As you will know if you work in an investment bank, clawbacks have become an increasingly common element of performance-related compensation.
Clawbacks are the compulsory repayment of cash or transfer of shares or other assets, previously paid or delivered to an employee in the form of a bonus or share incentive award.
They may be imposed because the supposedly good performance for which the original payment was made has been reassessed, because the performance of the business has deteriorated severely after the payment, or because the employee has misbehaved in some way.
There are signs that clawbacks are becoming more punitive rather than less.
This summer, Deutsche Bank announced a new type of clawback – which will apply to bonuses earned by its current employees whilst they were with former employers. The bank has confirmed that the new clawback will apply to the unvested share awards earned by its senior bankers before they worked for Deutsche. These are converted into Deutsche Bank shares when senior bankers join. The rule applies to all senior bankers who commenced employment at Deutsche Bank in or after January 2012.
If you are affected by a clawback, are you able to contest the ruling? The answer is often yes, with the caveat that clawback provisions are extremely technical and complex and differ from case to case.
Legal complexities of clawbacks
There are a number of legal tests that must be satisfied to enable clawback provisions to be enforced. For example, clawbacks may be found to be “in restraint of trade” and therefore unenforceable if they apply when an employee has breached a post-termination restriction that was in their employment contract. For example, a clawback may be imposed if an employee breaches a provision preventing him or her from working for a competitor. If it is deemed not to be “reasonable” and “necessary,” this kind of restriction may be unenforceable. If this is the case, the clawback provisions that follow are likely to be unenforceable too.
In addition, clawbacks may not be enforceable if on balance they are deemed to be ‘penalty clauses’ i.e. if the primary intent of the provision is to deter a breach of contract rather than as a compensation payment.
Even if clawback is triggered by the employee being in breach of contract, it may not be upheld if it is found to be a penalty clause.
An employer can operate a clawback for an agreed sum of ‘liquidated damages’ (a form of compensation for a specific breach) only if it is seen to have been intended to a genuine pre-estimate of damages to compensate the injured party and not to punish the wrongdoer. For example, the employee’s contract with the bank provides that if the employee breaches any of his restrictive covenants after leaving, the bank can claw back the bonus paid to him. Because the possible damage suffered by the bank bears no obvious relation to the amount of the bonus, this could well be unenforceable as a penalty clause.
Clawbacks are less likely to be viewed as penalty clauses if the bargaining powers of both parties are equal. However, specific advice should always be sought as each case is different.
There is one exception where a clawback triggered by an employee breach may be enforceable, despite the law on penalty clauses. Rights to share incentives and bonuses usually terminate on dismissal.
There is also case law that employee share options may not be exercised when the employee is in breach of the employment contract. As a result, the courts may uphold a provision for clawback if and when the employer discovers there was a serious breach by the employee such as gross misconduct (which would have led to dismissal if recognized), which occurred before or at the same time as a share incentive was exercised or vested or possibly when a bonus was paid.
As for clawback when performance is found to have been overstated, the employer would need to be scrupulously objective and reasonable in applying the clawback provision. If not, the company would risk a successful claim from the employee for improper exercise of its discretion and authority.
Clawback provisions are often complex, but they can also be negotiable. Before signing any employment contract, it’s advisable to have your package reviewed. Equally, if your employer is seeking to amend your remuneration in any way by introduction of a clawback, you may be able to make a claim for breach of contract and you should seek advice.
Deborah Casale is a partner at Gannons Solicitors, an employment law firm offering advice to employees on all aspects of their employment relationship. For more information, please visit Gannons