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Glossary Terms
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Clawback provisions, often found in executive compensation agreements or incentive plans, are contractual clauses that allow a company to recover previously disbursed compensation or benefits under certain circumstances.
Clawback provisions, often found in contracts or agreements, are clauses that enable a party to reclaim previously disbursed compensation or benefits under specific circumstances. These provisions are designed to address situations where the recipient of compensation engages in conduct that is detrimental to the interests of the party providing the compensation.
Clawback provisions can be implemented in various contexts, including executive compensation agreements, incentive plans, investment contracts, and employment agreements.
A common clawback provision example is found in executive compensation agreements. Suppose a CEO receives a $500,000 performance bonus based on the company’s annual revenue.
Later, the revenue is restated due to accounting errors, revealing the performance target was not actually met. Under the claw back provision, the company can demand the return of that bonus, either in part or in full.
This kind of clawback provision protects companies from rewarding inflated or inaccurate results and is especially prevalent in publicly traded firms.
In a Limited Partnership Agreement (LPA), a clawback provision ensures that general partners (GPs) do not receive more than their entitled share of profits over the fund’s life.
For example, if a GP receives carried interest early in the fund’s life based on initial gains, but subsequent investments underperform, the clawback provision requires the GP to return the excess amount to limited partners (LPs).
This protects LPs and ensures a fair distribution of profits, maintaining the integrity of private equity or venture capital arrangements.
Clawback provisions are generally enforceable across most U.S. states, but their legality can depend on how they are drafted and the specific employment laws of the state. While federal laws like the Sarbanes-Oxley Act and Dodd-Frank Act mandate clawback provisions in certain public company scenarios, state-level enforceability may hinge on:
Some states may have stricter rules about deducting wages already paid, especially for rank-and-file employees, so legal review is recommended before enforcement.
Yes, clawback provisions can apply to stock options and Restricted Stock Units (RSUs). These equity-based incentives often come with performance or service conditions. If an employee leaves under disqualifying circumstances—such as misconduct—or if the performance metrics tied to the awards are later found to be inaccurate, the employer can invoke a claw back provision to reclaim the value of those equity grants.
This is especially common in executive compensation plans to ensure alignment with long-term shareholder value and regulatory compliance.
Clawback provisions help maintain ethical standards and financial accuracy within a company. They are especially crucial in cases involving bonuses, stock options, or incentives where performance results are later found to be inaccurate or fraudulent. This provision builds trust among stakeholders by reinforcing responsibility and discouraging unethical behavior.
Companies usually enforce claw back provisions after discovering:
It typically comes into play post-payment, often months or even years after the initial compensation was issued.
A clawback provision is triggered based on predefined terms in a contract. Once the triggering event (like accounting fraud or performance shortfall) occurs:
Legal enforceability may vary by jurisdiction and contract wording.
