The Advisors' Blog

– Scott Landau and Bradley Benedict, Pillsbury Winthrop

As noted in our recent memo, regardless of the reasons for adopting a clawback policy, certain legal issues must be addressed at the outset of its implementation. A failure to take into account the legal context may undermine the company’s ability to recoup payments.

Wage laws in some states may limit the ability to recover amounts paid or owed in connection with the performance of services. Even some bonus compensation that has not yet been paid may not be forfeitable if the amount is considered “wages” that are owed to the employee. Often, the degree of employer discretion in awarding the bonus will be determinative as to whether the compensation is considered nonforfeitable. Once paid, however, even a discretionary bonus may be deemed to be wages not subject to forfeiture.

In the US, applicable state law may also limit the utility of clawbacks triggered by the breach of a restrictive covenant. Restrictive covenants may be wholly or partially unenforceable in some states. Recovery under such a clawback provision in these jurisdictions may not be possible. Multinational companies must consider applicable foreign law as well.

Relevant jurisdictions should be identified not only to determine the legal limitations to recovery, but also to ensure that appropriate steps are taken as soon as a policy is agreed upon to facilitate enforcement. At a minimum, this should include comprehensive documentation of employee communications, including acknowledgments and/or consents from the individuals subject to the clawback. The simplest enforcement mechanism, of course, is the forfeiture of prospective payments, but even these straightforward designs may be problematic if the employee may be construed as having a legal right to the compensation.

Another enforcement issue concerns the treatment of an employee who is financially unable to repay the required amount or who would suffer undue hardship by doing so. Both business and legal considerations may be implicated by the company’s actions. For example, agreeing to accept payment over an extended period of time could implicate the Sarbanes-Oxley Act’s prohibition against issuing companies granting loans or extending credit to executive officers and directors. A clawback policy that provides the company considerable discretion in application and enforcement will generally leave it with more options in such cases. Nevertheless, it may be desirable to determine default procedures to be followed in order to ensure consistent and fair implementation of the clawback.