Should Your San Diego Business be Using Clawback Provisions?

Clawback provisions are commonly used in various types of contracts. Typically, these are seen in investment and financial-related transactions where payments/salary are incentive-based. Sometimes these are called “Recoupment of Incentive Compensation” provisions. Indeed, some clawback provisions are mandated by federal law where misconduct requires the financial statements to be redone and refiled. Increasingly, clawback clauses are being used in employment contracts — particularly for executive employment contracts — as punishment for misconduct, for being involved in a scandal that taints the employer, for violation of a morality clause, and the like. A prominent example is Wells Fargo’s decision to clawback $180 million worth of executive bonuses following a 2017 scandal where over 2 million unauthorized bank accounts were opened. The accounts were fake and most of the “new” customers did not know that accounts had been opened for them. Five senior employees were fired and the company clawed back more than $180 million in bonuses. That was just about enough to pay the $185 million fine imposed by government regulators. See news report here.

As the name would suggest, a clawback clause allows a party to require repayment from another party of monies previously paid if certain events transpire. With incentive-based payments, the “event” is a failure to achieve whatever goals are the basis of the incentive payments — such as sales or revenue targets. With respect to other types of clawbacks, the “event” is whatever has been agreed to by the parties.

Typically, clawback clauses are long and detailed. But a simple example might look like this (related to criminal behavior or a scandal):

“CLAWBACK PROVISION: EMPLOYEE shall pay over and repay the COMPANY or otherwise deliver to the COMPANY anything of value (such as stock shares) given to EMPLOYEE as compensation or reward or similar in the event the employee engages in or commits a breach of confidentiality, a felony, an act of theft, embezzlement or fraud, a material breach any agreement with the COMPANY or a violation of any COMPANY policy (including ….).”

As can be seen, this clawback clause is broad, but it can be made broader still. Instead of stating “… engages in or commits …,” the provision can use this language “… employee is involved in a circumstance relating to a breach of confidentiality….” Under this extremely broad wording, the clawback provision would become operational even if the employee has not been found guilty of the prohibited behavior. Such is justified — from the vantage of the company — as a mechanism for avoiding bad publicity and restoring consumer confidence in the business if a key employee has become tainted with scandal or other behavior that might damage the reputation of the business.

There are other advantages to using clawback provisions. When a senior-level employee is terminated, often litigation is threatened and there is a long process of negotiating a severance package. Having a clawback clause gives the business leverage and can save the company money on the severance package. Essentially, the proposed clawback is offset against what the executive employee wants as part of his or her severance.

If litigation is filed, clawback clauses help in a similar fashion. The company’s claim for clawback becomes part of the counterclaim or offset reducing — in theory — the amount the judgment that the employee can obtain. This can slightly reduce the personal incentives of a former executive to initiate litigation which, in two ways, can save the company money.

Contact San Diego Corporate Law

If you would like more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard provides legal services related to business law, contracts, corporate entity formations and maintenance, private securities offerings/sales, the sale/purchase of a business, and mergers and acquisitions. Mr. Leonard can be reached at (858) 483-9200 or via email.

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