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How can a clawback provision protect my business?

If you have been in business a while, chances are you have learned many things from making mistakes. While this is not the ideal way to learn, those lessons you gain through mistakes often come with a determination to avoid that kind of trouble from now on. One difficult lesson many business owners learn is paying an executive a large bonus only to have the employee bring failure or scandal to the company.

The employment contract is a tool you may use to protect yourself from contingencies such as a departing employee taking trade secrets or an employee seeking work with your competitor. However, by including a clawback in your employee contracts, you can provide your company with an option for dealing with scandal or poor performance from your executives.

How can I use a clawback?

Clawbacks as part of employment contracts have been gaining popularity over the years. In fact, between 2005 and 2010, employment contracts that included clawback provisions rose from 3 percent to 82 percent. If you are considering adding such a provision to your standard employment contract, it may help to understand some of the basics regarding clawbacks:

  • A clawback allows your company to take back any incentive-based pay, perhaps with penalties, when the employee who received the pay does not meet the terms of the contract.
  • This could mean failing to reach profit goals, participating in misconduct or bringing scandal to the company.
  • You may also enforce a clawback for accounting errors or fraudulent bookkeeping even if the individual employee is not responsible for the error.  
  • Incentive-based pay can include any bonus, stock options, dividends or other payment in excess of an employee's salary.
  • You may not clawback an employee's salary or 401(k) contributions.
  • You may be able to execute a clawback provision if an employee leaves your company and subsequently violates the non-compete clause in his or her contract.

Clawback provisions accomplish three goals. First, they allow your company and its shareholders to recoup losses related to misconduct or poor performance. They also send a company-wide message that your organization will not tolerate bookkeeping mistakes, fraud and scandal. Finally, using a clawback may restore confidence in the public eye regarding the integrity of your company.

If the use of a clawback provision in your employment contracts is something you are considering, you would benefit from obtaining advice about how to remain compliant with Utah and federal employment laws. An experienced attorney can provide guidance and assistance.

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