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Clawback Clauses: Everything Your Business Needs to Know

What happens when an employee receives a bonus or an incentive payment and it’s later discovered they did not meet their performance requirements? Or what if an unscrupulous employee falsifies the numbers on his financial reports?

In order to protect themselves, many companies utilize something called a “clawback” clause.

What is a Clawback Clause?

A clawback clause is a provision within a business or employment contract that allows—under a prescribed set of circumstances—an organization to reclaim incentive or bonus funds previously paid to an employee. Clawback clauses provide a form of guarantee in situations where a business needs to respond to employee misconduct, poor job performance, low achievements or a general decline in revenue.

If an employee is offered a sign-on bonus upon starting employment, this may come with a clawback clause stating that the bonus must be returned in event of an early departure from the company. Clawback clauses attached to these and other bonuses can incentive high-performing employees to stick around longer.

Clawback provisions in contracts are usually designated as non-negotiable and often include some type of fee or penalty in addition to the amount paid back.

Clawback Clauses in the Financial Industry

In addition to providing repayment of funds, clawback clauses also help companies—particularly in the financial industry—to proactively discourage employees from engaging in unethical practices such as reporting inaccurate revenues or other financial data. Many banks began utilizing clawback clauses after the 2008 economic crisis as a way to prevent future faults by their employees and to help rebuild public trust in financial institutions.

Prior to 2005, fewer than 3% of Fortune 100 companies used clawback clauses. But by 2010, that figure had risen to 82%. In 2015, the Securities and Exchange Commission issued a ruling that required companies to institute clawback provisions involving executive compensation packages, including stock options and other bonuses.

Common Uses of Clawbacks

Many private sector industries and government agencies utilize clawback provisions as part of their standard business contracts. Examples include:

  • Executive pay agreements: If an executive breaches their employment agreement or goes to work for a competitor (within a specified period of time), the executive may be required to reimburse their previous employer.
  • Mortgage lending: Most lenders now use clawback provisions to recoup money from unprofitable home loans.
  • Life insurance: If a customer cancels their policy, a clawback provision might require the benefits and payments previously received to be repaid.
  • Pensions: Pensions can be subject to clawback clauses as well, if it is found that there has been some fraudulent activity and suppression or adulteration of information.
  • Dividends: Under certain circumstances, such as bankruptcy, dividends can be clawed back.
  • Medicaid recovery: States allow their Medicaid offices to recover money paid in advance for the healthcare of recipients who have died and therefore no longer need care. For example, the state can recover money spent in advance on long-term care such as nursing homes.
  • Government contracts: If a government contractor has failed to meet specified quality standards or if the requirements of their contract are not fulfilled, then funds may be clawed back.

Creating Clawback Clauses

When introducing clawback clauses, here’s what HR professionals should keep in mind:

  1. What types of compensation are covered under your company’s clawback clause? Does it apply to cash bonuses only or stock options as well?
  2. What types of penalties are to be added and how will they be determined?
  3. Which employees are subject to your clawback provisions (senior executives, or all employees with incentive-based compensation)?
  4. What specific events will trigger the clawback provision? Does it involve performance or financial data reported or can it include secondary issues that may impact a company’s performance (i.e., an employee who causes reputational harm to the company, which may impact revenue)? These need to be spelled out clearly.
  5. How long a period of time should the employee’s compensation be subject to a clawback provision? This may vary based on the type of compensation and triggering incident.
  6. What type of discretion does the internal enforcement body (e.g., the board of directors) have over the enforcement and administration of the clawback?
  7. What specific laws or regulations does your state have that may impact your clawback provisions, the recovery of funds or the administration of penalties?

What Does This Mean for HR?

Clawback provisions are very important to the fiscal safety and reputation of your company, so it’s critical to familiarize with their details and how they can impact your employees. As an HR professional, you are the first line of communication and interaction with employees on these important issues and you must have a deep understanding of how and when a clawback clause is applied.

How Paycor Helps

Paycor builds HR solutions for leaders. With Paycor, you can modernize every aspect of people management, from the way you recruit, onboard and develop your team, to the way you pay and retain them. See how Paycor can help the leaders of your organization solve the problems of today and tomorrow.