A clawback provision can appear in your employment agreement, stock grant agreement, or stock plan. If it is triggered, you must surrender to the company any gains from option exercises or restricted stock vesting, or any type of bonus or incentive compensation, within a certain period. The clawback may be triggered if you leave to work for a direct competitor or if you engage in other detrimental activity that violates "bad boy" clauses, such as the disclosure of company secrets, the infliction of serious financial or reputational harm, the solicitation of employees for a new venture, or the perpetration of financial fraud.
To enforce the clawback, the company may sue you to recover gains from stock compensation. The company can also require you to forfeit outstanding equity grants (see an example at Wells Fargo). If you have not yet exercised your options, the company will stop you from exercising, cancel all unexercised options, and take away unvested restricted stock and performance shares. The company will also try to prevent you from selling any shares that you hold.
Alert: Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act makes clawback provisions mandatory for accounting restatements caused by the failure to comply with SEC reporting rules. Companies must recover gains received by any current or former executive officer that stem from incentive-based compensation and were paid during the three-year period preceding the date by which the company is required to prepare the accounting restatement. The law requires clawbacks for a restatement even without any misconduct by executives. On July 1, 2015, the SEC issued proposed clawback rules, as required by Dodd-Frank. For more on the proposed rules, see commentaries from the law firms Ropes & Gray, McGuireWoods, and Winston & Strawn.
Another type of clawback comes into effect only if a court finds the general noncompete provision in your employment agreement invalid or unenforceable. In Olander v. Compass Bank (2004), the 5th Circuit Court of Appeals upheld this type of alternative clawback. The company structured the loss of stock option profits as a backup that applies only when any court finds the separate two-year noncompete invalid or unenforceable. When the court struck down the noncompete by refusing to enjoin the former employee from working at his new job, it instead enforced the backup provision, requiring the executive to return his stock option gains. It reasoned that this compensation was conditioned on the executive's not competing.
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Outside the United States, clawback provisions triggered by the violation of a contractual agreement (e.g. noncompetition, nonsolicitation) can be tricky for companies to enforce.