament.

2. Section 104K Employment Rights Act 1996

The absence of comment in Parliament and the media about the new section 104K ERA 1996 is perhaps explicable as the section was introduced under the dull and arguably misleading heading of ‘redundancy’.  It was added to the promised provisions on ‘fire and rehire’ (see Alan Bogg, Fire and Rehire: An Agenda for Reform; and Alan Bogg and Sarah Green, ‘The Good, the Bad, and the Ugly: Fire and Rehire in the Employment Rights Act 2025’ (2026) Industrial Law Journal (forthcoming)).  Those provisions were intended to make ‘fire and rehire’ of employees on inferior terms such as pay cuts an expensive course of action for employers. Under the amended Employment Rights Act 1996 sections 104I and 104J, dismissals in the context of ‘fire and rehire’ will be regarded as automatically unfair dismissals in the case of major adverse changes, or, in the case of minor changes, will be subjected to an assessment of reasonableness, thereby opening the possibility of a claim for substantial compensation for victims of this management restructuring technique.   Prior to this legislation coming into effect on January 1 2027, such dismissals are unlikely to be dismissals for redundancy (except for the purpose of consultation required for dismissals of more than twenty employees), because there is no reduction in the requirement of the business for employees of a particular kind in accordance with the statutory definition of redundancy.  Furthermore, the employer’s offer of re-engagement may prevent any finding of dismissal.  Alternatively, a claim for unfair dismissal is unlikely to succeed, because the employer could successfully argue that the employees’ refusal to accept inferior terms and conditions such as a pay cut is a substantial reason for dismissal, and that it is reasonable for the employer to dismiss for that reason if the employer had a sound business reason for trying to achieve a reduction in labour costs.  This was the conclusion of the Court of Appeal in Hollister v National Farmers’ Union [1979] ICR 542 and subsequent cases, which agreed with the surprising proposition that an employer’s repudiatory breach of contract at common law was a fair constructive dismissal for a substantial reason.  

Section 28 ERA 2025 is designed to replace this law on fire and rehire with the new section 104l ERA 1996. This amendment makes fire and rehire on inferior key terms such as wages and hours an automatically unfair dismissal in most circumstances, except where the employer believes that the measures are necessary to address the insolvency of its business or similar financial crisis.  By the same amendment, this restriction on fire and rehire is extended to cases where the employer dismissed existing employees for refusing to agree to inferior terms, but then offered much the same jobs to new replacement employees on those inferior terms.  Although this law does not prohibit fire and rehire (or replace) on inferior terms completely, this risk of liability for a compensatory award for an automatically unfair dismissal must render many such managerial initiatives unprofitable. Having reviewed those clauses, however, it must have been realised by the government that section 28 ERA 2025 left one loophole that would need to be closed.

What would happen if the employer terminated the contracts of existing employees for refusing to agree to a disadvantageous variation in their terms and then, instead of offering them or others new employment contracts on the inferior terms, the employer offered the same work to people on contracts that would not treat them as employees of the employer?  This is what happened in the notorious case of P&O ferries (see  e.g. Ioannis Katsaroumpas, ‘Authoritarian Liquid Transgressions: The Case of P&O Ferries’ (2024) 51 Journal of Law and Society 263). These new workers might be agency workers, employees of a contractor, independent contractors, employees of a personal service company, franchisees, or similar contracts that fall outside of the definition of contracts of employment.  The replacement workers would be doing the same jobs as the dismissed employees, but they would not be employees of the core employer.  Under the new section 104I ERA 1996, the dismissed employees would have no protection against unfair dismissal and only an arguable claim for a redundancy payment (as there is a reduction in the employer’s requirement for ‘employees’, though the work required remains the same).

This is where section 28 ERA 2025 steps in to insert a new section 104K ERA 1996.  In brief, it states that a dismissed employee will be automatically unfairly dismissed if the principal reason for the employee’s dismissal is to replace the employee with an individual who is not an employee of the employer, but who carries out substantially the same activities as the dismissed employee.  This protection from unfair dismissal includes cases where the dismissed employee returns to the job but under any other contractual arrangement than as an employee of the employer, such as an agency worker or an independent contractor.  That was the fact situation inCatamaran Cruisers v Williams, where the employer insisted that the employee should be rehired through a personal service company in order to avoid PAYE tax administration.  The new measure closes this loophole left by the new provisions on fire and rehire by extending it to replacements by workers doing the same job but not under contracts of employment.  That narrow purpose is perhaps how the amendment was presented and understood.  

But further reflection demonstrates that its ramifications are much more significant and wide-ranging than merely closing a loophole.  It is worth studying the full text of the new section 104K ERA 1996:

(1) An employee who is dismissed is to be regarded for the purposes of this Part as unfairly dismissed if—

(a) the employee was employed for the purposes of a business carried on by the employer, and

(b) the reason (or, if more than one, the principal reason) for the dismissal is to enable the employer to replace the employee with an individual who is not an employee of the employer.

