How Updated DOJ Guidance on Compensation Clawbacks Intersects With the World of Employment Law
Through recent updates to its guidance on corporate compliance, the US Department of Justice (DOJ) is encouraging companies to consider adopting (or updating) policies on compensation clawbacks. Actually seeking to claw back compensation from current or former employees who engaged in or oversaw wrongdoing, however, is not an easy task. In this Advisory, we discuss how compensation clawback policies may intersect and possibly conflict with the world of employment law as well as practical reality, including potential legal bases for clawing back compensation, what clawing back compensation may actually look like in practice, and potential complications.
Background on DOJ Corporate Compliance Guidance
In March 2023, DOJ’s Criminal Division updated its guidance on Evaluation of Corporate Compliance Programs. One of the key changes is the emphasis on tying employee compensation systems to compliance, including through potential clawbacks of compensation paid to employees who engaged in or oversaw wrongdoing. To further encourage companies to implement such compensation systems, the Criminal Division has also launched a Pilot Program Regarding Compensation Incentives and Clawbacks. Among other features, the Pilot Program will provide companies that successfully recoup compensation from errant employees with a reduction of fine in the amount equal to any compensation successfully clawed back. In addition, even if ultimately unsuccessful, companies that, in good faith, attempt to claw back compensation from employees engaged in wrongdoing may be eligible to receive a fine reduction of up to 25% of such compensation. Thus, DOJ is strongly encouraging all companies – public and private, large and small – to consider adopting a compensation system that includes clawback policies as part of an overall approach to improving and developing a compliance program and demonstrating ethical leadership.
Law for Public Companies on Clawbacks
The idea of a compensation clawback policy is not new, at least for publicly traded companies. Since 2002, Section 304 of the Sarbanes-Oxley Act has permitted the SEC to order the clawback of any bonus, incentive pay, or stock sale profits received by a CEO or CFO, where the company has had to restate its financials as a result of misconduct. And since 2015, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Section 10D of the Securities Exchange Act) has required the SEC to direct stock exchanges and securities associations to require listed companies to adopt and comply with a written clawback policy, again focusing on incentive compensation paid and calculated based on financial statements that were later restated due to noncompliance with financial reporting requirements. After eight years, the SEC issued final rules (Rule 10D-1) in January 2023, with a scheduled effective date in November 2023.
Faithless Servant Doctrine
Some states have long recognized the common law “faithless servant” doctrine. Rooted in the law of agency and fiduciary duty, the “faithless servant” doctrine gives employers the ability to sue an employee for acts of disloyalty, and, importantly, recover compensation paid to that employee during such periods of disloyalty or faithlessness. While New York is the most well-known for recognizing the doctrine,1 several other states – including New Jersey,2 Massachusetts,3 California,4 Maryland,5 Georgia,6 Illinois,7 and Missouri8 – and the District of Columbia9 have recognized or potentially recognize a form of the faithless servant doctrine.
Depending on the state, the scope of recoverable compensation may differ. For example, some New York courts have allowed for recovery of all compensation since the first act of disloyalty, though recent decisions have carved out some limitations to this absolute forfeiture rule.10 In other states, such as Massachusetts, damages may be limited to only the portion of compensation related to disloyalty, if the employee proves the value of services s/he rendered.11 In Maryland, courts may not award recovery of full compensation for “less fragrant” misconduct and may even conclude that no recovery is warranted for “minor” misconduct.12
Considerations and Potential Challenges in Enforcing Compensation Clawback Policies
Actually implementing and enforcing an effective compensation clawback policy may be challenging and costly. Here are some considerations and potential challenges that companies may face in seeking to claw back compensation from its employees.
Clear, Written Policy, Plan or Contract
First, companies will need to have in place a clear, written clawback policy or other clear, written provisions on compensation clawback (e.g., in employment agreements, incentive compensation plans, or award agreements). This is critical because companies seeking to enforce clawback policies/provisions will need to prove that there is an enforceable agreement (whether based on the policies or written provisions in a plan or agreement) that requires employees to return certain compensation that is already paid in cases of wrongdoing or violations of the company’s compliance policies.
Employee Acknowledgement and Agreement
Once a clear, written compensation clawback policy is established, companies should obtain acknowledgement and agreement from employees. Maintaining a clear record of such acknowledgement and agreement will be crucial should a company need to enforce the clawback policy or agreement. For example, some companies may choose to include the compensation clawback policies as part of an employee handbook or as a stand-alone policy, and to obtain employee signatures for their acknowledgement of and agreement with the various policies contained therein.
