# Clawback: Definition, Meaning, How It Works, and Example

## What Is a Clawback?

A clawback is a contractual provision requiring that money that's already paid to an employee must be returned to an employer or benefactor, sometimes with a penalty.

Many companies use clawback policies in employee contracts for incentive-based pay such as bonuses. They're most often used in the [financial industry](https://www.investopedia.com/terms/f/finra.asp). Most clawback provisions are non-negotiable. Clawbacks are typically used in response to misconduct, scandals, poor performance, or a drop in company profits.

### Key Takeaways

*   A clawback is a contractual provision that requires an employee to return money that's already paid by an employer, sometimes with a penalty.
*   Clawbacks act as insurance policies in the event of fraud or misconduct, a drop in company profits, or poor employee performance.
*   Provisions typically only involve incentive-based pay such as bonuses or other benefits.
*   Clawbacks are used primarily in the financial industry but they can also be found in government contracts, pensions, and Medicaid.

![Clawback](https://www.investopedia.com/thmb/DJKC30EzPpyk4IMM7YboLMmDuug=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/TermDefinitions_Clawback_finalv1-46ee9465e67a42eeb8dbfa040a262c8d.png)

*— Investopedia / Mira Norian*

## Understanding Clawbacks

Clawback clauses have increased since the financial crisis of 2008 because they allow a company to recover incentive-based pay from CEOs in the case of misconduct or any discrepancies in the company's financial reports. In 2005, 17.6% of Fortune 100 companies used clawback provisions. By 2021, this rate has jumped to 81%. Also, over 90% of the companies in the S&P 500 and over 65% of companies in the Russell 3000 use clawback policies. This massive adoption of this clause is largely driven by regulatory changes aimed at enhancing corporate governance and accountability.

Clawbacks are also written into employee contracts so employers can control bonuses and other incentive-based payments. The clawback acts as a form of insurance in case the company needs to respond to a crisis such as fraud or misconduct or if the company sees a drop in profits. The employee must also pay back monies if the employer feels that their performance has been poor.

Clawbacks are different from other refunds or repayments because they often come with a penalty. An employee must typically pay additional funds to the employer when a clawback goes into effect.

Clawback provisions prevent people from using incorrect information and they're used to put a balance between community development and corporate welfare. They can help to prevent the misuse of accounting information by employees in the financial industry.

Clawbacks are considered an important part of the business model because they help to restore the confidence and faith of investors and the public in a company or industry. Banks implemented clawback provisions following the financial crisis as a way to correct any future mistakes by their executives.

## Clawbacks and Executive Compensation

The [Sarbanes-Oxley Act](https://www.investopedia.com/terms/s/sarbanesoxleyact.asp) of 2002 was the first federal statute to allow for clawbacks of executive pay. It provides for clawbacks of bonuses and other incentive-based compensation paid to CEOs and CFOs if misconduct on the part of the company and not necessarily the executives themselves leads it to restate financial performance.

The Emergency Economic Stabilization Act of 2008 was amended in 2009. It allows for clawbacks of bonuses and incentive-based compensation paid to executives or the next 20 highest-paid employees. It applies in cases where financial results are found to have been inaccurate, regardless of whether there was any misconduct. The law only applies to companies that received Troubled Asset Relief Program (TARP) funds.  

### Note

Dodd-Frank Wall Street Reform and the Consumer Protection Act of 2010 required companies to implement policies to recover executive compensation in the event of financial restatements due to noncompliance with accounting standards​.

A proposed Securities and Exchange Commission (SEC) rule was proposed in July 2015. It was associated with the Dodd-Frank Act of 2010 and would allow companies to claw back [incentive-based compensation](https://www.investopedia.com/terms/a/accounting-based-incentive.asp) paid to executives in the event of an accounting restatement. The clawback is limited to the excess of what would have been paid under the restated results. The rule would require stock exchanges to prohibit companies that don't have such clawback provisions written into their contracts from listing.

This rule was approved on Oct. 26, 2022.

## Clawbacks in Private Equity

The term clawback can also be found in some other settings. It refers to the limited partners' right in [private equity](https://www.investopedia.com/terms/p/privateequity.asp) to reclaim a portion of the general partners' carried interest in cases where subsequent losses mean the general partners received excess compensation.

Clawbacks are calculated when a fund is liquidated. [Medicaid](https://www.investopedia.com/articles/pf/07/medicare-vs-medicaid.asp) can claw back the costs of care from deceased patients' estates. Clawbacks may not even refer to money in some cases. Lawyers can claw back privileged documents that were accidentally turned over during electronic discovery.

> **Important**
>
> The term clawback also refers to a fall in a stock's price after it increased.

