Clawback Provisions: Balancing Risk With Rewards

Could this little-known contract clause hold the biggest secret to your sales transformation?

Contrary to popular wisdom, life does give us a second chance. Revenue leaders call it a Clawback.

If a payout - such as a sales commission or a performance-based incentive - has been made in error, or has somehow gone ‘bad’, clawback clauses allow the business to recover the cost or loss.

By doing so, clawback clauses aim to provide a level of protection against the business without hurting performance incentivization or demotivating employees.

A recent study tells us that four of five companies (with $10 billion or more in market capitalization) have clawback provisions in their contracts in some form or the other. A sizeable portion also enforce it well beyond stipulated mandates, throwing additional clauses into the mix for good measure.

Defining a clawback

A clawback provision or clause is a legally enforceable obligation that’s part of an employment contract or executive package. It mandates the individual to return compensation and benefits, in part or in full, under ‘special’ circumstances; these special conditions are specified in the contract agreement.

Clawbacks are non-negotiable and usually involve a penalty, making them different from a simple refund or repayment. Clawback provisions increased by 79% from 2005 to 2010 amongst Fortune 100 companies.

When do clawback provisions come into play?

Corporate scandals like the Enron case catalyzed the adoption of clawbacks in the early 2000s as lawmakers and regulators stressed on stronger governance measures.

Clawback provisions are triggered by a variety of reasons and contingencies. Here are some.  

Compensation can be claimed back by the company if fraudulent activity - such as financial misreporting, adulteration of facts or suppression of information - is detected.

Payouts can be reclaimed if a deal is found to be phony, or in breach of company values and policies.  

Compensation plans can feature clawback provisions for deals that don’t translate into a positive transaction within a stipulated period of time.

Clawbacks reset the financial equilibrium when a product is returned, a subscription is cancelled, a client churns (within the allowed time leeway), a customer defaults, or a sale is cancelled.

Conversely, clawback clauses can also come into play when a customer has overpaid.

Clawback provisions also come into effect when an employee’s performance doesn’t match up to expectations, and the company’s revenue is in steady decline.

Understanding the need for clawback provisions in commerce and business

Clawback provisions are much more than just hedges and balances that act as insurance mechanisms for the financial well-being of a business.

When embraced with sensitivity and practiced with consistency, they can be instrumental in molding a ‘lean, mean sales machine’ that’s equipped with the intelligence and instinct to sniff out unprofitable deals a mile away.

A clawback system done right embeds judicious planning, healthy reflection and efficient emotions deep inside the operational fabric of sales teams and channels, channelizing energies only on prudent initiatives and high-ROI habits.

Here are some standout reasons why every sales driven department and business must prioritize clawback clauses-

• By ensuring that compensation is paid only if revenue has actually been realized, clawback provisions safeguard a company’s coffers from being drained from overcompensation.
• Conversely, the absence of a clawback buffer can damage profitability and dent cash flow.
• A clawback provision ensures that payouts are made only when certain conditions are ticked, ensuring smarter alignment between incentives and performance.
• Perhaps the biggest benefit of clawback clauses is that they incentivize the right sales behaviour. They encourage desirable practises and values like vetting, verification and so on.  
• Be it employees, extended teams or channel partners, people stop chasing ‘iffy’, high risk deals, and start focusing on those with greater chances of fulfilment.
• As an extension of the above point, clawback provisions will motivate sales folks to think beyond just encashing their commissions, and  double down on customer experience. They will follow up more diligently, prioritize after-sales satisfaction and invest in igniting long-term relationships, laying the foundation of long term gains.   
• Clawback adoption enhances the verifiability and credibility of financial forecasts by ensuring fairness in commission calculations and can perceptively improve the quality of financial audit and reporting.
• Clawback provisions are a deterrent against fraudulent approaches: They discourage unethical behaviour and nurture sustainable culture bulwarks based on responsibility, transparency and accountability.
• Clawback clauses build confidence amongst the larger ecosystem of investors, stakeholders and markets.

Kinds of clawback provisions

Clawback clauses can come in different shapes and sizes. Let’s take a look at some of the more popular avatars-

• The most straightforward instance is when a sales person has to return the entire commission or compensation amount on a cancelled or bad deal.
• Then there are clawback provisions applicable on tiered-based incentive models where quotas are reset by subtracting the value of the transaction that didn’t go through.
• Quota adjustments of the above nature can be time flexible, that is, may be done retroactively or for future adjustments.
• Quota adjustments may also be partial, making room for the percentage of the deal that was successfully fulfilled.

When clawbacks biteback

In an imperfect world, what benefits a company financially can come out of the pocket of a worker, leading to friction and making clawbacks a potentially double-edged sword.

This Oracle case study is a reminder that a simple miscalculation may bring unintended consequences, hurting a business financially and reputationally.

Let’s see why organizations need to be mindful and careful in the way they design their clawback provisions-

• Clawback provisions can demotivate employees as compensation and recognition for effort - done in earnest – may be denied.
• Clawback clauses can also pull the brakes on rockstar performance as sales folks ditch spectacular, high-risk, high-reward gambits in favour of safer approaches.  
• Salespeople can spend undue amounts of time decoding and tracking complicated clawback calculations, compromising on focus, building up stress and blunting productivity.
• Ambiguous and confusing clawback terms can be a nightmare for accounting and administrative teams, hindering the process of financial reporting.
• A mix of some of the above aspects can lead to interdepartmental distrust, unpopular appraisals and low morale, causing the organizational culture to suffer.
• The result could be high employee churn and negative brand reputation in talent markets, affecting the organization’s ability to attract top performers.
• Finally, employees can recourse to lawsuits and legal instruments to ‘get back’ at the company.

How to bake a great clawback plan into your compensation strategy

When implemented right, clawback provisions can open new doors of opportunity for an organization. The flip side, on its part, features stark risks. It is therefore expected that company leaders invest necessary time and focus to build a balanced and reasonable clawback provisions framework that works best for their specific situation.

• First things first, Clawback provisions must be approached from a progressive mindset, not a punitive one. It works best when we are looking to correct course and elevate behavior, not when we are trying to restrict and punish.
• The right legal counsel must be sought to ensure proper compliance with rules and regulations.
• Make it easy for everyone to understand and track with an uncomplicated structure, clear expectations and regular channels of communication.
• Make relevant documentation and literature easy to access for everyone and provide detailed guides and FAQs that simplify complicated clauses and targets.
• Clawbacks can be complex, making equitable deployment a challenge. Leaders must embrace appropriate systems and technologies - like digital management systems and automation - to reduce implementation burden on accounting and admin teams.
• Review your clawback provision setup in the context of business outcomes and employee performance from time to time, ploughing the insights back to iteratively refine the model.
• Coach and educate sales teams and channels constantly. When doing so, step beyond the ‘what’ by shedding light into the ‘why’, explaining clawback provisions in the context of the larger organizational purpose.