Clawback

What Is a Clawback?

A clawback is a contractual provision that requires a person or entity to return money or benefits already paid, sometimes with penalties. Clawbacks most often apply to incentive-based pay—bonuses, stock awards, or carried interest—and are used to recover compensation after misconduct, accounting errors, restatements, poor performance, or other specified triggers.

Key Takeaways

• Clawbacks force return of previously paid incentive compensation and can include additional penalties.
• They act as a safeguard against fraud, accounting irregularities, or excessive pay tied to misstated results.
• Clawbacks are common in finance but appear in many contexts: executive pay, private equity, government contracts, pensions, Medicaid, and insurance.

How Clawbacks Work

Clawbacks are typically written into employment contracts, bonus plans, fund agreements, or statutes. When a triggering event occurs—such as fraud, a financial restatement, or violation of contract terms—the employer or sponsor can demand return of the excess payments. Successful enforcement usually depends on clear, written provisions agreed to at the time compensation was awarded.

Clawbacks differ from ordinary refunds because they often add interest or penalties to the amount recovered. They serve both as corrective measures and as deterrents, helping restore investor and public confidence after misconduct or reporting errors.

Clawbacks and Executive Compensation

Legislation and regulation have expanded the reach and use of clawbacks in corporate governance:

• Sarbanes-Oxley Act (2002): Authorized recovery of bonuses and incentive pay from CEOs and CFOs in cases where corporate financials were misstated.
• Emergency Economic Stabilization Act / TARP (2008, amended 2009): Allowed recovery of incentive pay from top executives of companies that received TARP funds when financial results are inaccurate.
• Dodd-Frank Act (2010) prompted rulemaking to require clawback policies for restatements due to noncompliance with accounting standards.
• SEC rulemaking finalized in 2022 requires companies to adopt clawback policies to recover erroneously awarded incentive-based compensation following an accounting restatement; recovery is limited to the excess paid under the original (incorrect) results.

These rules typically target incentive-based awards and limit recoveries to amounts above what would have been paid under corrected results.

Clawbacks in Private Equity and Other Settings

Clawbacks appear beyond corporate compensation:

• Private equity: Limited partners may reclaim part of general partners’ carried interest if later losses show the general partners received more than their fair share. Calculations often occur at fund liquidation.
• Medicaid: State Medicaid programs can recover payments for long-term care from a deceased recipient’s estate under estate recovery rules (subject to age thresholds and hardship exceptions).
• Legal discovery: Privileged documents inadvertently produced can be “clawed back” and withdrawn.
• Other: Clauses may apply to dividends, life insurance payouts, government contracts, and pensions when fraud or contractual breaches occur.

Common Examples

• Executive compensation: Recovery when an executive breaches agreements, misuses proprietary information, or when financial statements are restated due to errors.
• Pensions and insurance: Reversal of benefits where fraud or material misrepresentation is discovered.
• Government contracts: Recoupment of payments if contractual obligations aren’t met.

Medicaid Specifics

State Medicaid programs are generally required to recover certain payments for nursing facilities, hospitals, prescription drugs, and home- and community-based services from the estates of recipients who were 55 or older at the time services were provided. States must provide hardship exceptions and follow statutory rules governing recoveries.

Defenses and Limitations

Defenses to clawback claims vary by jurisdiction and contract terms. Possible defenses include:

• Absence of a written, signed agreement specifying the clawback.
• Conflict with state wage-and-hour laws or other statutory protections.
• Unequal or discriminatory enforcement compared with how the employer has treated others.
• Procedural challenges to the legal validity of the clawback clause.

Because enforcement often hinges on contract language and applicable law, legal counsel is advisable if faced with a clawback demand.

Penalties and an Example

Clawbacks may require repayment plus additional charges such as interest or a fixed penalty. Example: An employee who received a $5,000 bonus tied to a sales target that later proves falsified might be required to repay the $5,000 plus a 10% penalty, for a total of $5,500.

Conclusion

Clawbacks are powerful tools to correct overpayments and deter misconduct, especially for incentive-based compensation. They are most effective when clearly documented and legally enforceable. If implicated in a clawback—particularly where government programs or retirement benefits are involved—seek legal advice to understand your rights and obligations.