## Examples of Clawback Provisions

Several federal laws allow clawbacks of executive compensation based on fraud or accounting errors. Companies may also write clawback provisions into employee contracts whether such provisions are required by law or not so they can take back bonuses that have already been paid out.

Some of the most common clawback provisions used by corporations, insurance companies, and the federal government include:

*   **Executive compensation**: Clawbacks can be used if an executive breaches an agreement, misuses information, or goes to work for a competitor.
*   **Life insurance**: A provision could dictate that the [policy](https://www.investopedia.com/terms/l/lifeinsurance.asp) is canceled and payments will have to be returned.
*   **Dividends**: These can be clawed back under certain circumstances. 
*   **Government contracts**: [Contractors](https://www.investopedia.com/terms/i/independent-contractor.asp) may be subject to clawbacks if some requirements of the contract aren't met. 
*   **Medicaid**: Medicaid can recover any monies paid to care for a Medicaid recipient after they've died.
*   **Pensions**: Companies can claw back pensions if there's any evidence of fraud or misuse of information by the pensioner.

## When Can Medicaid Claw Back Care Costs?

State Medicaid programs are required to claw back payment of costs for nursing facilities, hospitals, prescription drugs, and home- and community-based services but this rule applies only to recipients who are age 55 or older. This money is typically recouped from their estates after death but there are provisions for undue hardships imposed upon surviving kin.

## Are There Any Defenses Against Clawback Provisions?

It depends on the nature of the provision but a clawback that isn't supported by a written, signed agreement at the time a business relationship is entered into can be argued as being unsupportable.

State wage and hour laws can also support or defend against this issue in employment matters.

It might help to establish that a clawback was never initiated against anyone else under the same circumstances, indicating that some level of prejudice exists.

## What's an Example of a Clawback Penalty?

Again, it can depend on the nature of the provision and the source of the money in question but a penalty is typically an amount that's added to the money being reclaimed.

An employee might receive a $5,000 bonus for reaching a sales goal but the bonus came with a clawback provision. It's later discovered that the employee tinkered with sales records and didn't reach that goal. The clawback might include a $5,000 repayment plus a 10% penalty for a total of $5,500.

## The Bottom Line

Clawbacks often result from issues of misconduct or poor performance by an employee but they can also occur when a company is experiencing financial woes due to no fault on the part of the employee involved. A clawback can typically be enforced if it’s agreed upon in a written, signed contract.

You’ll want to seek legal help in any case if you’re hit with one so you’re sure you understand all your rights, options, and obligations. This is particularly the case when the government is involved, such as with Medicaid, or if your retirement provisions are threatened.

> **Article Sources**
>
> 1.  Gibson, Dunn & Crutcher LLP. "['Clawbacks' of Executive Compensation; Letter, July 9, 2008](https://corpgov.law.harvard.edu/wp-content/uploads/2008/07/070908-clawbacksonexecutivecompensation.pdf)." Page 2.
>     
> 2.  Society for Corporate Governance. "[Re: Release No. 33-10998; 34-93311; IC-34399; File No. S7-12-15 (Reopening of Comment Period for Listing Standards for Recovery of Erroneously Awarded Compensation); Letter, November 29, 2021](https://higherlogicdownload.s3.amazonaws.com/GOVERNANCEPROFESSIONALS/a8892c7c-6297-4149-b9fc-378577d0b150/UploadedImages/Comment%20Letters/Society_Comment_Letter_Clawback_Rule_2021.pdf)." Page 5.
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> 3.  Gibson, Dunn & Crutcher LLP. "["Clawbacks" of Executive Compensation; Letter, July 9, 2008](https://corpgov.law.harvard.edu/wp-content/uploads/2008/07/070908-clawbacksonexecutivecompensation.pdf)." Page 1.
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>     
> 5.  Harvard Law School Forum on Corporate Governance. "[Clawbacks Under Dodd-Frank and Other Federal Statutes](https://corpgov.law.harvard.edu/2011/06/09/clawbacks-under-dodd-frank-and-other-federal-statutes/)."
>     
> 6.  U.S. Securities and Exchange Commission. "[Fact Sheet/Recovery of Erroneously Awarded Compensation](https://www.sec.gov/files/221025-clawbacks-final-rule-fact-sheet-embargo.pdf)."
>     
> 7.  Harvard Law School Forum on Corporate Governance. "[SEC Finalizes New Clawback Rules](https://corpgov.law.harvard.edu/2022/11/15/sec-finalizes-new-clawback-rules/)."
>     
> 8.  Medicaid. "[Estate Recovery](https://www.medicaid.gov/medicaid/eligibility/estate-recovery/index.html)."
>     
> 9.  Epstein, Becker & Green. "[Bonus Compensation and Clawbacks: What Employers Need to Know](https://www.ebglaw.com/insights/publications/bonus-compensation-and-clawbacks-what-employers-need-to-know)."