Back in February, the 21st of February, the LZBlog posted an article about Golden Parachutes. Looking back to that article, a refresher definition of a golden parachute is “a type of employment contract provision that provides substantial financial compensation to an executive or key employee in the event that they are terminated, often in connection with a change in ownership or control of the company.” The purpose of a golden parachute is to remind those employees and/or executives that they should work towards the success of the business, no matter how shaky the ground may feel under them. No matter who owns or a runs a business, employees are supposed to aim for the collective success of all who work within it. Is there another course of action for those who don’t consider working for the overall success of a company? Of course there is. If one looked for an analogy, golden parachutes are like carrots, and, sometimes, a stick is considered necessary by some executives and business owners.
This is where the “clawback” comes into play. A clawback is a provision in a contract “that allows one party to recover some or all of the compensation or benefits paid to the other party under certain circumstances.” On the surface, clawbacks closely resemble their cousin, the golden parachute. However, instead of protecting the employee, the clawback allows the company itself to get back rewards, bonuses, etc. According to LinkedIn, “Clawback provisions are typically used in situations where the receiving party has engaged in conduct that is detrimental to the interests of the paying party, such as fraud, misconduct, or a violation of law or regulation.” Here, the clawback reminds the employee that what is given can indeed be taken away if the rules and codes of conduct are not followed to the detriment of the company as a whole. So how do clawbacks work?
“My Boy Only Breaks His Favorite Toys,” Clawback’s Version
Fundamentally, clawbacks are legal provisions. Therefore, if there are no clawback provisions in a contract, the company will not be able to take back any paid out any bonuses, extras, or, truly, any money paid out to an employee. These clawback policies, if they are laid out in a contract, are to specify the times it is okay for a company to take money, stocks, etc. back, and they are, according to Indeed.com, only to be used sparingly and as part of a legal contract.
Clawbacks are most frequently used by those in the finance industry, insurance industry, government organizations, or in the upper echelons of large corporations. However, any industry can add clawback provisions to their contracts if they believe they are needed. There are six main examples of clawbacks:
- Executive level bonuses: C-level employees might see a clawback applied to them after times of poor financial performance or in response to objectionable executive behavior.
- Company pensions: A pensioner may have to return their pension payments if the employee was found to have fraudulently or erroneously claimed them.
- Medicaid payments: Clawbacks have been used by Medicaid if they find they have made payments to someone who was deceased.
- Life insurance policies: “A cancelled policy might rely on a clawback revision that dictates when payments need to be returned.”
- Contracts: This is the most commonly seen clawback. If the work performed by an employee or a company as a whole does not meet with the contractual obligations, the payments for the work can be clawed back.
- Dividends: Dividends paid out to shareholders can sometimes be taken back if share value reverses or if profit margins can’t support the payments.
Why do some companies use clawbacks? Clawbacks are only legal and enforceable if they are written into a contract between a company and employee or contractor. Every clawback is different as well; with every company being different, it only makes sense that every provision for a clawback would have differences as well. From their purposes, to the time frames they use to decide when to initiate clawbacks, to the events after the triggering of a clawback, and, finally, its impact, these provisions are placed into contracts for the company to have recourses for inappropriately paid funds. What are some of the reasons that clawbacks are written into contracts?
- To protect against liability: Clawbacks can be used to mitigate the risks of potential fraud or misconduct. Any employee or contractor that dares to take advantage of a company will find that any payments can be taken back if the provisions exist within a contract. “Many clawback provisions also include penalties that accompany the retrieval of funds,” such as being fired from the company or fines for committing fraud.
- Responding to unexpected circumstances: Sometimes, emergencies happen, and companies need to reallocate profits or as stated above, reclaim some dividends paid out to stockholders. Clawbacks make this possible.
- To provide assurance to investors: Having clawback provisions ensures shareholders that the company is actively trying to deter fraudulent behaviors and promote accountability on all levels of the business. Whether it is having a recourse for high-level executives who are acting badly or simply having a way to retrieve mistakenly paid out Medicaid payments, clawbacks can give a feeling of security to those who are invested in the success of a business or organization.
These provisions should only be used in case of an unexpected and undesirable event. A company cannot simply snatch back previously paid funds without cause, and, with contracts and state laws in full effect, the business will have to go through the proper processes to even begin a clawback.
There can be challenges to implementing a clawback provision into work contracts. There are legal implications, and, as stated above, each clawback policy is different and depends on the industry and company it is written for. It is extremely important to have HR and Legal departments look closely over each clawback provision to make sure it falls in requirements set by the courts and government. Also, clawbacks can be impactful to employee motivation and morale. Some workers will be too worried about potential blowback from mistakes made if they see a clawback hanging over their head.
The best way to combat these concerns is to develop painstakingly clear and transparent clawback provisions. They must also be balanced and fair to both employees and investors. Don’t forget to also review and update any clawback policies already in place to ensure that they remain fair and effective. This should be done periodically to make sure they stay up to date.
According to Workforce.com, there are seven steps that need to be taken to ensure a clawback provision stands up to whatever is thrown against it.
- Identify all of the types of compensation that should be applicable in a company’s clawback policy, including bonuses, stock options, interest, overtime, etc.
- Research and decide the penalties that should be added, if any should be added at all. This includes fees, fines, or other disciplinary action.
- Be sure to cover which employees can or should be covered by a clawback policy. Also, decide if the clawback provisions should differ between different tiers of employees.
- Decide what triggers a clawback provision and be specific.
- Include how long after an improper action to have a clawback provision take effect. In other words, what is the cut-off point that a bonus or payment can clawed back by a company?
- Have a department or person responsible for triggering a clawback provision, and make sure that that person is specified in the contract.
- Finally, have the clawback provision reviewed by HR and Legal departments. This is important to ensure that it does not go against any state or federal laws. There are several federal statutes that have been put into place because of high-profile scandals where clawbacks have either been requested or needed. The Emergency Economic Stabilization Act of 2008 and the Dodd-Frank Act of 2010 both came out of the economic crisis of 2008, and each of them created spaces for clawback provisions to be enforced due to accounting errors or abuses. It is important to keep these statutes in mind when crafting clawback policies.
Conclusion
After everything above, it is imperative to remember that it is never ideal to be in a situation where clawbacks are necessary. These provisions are important to keep in contracts in order to protect a business from those who make mistakes or those who set out to do a business harm, but, hopefully, there will never be a cause to trigger the clawback at all.
____________________________________________________________________________
Meaghan Goldberg covers recruitment and digital marketing for Lionzone. A Patterson, GA native, after graduating from both Valdosta State University and Middle Tennessee State University, Meaghan joined Lionzone in 2018 as a digital recruitment strategist before becoming the social media manager.
Resources:
https://www.linkedin.com/pulse/golden-parachute-claw-back-hemant-patil
https://www.indeed.com/career-advice/pay-salary/clawback
