Equity Clawback: Everything You Need to Know
An equity clawback allows a bond issuer to refinance a specific percentage of outstanding bonds.3 min read
An equity clawback allows a bond issuer to refinance a specific percentage of outstanding bonds. The refinancing happens using proceeds from an equity offering, which is from the initial or follow-up offerings. They are contract provisions for money paid for services which are reimbursable under specific circumstances outlined in the contract. Essentially, they create a balance between economic and community development and corporate welfare.
What is a Clawback?
The term clawback means an action where a benefactor or employer takes back money that was already distributed, likely with a penalty added on. Some companies might include clawback provisions into their employee contracts, whether these provisions regardless of legal requirements. For example, these allow the employer to recover bonuses that have already been paid out.
A fund liquidation prompts clawback calculations. For example, Medicaid can “claw back” costs from the estate of a deceased patient. There are other instances where a clawback might not even be monetary. An attorney can claw back privileged documents that were accidentally submitted during electronic discovery.
Clawbacks can also be used to keep people from using false information, like the misuse of accounting information in the financial industry. Clawbacks can also be used in other circumstances as well. In private equity matters, a clawback refers to a limited partner's rights to reclaim a portion of a general partner's carried interest in matters where consequent losses mean general partners received excess compensation.
Executive Compensation and Clawbacks
The Sarbanes-Oxley Act of 2002 was the first federal statute that allowed clawbacks for executives' pay. It allows for claw back of incentive-based compensation and bonuses of CFOs and CEOs if any misconduct by the company requires them to restate their financial performance. It should be noted that it's not required that the CFO or CEO was the one who committed any wrongdoing.
Another act that allows for clawbacks of incentive-based compensation and bonuses that were paid to a company executive or the next 20 highest-paid employees is The Emergency Economic Stabilization Act of 2008. It's applicable to companies receiving TARP funds, and when there's a determination that financial records were inaccurate, no matter whether there was misconduct or not.
There is a limitation on the clawback. It is only applicable to the excess of what would've been paid under the restated financial results.
Examples of Clawbacks
Clawbacks can be found in a number of areas:
- Government contracts — Contractors can be subject to a clawback if they fail to meet certain government contract requirements
- Life insurance — There could be a provision that dictates if a policy is canceled, payments must be returned.
- Dividends —There are certain circumstances where dividends can be clawed back
Why are Clawback Clauses Important for Employees
Clawback clauses can have a significant impact on startup company employees. Shareholders and investors need to find skilled technical and nontechnical employees. This can be a challenge since startup companies have their share of challenges, like lower salaries, hectic work schedules, and certainly the risk that the company won't survive. To offset this, startups sometimes offer the promise of a payoff later. Employees might receive stock options, equity, or other benefits that can make up for the initially lower salaries. Any benefits like this will be outlined in a clawback clause.
In the event, you signed a contract that contains a clawback clause and you quit or get fired for due cause, the company may seek a vested equity. This is to encourage employees to stay with the startup company rather than jump ship if a better opportunity comes along.
Clawback clauses are pretty typical in European countries, especially with startups. They are more commonly known as a good leaver/bad leaver clause, which establishes an employee's rights based on his or her reasons for departing the company.
Employees who leave for certain reasons are considered good leavers:
- Unfair dismissal
On the flip side, bad leavers are ones who depart under less than desirable circumstances, and therefore do not receive the entire amount outlined in their clawback clause:
- Voluntarily quit
- Legally terminated
- Breach of contract
Reasons Not to Use a Clawback Clause
Many lawyers will advise clients against accepting clawback clauses for a number of reasons:
- There is a lack of security since promised funds and options are revocable,
- At-will employees don't have union protection so termination may occur at any time.
- Be cautious if you signed a noncompete clause and start working for a competitor as you could be subject to financial penalties.
If you need help with an equity clawback, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.