Law Firm Describes Clawback Policy Limitations

February 5, 2010 ( - A new client advisory bulletin from a New York law firm cautions employers putting together a “clawback” policy to recoup compensation in the event of employee wrongdoing to make sure it meets the company’s needs.

Bulletin authors Scott E. Landau and Bradley A. Benedict, lawyers with the Pillsbury Winthrop Shaw Pittman firm, said the architects of a company’s policy can’t just focus on the advantages of helping to dissuade employees from committing fraud or engaging in “excessively risky or other harmful activities.” Such policies can strictly be aimed at dealing with specified bad acts by employees or can give the employer a chance to recoup bonuses when the financial benchmarks called for in those bonuses turn out not to be properly met, the lawyers said.

“Adopting such measures can signal to investors that the company is taking a proactive approach to improve pay-for-performance principles,” Landau and Benedict wrote. “However, it is essential that compensation committees implementing clawbacks understand both the benefits and the limitations of clawback provisions and carefully integrate them with existing compensation plans and agreements.”

According to the lawyers, clawback policies may be limited by state wage laws governing amounts paid for the performance of services or state law may limit clawbacks triggered by a breach of a restrictive legal covenant in an employment agreement. The policies can also be limited by the rules governing 409A deferred compensation agreements.

The bulletin suggests a series of questions for compensation committee members to consider while fashioning a clawback policy, including the types of compensation to be covered, which employees should be subject to the rule, specifically how the rule will be triggered, and the length of time affected employees will be covered by the policy.

According to the bulletin, the use of clawback provisions is generally increasing and is being driven at least in part by public attention to allegedly excessive bonuses being granted to executives in the financial services sector. However, the practice is spreading to all industries and to both public and private companies, the lawyers assert.

The bulletin is available here.