(2) For the purposes of this section—

(a) an employer replaces an employee with an individual who is not an employee of the employer if (and only if)—

(i) the individual, or the individual taken together with one or more employees of the employer or other individuals, is to carry out activities, in pursuance of a relevant contract, for the purposes of the employer’s business,

(ii) those activities are the same, or substantially the same, activities as the employee, or the employee taken together with one or more other employees of the employer, carried out before being dismissed, and

(iii) the employee’s dismissal is not wholly or mainly attributable to the fact that the requirements of the employer’s business for those activities to be carried out have ceased or diminished or are expected to cease or diminish;

and any reference in this section to replacing an employee is to be read accordingly;

(b) a reference to replacing an employee with an individual who is not an employee of the employer includes the case where the individual is the one who has been dismissed;

(c) “relevant contract”, in relation to an employer, means a contract, other than a contract of employment, to which the employer is a party (whether or not the individual carrying out activities in pursuance of the contract is a party to it).

(3) Subsection (1) does not apply in relation to an employee if on the effective date of termination the employee has not yet started work.

(4) In the case of an employer that is not a local authority, subsection (1) does not apply in relation to an employee if the employer shows that—

(a) the reason for the replacement was to eliminate, prevent or significantly reduce, or significantly mitigate the effect of, any financial difficulties which at the time of the dismissal were affecting, or were likely in the immediate future to affect—

(i) the employer’s ability to carry on the business as a going concern, or

(ii) where the employer is a public sector employer, the financial sustainability of carrying out the employer’s statutory functions, and

(b) in all the circumstances the employer could not reasonably have avoided the need to replace the employee.

Notice in particular the significance of the definition of ‘relevant contract’ in section 104K(2)(c) ERA 1996. This applies the section to any kind of contract with the core employer except a contract of employment.  It therefore sweeps up the whole gamut of contracts for performance of work including agency work and work provided by an independent contractor or employees of a contractor.  Unless the employer can claim under section 104K(4) that the outsourcing of the work to non-employees was necessary to save the business and a tribunal finds that the employer could not reasonably have avoided the need to replace the dismissed employee with outsourced workers, the outsourcing will be an automatically unfair dismissal.  The ramifications of this provision extend not only to the entire structure of flexible labour markets in the UK, but also to the whole process of ‘off-shoring’ through international production networks.  To appreciate the extent of these implications, we should recall how the flexible labour market emerged from the destruction of large integrated businesses that dominated the economy until the 1980s. 

3. Flexible Labour Markets

It is debatable, of course, whether flexible labour markets have been a strength of the British economy, as claimed by Kemi Badenoch.  They have probably enabled employers to keep wages lower than they would have been without the flexibility.  That may have encouraged job creation, though the evidence is thin.  Yet the jobs created in the flexible labour market have usually been poorly paid and precarious.  This pattern of creating a secondary labour market of low-paid, precarious work has the serious disadvantages for the taxpayer of lowering productivity, reducing tax receipts, and requiring increased state support for working families.  These disadvantages of the flexible labour market were so great that even Conservative governments eventually became advocates of a mandatory living wage. 

How were flexible labour markets created?  The perceived problem in labour markets was that the UK economy was dominated by large businesses that offered secure jobs with well remunerated jobs, often protected by support from recognised trade unions and collective bargaining.  Governments of all hues supported a policy of the ‘derigidification’ of labour markets in order to ensure that employers only paid competitive rates of pay (see: Paul Davies and Mark Freedland, Towards a Flexible Labour Market: Labour Legislation and Regulation since the 1990s (2007)).  Methods for achieving that goal were vertical disintegration of these large private sector businesses and privatisation of public services.  If parts of the business or the public service were contracted out to independent business, the price for labour would no longer be fixed in many cases by collective agreements or the job grading system of the large company, but rather by competitive markets, the external market rate.  Wages would therefore rise and fall according to demand and labour productivity in accordance with the idealised models of neoclassical economics. Outsourcing of jobs became the main vehicle for pushing work into a secondary labour market, where the forces of supply and demand were unrestrained by collective bargaining and institutional security.

In the secondary labour market to which the jobs were exported, flexible working of many kinds flourished.  Casual work in which work is only required and paid exactly when needed created job insecurity, depressed wages, and in many cases deprived the workers of employment protection rights because they were not regarded as employees.  External contractors providing a service to the core company could reduce costs by rejecting collective bargaining, by avoiding ancillary benefits such as occupational pensions, and driving down wages to minimum rates.  The savings promised by external contractors could be even greater in some cases if the production network became international, so that the contractor could pay the local rates in the global south.  Avoidance of national insurance and employment rights also enabled the reduction of costs.  Increasing legislative controls over the activities of trade unions combined with an influx of migrant workers willing or indirectly pressured to take precarious and poorly paid jobs accelerated the growth of the secondary labour market.   

