What happens when there is a promise to perform, and money is paid to the person who makes the promise, but the promise is not honored, or the performance information is flawed? These are examples of circumstances when clawback provisions might be enacted.
"Clawback" is an interesting word. It sounds pretty dramatic, and it can be because it can force someone to give back money as a penalty. A clawback provision in a business contract is a provision that requires something to be given back, depending on the circumstances.
How Clawbacks Work
Let's say a business has a chief executive officer (CEO) whom it wants to reward for keeping the company profitable. Maybe the CEO has a golden parachute contract. So the company includes a clause in her employment contract that she will receive an additional $100,000 bonus if the profits of the company increased 10% over the next two years. The corporate financial statements show the company profits increased 12% over that time, so you give her the money at the end of the two years.
Then the company's auditors find out that the company's profits only increased by 8%. It is hard to tell whether this change was deliberate hiding of the facts or just an error. But, the CEO's contract had a clawback provision that allowed the company to get the bonus back if the profits changed. Bye, bye, $100,000. Since the CEO signed the contract, there's little she can do to contest this forced return of the money.
In some cases, the employment contract with the executive may include a penalty. This is to prevent an executive from deliberately hiding facts that might negate the clawback.
Clawback Provisions in the Financial Recovery Act
Clawback provisions have been in the news since the 2008 financial crisis. In July 2015, the Securities and Exchange Commission issued a ruling on clawback provisions as part of the Dodd-Frank financial reform legislation.
The SEC rule requires companies to institute clawback provisions against executive compensation if the company's financial statements must be restated (changed).
Executives of a company may also be required to return stock options exercised or bonuses if the corporation's earnings do not meet specified levels.
Clawback Provisions in Medicaid
Clawback provisions are used in other circumstances, in addition to employment contracts. The Medicaid Recovery Program (in essence, a clawback provision) allows Medicaid to recover money paid for the healthcare of a Medicaid recipient who has died. Elizabeth Davis, RN says,
All states try to recover Medicaid money spent on long-term care such as nursing homes.
Some states also try to recover money spent on other healthcare expenses. States aren’t allowed to take more money from your estate than they spent on your care.
While this seems cruel, the provisions were enacted to help lower Medicaid costs by recovering money from individuals after their deaths.
Other Examples of Clawback Provisions
- In life insurance, a clawback provision might require that payments be returned if the policy is canceled.
- If dividends are received, they may be clawed back under certain circumstances.
- There are clawback provisions in pensions if it's found that the pension money was distributed fraudulently.
- Government contracts with contractors may include clawbacks of payments to the contractor of certain requirements of the contract are not met.
- In executive pay agreements, a clawback provision might require the executive to reimburse the company specified amounts if the executive breaches a non-compete agreement and goes to work for a competitor within a certain number of months after leaving the company.