Clawback

What is Clawback?

Clawback is a contractual provision that allows an employer, government, or organization to reclaim money or benefits they’ve already paid out due to misconduct or specific conditions not being met. It’s commonplace in employment contracts, executive compensation agreements, government subsidies, and tax incentive programs.

A common example of this is the clawback provisions in sales commission agreements. If a salesperson receives a commission for closing a deal, but the deal falls through later for whatever reason, the sales rep who owns the deal will have to “repay” the commission they received for that deal (e.g., through money off their next commission check).

Synonyms

• Clawback clause
• Clawback provision
• Sales clawback
• Chargeback

Importance of Clawback in Sales Commissions

Clawback provisions protect organizations from overpayments, fraud, and improper behavior. That’s why they’re so prevalent in the business world, particularly in corporate governance and financial regulation.

When it comes to incentive-based compensation, there are several advantages to having a clawback clause:

It protects company revenue.

If you had to pay out your sales reps for every deal that fell through but continued to lose all the money on that deal, your company’s bottom line would suffer tremendously.

It encourages ethical behavior.

By including a clawback provision in every sales compensation plan, you’re preventing reps from closing deals they know won’t bring in actual revenue just to earn a commission.

It incentivizes long-term success.

With a clawback clause, sales reps aren’t just closing deals at any cost. They’re invested in each prospect’s long-term success. These compensation terms facilitate thorough lead qualification and a customer-centric sales process — both of which are crucial to high CLV.

It keeps things fair among your sales reps.

Sellers who close higher-risk deals at the end of a quarter, when they’ll likely be more incentivized to find buyers with lower qualifications just to make quota, won’t get an unfair advantage over reps who already met theirs.

How Clawback Works

Whether it’s for nonperformance, misconduct, or financial losses due to a deal falling through, clawback provisions are meant to be a deterrent against bad behavior or an unfavorable financial outcome. They’re legal and binding — so long as they don’t violate any employee rights or labor laws.

Clawback triggers

In a business context, clawbacks typically target incentive-based compensation, like bonuses, stock options, or commissions — things you award based on sales performance or individual achievements. Clawback provisions ensure that if these metrics were inaccurate or manipulated, your company can retrieve the payments that are rightfully theirs.

Clawback is typically triggered by specific events or conditions, like:

• Falsification of financial records
• Misrepresentation of performance or achievements
• Fraud or misconduct from one or more contracted parties
• Failure to meet specific conditions or targets set forth in the contract
• Accounting errors or financial restatements
• Failure to meet performance goals
• A deal that fell through within a certain timeframe

Let’s say someone from your sales team closes a deal, but the new customer has a three-month buffer period where they can back out of the contract for a refund on unused months if they’re not satisfied. The client pays upfront, so you have the cash ready in your account.

To prevent your sales rep from waiting more than half a year before seeing their commission check, you could pay them right away and include a clawback clause. That way, the rep will owe the company a portion of that commission back if the customer backs out during the specified timeframe and the company needs to pay back the customer.

Calculating the clawback amount

Your contract will detail the scope, including how much money can be clawed back and under what conditions​. Some clawbacks are unlimited, but most have a cap. This could be based on a number of factors such as time period, total compensation received, or specific performance metrics.

Sales commission payouts are often based on a percentage of the deal’s value (either annual contract value or total contract value). So, if a sales rep closes a $100,000 deal and is on a 10% commission plan, they’ll get $10,000.

But the buyer might back out during the clawback period. They may have used your product or service for a month and then requested a refund for the remaining 11 in the sales contract.

How much money and which specific payment sources you can retrieve through clawback depends on the legal framework, applicable regulations, and your organization’s internal policies. In general, it’s fair to assume that if the buyer gets their money back, you’ll get a proportional refund of what you paid your sales rep.

In the above case, they’d pay back 11/12ths of their $10,000 commission — or about $9,167 — for the 11 unused months you’re refunding your customer.

Clawback implementation process and timeframe

Commission clawbacks generally have a specific time window during which they’re enforceable. In the case of sales agreements, it’s generally the same period that your customer can qualify for a refund for cancellation. For example, a month-to-month contract could have a one-month clawback period.

As far as the actual recoupment of funds, there are a few ways to do that:

• Recoupment of already vested stock
• Cash repayment
• Reduce future compensation
• Offset current or future payments

You want to be considerate of your sales team when getting your funds back. If the sales rep from our example above owed your company that $9,167 after a deal fell through, it’d be better to take it out of one or more of their upcoming commission payments rather than ask them to pay it directly.

Examples of Clawback Provisions

Clawback’s main operating principle is that it sets guidelines for reclaiming funds or benefits. However, the details of how that happens can vary wildly.

Since there are several different types of clawback provisions that serve different purposes, let’s explore a few common scenarios:

Executive compensation

Company execs generally receive compensation packages that include performance-based bonuses and stock options.

If the company later discovers that the financial results used to justify these payouts were misstated or fraudulent, a clawback clause allows the company to recover the compensation.