In the space of a couple of decades, by the turn of the twenty-first century, business use of outsourcing, no doubt assisted in large measure by developments in information technology, transformed the institutional structures of capitalism.  Instead of large vertically integrated firms performing a wide range of functions through an integrated workforce organised in structures of grades and hierarchies, the external labour market was used to allocate work and rewards.  Instead of firms tending to prefer to make products and services for themselves in the core business, they increasingly preferred to buy everything in that they could including many core activities of the business.  Indeed, the puzzle in some cases was why the core business bothered to employ anyone at all, rather than contract out every aspect of its functions. 

4. Legal Responses to Outsourcing

This transformation of labour markets was perfectly legal.  It relied on the bedrock principle of freedom of contract and the general deference of the law to business decisions.  Employers might incur liability to pay a small redundancy payment for dismissals of staff, but these payments would hardly put a dent in the profits to be gained by exploiting the secondary labour market.  Nevertheless, the transformation was met of course by some resistance both by organised labour and political calls for new legislation. 

One recurrent ingredient in the response to flexible labour markets was to try to ensure that workers in the secondary labour market would receive employment rights, even if they did not satisfy the common law tests for employment status.  Lawyers drafted contracts for the personal performance of work that appeared to create a legal relationship between independent businesses to which no employment laws would apply.  In response, Parliament expanded the scope of some employment rights to the broader category of ‘workers’, who were independent contractors under the common law but whose terms of employment, when interpreted realistically, share many features of the subordination of employees in a contract of employment.  Despite these efforts, as is well known, ‘workers’ are excluded from important labour rights such as unfair dismissal.  A key ingredient of the flexible labour market, job insecurity, is therefore preserved. 

A second response to outsourcing and flexible labour markets arose from an expansive interpretation of the Acquired Rights Directive of the European Union, Directive 2001/23/EC (as amended), implemented by the Transfers of Undertakings (Protection of Employment) Regulations 1981, revised in SI 2006/246.  Although this statutory instrument was presented as giving employees the same rights when their employer’s business was sold by a transfer of shares or a sale of the undertaking as a going concern, it was interpreted by the Court of Justice to apply potentially to outsourcing in all its forms.  The somewhat metaphysical question was whether the ‘entity’ retained its ‘identity’. If the outsourced operation was doing much the same work as had been performed by employees in the core business before, there would probably be a transfer of an undertaking.  If so, employees who had been re-employed by the outsourced business would be entitled to their existing terms and conditions.  Alternatively, if those employees were dismissed, there was a strong chance that the dismissals would be automatically unfair.  The main exception was where the principal reason for the dismissals was not the transfer of the undertaking but an ‘economic, technical or organisational reason entailing changes in the workforce’.  Such dismissals might be fair for reasons of redundancy or other substantial reason.  The precise scope of this exception in the context of outsourcing or ‘a service provision change’ has not been tested fully, though it seems possible that outsourcing is an organisational reason for a dismissal.  Although employers and governments tried to ignore this legislation on transfers of undertakings, eventually it was recognised that it usually applied to outsourcing and many techniques of privatisation.  By then, however, the flexible labour market was well established.

There have been other unsuccessful attempts to challenge the practice of outsourcing.  We have noted already that attempts to claim unfair dismissal have usually been blocked by the use of ‘other substantial reason’ as the ground for dismissal.  There was an unsuccessful attempt in Boohene & Ors v The Royal Parks Ltd to use the law of indirect discrimination to question whether outsourcing has an adverse effect on a minority group.  Such a group disadvantage often occurs because the work that is outsourced and then rewarded poorly may be predominantly or exclusively performed by women or minorities.  However, it is hard to hold the core employer responsible for causing the inferior terms offered by an outsourced contractor, and (as in many claims for indirect discrimination) the group disadvantage may not be clear from the available statistics. 

5. The New Weapon against Outsourcing and Flexible Labour Markets

Now there is a new weapon available to challenge outsourcing and the development of flexible labour markets.  Section 104K ERA 1996 states that if an employer outsources work to contractors, agency workers, and anyone who is not an employee of the employer, who then performs much the same job as the former employees, this is an automatically unfair dismissal.  It is not even necessary to demonstrate that the employer hoped by this indirect means to reduce labour costs.  Even if the motive is not to reduce labour costs but simply to avoid the legal responsibilities of employers towards employees, including PAYE tax administration, employees who are dismissed to enable this outsourcing will have been unfairly dismissed and entitled to higher compensation than a redundancy payment. 

