A clawback is a contractual provision whereby money paid to an employee must be returned to an employer, sometimes with a penalty.
Many companies use clawback policies in employee contracts for incentive-based pay like bonuses. They are most often used in the financial industry. Most clawback provisions are non-negotiable and are typically employed in cases of misconduct, scandals, poor performance, or a decrease in company profits.
Key Takeaways
- A clawback mandates an employee to return funds to their employer, occasionally with an additional penalty.
- It’s an insurance policy for employers against fraud, misconduct, declining profits, or poor performance.
- Typically found in contracts involving incentive-based pay like bonuses.
- While prevalent in the financial sector, clawback provisions are also used in government contracts, pensions, and Medicaid.
The Role of Clawbacks in Modern Business
Following the financial crisis of 2008, clawback clauses became more common as they enable companies to recover incentive-based pay from top executives in cases of misconduct or discrepancies in financial reports.
Clawbacks also appear in employee contracts to help employers manage bonuses and other performance-related payments. They serve as a protective measure if the company faces issues like fraud, misconduct, or a fall in profits, or even if employee performance doesn’t meet expectations.
Clawbacks are distinctive from other refunds as they often include penalties, requiring employees to pay additional funds back to the employer when invoked.
By preventing the misuse of incorrect information, clawbacks balance corporate welfare and community development. For example, they can deter employees in the financial sector from exploiting accounting mistakes.
They are valuable for restoring investor and public confidence in a company or industry. Banks, for instance, introduced clawback provisions post-2008 to rectify potential future executive actions.
Special Considerations
Clawbacks in Executive Compensation
The Sarbanes-Oxley Act of 2002 was the first federal statute allowing for clawbacks of bonuses and incentive-based pay from CEOs and CFOs if company misconduct necessitated a restatement of financial performance.
The Emergency Economic Stabilization Act of 2008 expanded this, allowing clawbacks for executives and the next 20 highest-paid employees at companies receiving Troubled Asset Relief Program (TARP) funds, even in the absence of misconduct.
In July 2015, an SEC proposed rule under the Dodd-Frank Act aimed to enable clawbacks of excessive incentive-based compensation following an accounting restatement. This initiative, pending approval, would bar companies from stock exchange listings if lacking such clawback provisions.
Clawbacks in Private Equity
In private equity, clawbacks refer to limited partners’ rights to reclaim part of the general partners’ carried interest in cases where subsequent losses mean excessive compensation was given.
Once a fund is liquidated, clawbacks are calculated. Medicaid may claw back care costs from a deceased patient’s estate. Sometimes, clawbacks refer to non-monetary issues, such as retrieving privileged documents mistakenly shared during discovery.
Real-World Examples of Clawback Provisions
Clawback provisions are used by corporations, insurance companies, and governments. Common examples include:
- Executive compensation: When executives breach agreements, misuse information, or join competitors.
- Life insurance: Policies may dictate return of payments if canceled.
- Dividends: Can be reclaimed under specific conditions.
- Government contracts: Contractors must adhere to contract requirements, or faces clawbacks.
- Medicaid: Can recover care costs from deceased patients’ estates.
- Pensions: Suspected fraud or information misuse allows companies to reclaim pension funds.
Related Terms: incentive-based compensation, Sarbanes-Oxley Act, Emergency Economic Stabilization Act, Dodd-Frank Act, private equity.