This became a hot issue after the 2008 financial crisis when companies were accused of excessive bonuses despite poor financial performance.

Now, thanks to the Dodd-Frank Act of 2010, companies listed on stock exchanges are legally required to have a clawback policy for situations like these. And most companies have followed suit to avoid potential legal issues and losses.

Fraudulent activity

In cases of fraud, companies often recover bonuses or incentives paid based on false information.

A notable example is Airbnb, which has a clawback policy allowing the company to reclaim cash incentives or equity awards if financial statements are restated due to fraudulent actions by employees or executives.

This policy ensures accountability when misreporting is uncovered.

Misrepresentation of sales data

Clawback situations happen when representatives misrepresent sales data to earn commissions (or, more commonly, when the data misrepresents the actual commission they’ve earned).

For instance

1. Salesperson A earns a commission for signing a contract.
2. That contract is later canceled, so the company can claw back the commission previously paid.
3. To account for this, they adjust the salesperson’s earnings based on actual, valid sales numbers.

Non-compliance with company policies

If an employee breaches company policies, companies can recover any bonuses or commissions tied to their performance. For example, you might put a clause in your contractual agreements allowing your company to claw back funds when employees violate internal policies or securities laws​ (e.g., profits from insider trading).

Post-sale disputes or chargebacks

There are several types of disputes that can come up after you complete the sale. When a customer disputes a charge, they might be due a refund for that charge. Or, if their situation warrants a cancellation, you might owe them a partial refund for unused services. 

Chargebacks are a type of clawback that happen when a customer initiates a refund for a product or service they’ve already paid for. Sometimes, customers purchases with their credit cards and then contest the charge when they’re unhappy with the product, irrespective of your refund policy.

Government clawbacks

Governments generally include clawback clauses when granting subsidies, tax breaks, or financial incentives to companies. If the company fails to meet the conditions for these incentives — such as creating a certain number of jobs or investing $X amount in a local area — the government can reclaim the benefits they disbursed.

Bankruptcy clawbacks

In bankruptcy law, clawback provisions allow trustees to recover payments made by the debtor to certain creditors before the bankruptcy filing, especially if these payments are seen as unfairly benefiting some creditors over others.

Best Practices for Implementing Clawback Clauses

Whether it’s a sales clawback on a commission payment or a more complicated financial arrangement, enforcement is a touchy issue. You need to clearly define the parameters of your clawback provision and implement them consistently.

When creating a clawback provision, keep in mind these best practices:

1. Clear and concise clause language

Most importantly, you have to make sure your  clawback clause is written in a way that’s easy to understand for all parties involved. If there’s any ambiguity or room for interpretation, you’ll have a harder time enforcing it because the other party may try to argue that they didn’t fully understand what the provision entailed.

To avoid this:

• Use simple language that everyone can understand.
• Clearly define the situations in which a clawback can be triggered.
• Specify how much money or benefits can be reclaimed.

Leave no room for ambiguity, and make your provision as uncomplicated as possible (e.g., “if X, then Y”).

2. Reasonable thresholds for employees and customers

If your deal structure leans too far in your customers’ favor (e.g., by allowing them to cancel far into their contract for a full refund), and then you transfer those costs back to employees, you will definitely have a retention problem.

It’s simply not fair to constantly take team members’ commissions back because you’ve made your refund and cancellation policies too lenient.

Set reasonable thresholds for your clawback policies so that your employees get the commissions they deserve. As an added benefit, this will help you protect your margins and get paid for the actual products/services you’ve delivered.

3. Fair and equitable application

You can’tuse clawbacks sometimes and not enforce them on others. Your team will accuse you of picking favorites. And they’d be right.

You have to apply clawbacks consistently, regardless of the employee or situation. If you want to exclude certain circumstances from your clawback provision, make sure it’s clearly stated in the language of the clause. And make sure it applies across you entire sales department.

4. Transparent communication with your sales team

If you’re going to claw back sales commissions, it’s not just about whether it’s legally enforceable or not. You also need to consider how it’ll affect your sales reps.

If they’re frustrated by the unpredictability of their commissions and bonuses, they’ll become demotivated. And if they don’t understand why you’re taking back the comission, you’ll frustrate them.

As part of your sales onbarding, tell your employees upfront when they’ll owe commission back, how that works, and why it’s important. And if you do claw back money, make sure to give them a detailed explanation of what happened and a heads-up warning so they can understand the situation, prepare for it, and learn from it.

5. Training and education on clawback policies

Beyond your sales team, management and HR need to be trained on how to implement your clawback policy and have a thorough understanding of when it’s appropriate. That way, if a dispute arises, your team is prepared to handle it in a way that’s consistent with company policy.

6. Regular reviews and updates for your clawback clauses

What happens when your business conditions or market changes? Does your clawback provision still make sense?

Make sure to review and update your clawback clauses regularly to ensure they’re still relevant and effective in protecting your company’s interests.

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