Are there loopholes through which employers might continue with the practice of outsourcing whilst avoiding the penalty of making automatically unfair dismissals?  In section 104K(2)(iii) ERA 1996 the legislation includes a puzzling exception: dismissals are not automatically unfair if the employees who are dismissed by the employer are performing jobs that the employer no longer requires or expects to no longer require.  In other words, the dismissal is not unfair if the principal reason is that the employees are redundant (whilst avoiding the technical definition of redundancy).  Given that the section only applies when the new workers acting as independent contractors or similar non-employee roles actually perform the same jobs as the dismissed workers, it seems unlikely that this exception could ever be invoked.  The only possibility is perhaps the situation where the number of replacement workers is fewer than the dismissed employees, which suggests that some of those dismissed employees were redundant.  There may also be a question about whether the new workers are performing the same jobs as before the dismissals, which may be difficult to prove.

The other main exception, contained in section 104K(4) ERA 1996, is where a private sector employer claims that outsourcing was necessary to save the business as a going concern because the business was encountering financial difficulties.    In the case of a public sector employer, the defence applies if outsourcing is necessary to preserve financial sustainability in the performance of statutory functions.  Consider, for instance, the case of a hospital that is running a significant deficit in its operations.  It is decided to outsource the cleaning of the hospital to contractors, because it is expected that the savings in costs will eliminate the deficit.  Whether the hospital is a public or private entity, it is arguable that the savings from outsourcing save the hospital from closure.  The savings may be hard to obtain immediately if the Transfer of Undertakings (Protection of Employment) Regulations 2006 apply, because the external contractor is required to observe the same terms and conditions as were previously enjoyed by employees of the hospital.  In the longer term, however, the external contractor will be able to cut costs by not applying collectively agreed wages and only offering the minimum wage to new hires.  In addition, the broad concept of dismissal for an economic, technical, or organisational reason may avoid a finding of unfair dismissal. 

If the hospital can satisfy the requirement that outsourcing was necessary for financial viability, it can only avoid a finding of automatic unfair dismissal if it satisfies a second condition in section 104K(6)(b) ERA 1996 that ‘in all the circumstances the employer could not reasonably have avoided the need to replace the employee.’ There is no further guidance on the meaning of reasonableness in this context.  It may require an employer to demonstrate that alternative courses of action such as reducing the number of wards at the hospital were not viable options, because they would not produce the required savings or in fact exacerbate the poor financial performance of the hospital in the long run.  It is unclear, however, whether employment tribunals have the necessary business acumen to challenge assertions by employers that the outsourcing was a reasonable response to the financial situation. 

If the two conditions of section 104K(4) ERA 1996 are met, the dismissal is not automatically unfair, but it still may be held to be unfair in the circumstances in accordance with the general test of reasonableness in section 98(4) ERA 1996.  The new section 104K(7) ERA 1996 adds, however, a requirement that an employment tribunal must consider whether the employer carried out a process of information and consultation at an individual level with the employee and at the collective level with a representative trade union or other suitable representatives of the workforce.   The statute also confers a power on the Secretary of State to add further guidance on the test of fairness and reasonableness in this context.  The requirement for the employer to carry out information and consultation is not contingent on the application of the amended rules on consultation in connection with redundancy enacted in the ERA 2025.  This is a new and different requirement for consultation that applies to decisions to fire and rehire in all its different manifestations of rehiring or replacing the dismissed employees. 

6. The Uncertain Future of a Flexible Labour Market

The new section 104K ERA 1996 makes outsourcing of work more difficult.  Even so, outsourcing is now an instinctive approach of managers to the need to improve the profitability of businesses or achieve other savings in costs that will not disappear.  When employers consider that a new task needs to be performed, their instinct is not to hire an employee to do the job, but to use a consultant, a freelancer, or some other kind of gig worker to do the job, so that employers will not be bound by employment law rights or relevant collective agreements.  The flexible secondary labour market will therefore continue to flourish. 

Yet politicians may now be regretting the enthusiasm with which they once greeted ‘derigidification of labour markets’.  When an ever-growing proportion of the labour force can only obtain the precarious badly paid jobs of the secondary labour market, they will likely reject the established political leaders and vote for untested and radical alternatives.  Perhaps the section 104K ERA 1996 will one day be seen as another U-turn when mainstream political parties realised that ‘derigidification’ of labour markets, far from being the policy that saved the UK economy, was ultimately a grave mistake for the long-term welfare of the people.

(Suggested citation: H Collins, ‘The Employment Rights Act 1996: section 104K and Flexible Labour Markets’, UK Labour Law Blog, 4 May 2026, available at https://uklabourlawblog.com/)