According to Ask A Manager, it is perfectly legal to give a bad reference, just as long as it is honest and as fair as possible. However, Nolo points out that making any false statements in a recommendation could lead to a defamation lawsuit being filed by the person who received the bad reference.
Ask A Manager maintains that corporate policies have been slightly altered as a result of character defamation lawsuits brought against some companies by disgruntled former employees. Some companies may allow references that verify employment dates and specifics about job descriptions, but do not allow opinions or judgements about the quality of the employee's work. While companies' internal departments may adhere to these policies, they are not law.
The legal website Nolo suggests keeping negative references brief and sticking to the facts regarding a former employee's job and the circumstances regarding their dismissal. Only one person in the company should be responsible for giving out references to cut down on any conflicting stories. Furthermore, any accusations or negative references should all be backed up with concrete, tangible proof.
Ultimately, the burden is upon the former employee to prove whether or not a bad reference is cause to bring a defamation lawsuit against the party who supplied it, maintains the Advisory, Conciliation and Arbitration Service, a section of the labor department in the United Kingdom.