Appropriate Scope of the Policy
In establishing a compensation clawback policy, companies will also need to determine the appropriate scope of the clawback policy. For example, to whom does the policy apply? While clawback provisions in securities laws focus on executive officers, DOJ guidance is broader and does not distinguish between officers, senior-level employees, and other employees. Therefore, companies will want to consider which employees to cover by their compensation clawback policies.
Companies will also need to determine what types of compensation may be covered by the policy. Typically, a compensation clawback policy would cover incentive-based compensation and bonuses. DOJ’s guidance, however, does not specifically limit its scope to incentive-based compensation and bonus payments only, and depending on the circumstances, companies may wish to consider whether clawback policies should also apply to other forms of compensation, such as sales commissions or even wages.
In addition, what will trigger a clawback? How broad should the policy be, how objective or subjective will the standard be for triggering a clawback, and who will be responsible for administering and overseeing the policy and deciding if the conditions for clawback have been met? Will there be an internal appeal process, or some other mechanism for an employee to challenge the decision?
Potential triggers might include a financial restatement; material breach of particular company policies; failure to supervise or identify risk; or even reputational harm to the company.
Litigation or Arbitration
When compensation clawback is required, companies will need to notify the employees and request repayment. Often, employees will not voluntarily hand back compensation that already has been paid to them, has had taxes taken and likely has been spent. Employees may also dispute that the conditions for clawback were met. For current employees, the risk of future employment with the company might be sufficient to prompt repayment, especially if the amount to be repaid is relatively small. Companies could also consider reducing or deferring future salary, bonuses or other compensation for current employees, which might be easier and less costly than trying to claw back money already paid. But for former employees, the same incentives and disincentives are not present.
While in some instances, companies may be able to negotiate for and reach a private settlement with an employee,13 in most cases, companies will need to resort to litigation or arbitration to recover the money from a former employee, including based on claims for breach of contract, breach of fiduciary duty, or the common law faithless servant doctrine. This means that companies may have to engage legal counsel, file a public lawsuit, engage in the discovery process, and incur other costs. These expenses could at times easily exceed the clawback amount at issue. Companies should carefully consider whether or not to require mandatory (private) arbitration of clawback-related claims (e.g., as part of an incentive compensation plan or award agreement).
Depending on the jurisdiction, clawing back compensation could create further legal complications. Some states – such as New York, California, Massachusetts, and New Jersey – prohibit or place strict limits on an employer’s ability to make “deductions” from an employee’s wages or require repayment of wages, even where the employer receives consent from the employee. Different states have different definitions and interpretations of what kinds of compensation constitute “wages.” These laws typically provide an exception for deductions that are “required by law,” but corporate compensation clawback policies are unlikely to be considered to be “required by law” (with the potential exception for compensation clawback policies established under securities laws and SEC rule).
In addition, some non-US jurisdictions also impose limits or restrictions on compensation clawback. For example, some jurisdictions, such as Portugal and Germany, may allow clawbacks only from certain senior or managerial employees, while others may impose limits on or prohibit the clawback of compensation that has already been paid out. Therefore, companies should carefully review employment laws of relevant jurisdictions before attempting to enforce a compensation clawback policy.
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Having a compensation clawback policy where employees engage in or are responsible for misconduct carries benefits, including setting an example of corporate compliance and ethics, creating a deterrence effect, and allowing for potential penalty reductions through DOJ’s Pilot Program. And companies should certainly evaluate and review their policies in light of the new DOJ guidance and Pilot Program. But at the same time, a compensation clawback policy may come at a cost and will require a lot of careful planning and analysis to be both effective and enforceable.
For questions about the DOJ’s updated guidance, Pilot Program, or corporate compensation clawback policies, contact the authors or any of their colleagues in Arnold & Porter’s White Collar Defense & Investigations or Labor & Employment practice groups.
Click here to watch our latest video: How Clawbacks Intersect (and Conflict) With Employment Law
*Junghyun Baek contributed to this Advisory. Mr. Baek is a graduate of Harvard Law School and is employed at Arnold & Porter’s Foreign Legal Consultant Office as a Law Clerk.
© Arnold & Porter Kaye Scholer LLP 2023 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
See, e.g., Murray v. Beard, 102 N.Y. 505, 508 (1886) (“An agent is held to uberrima fides [utmost good faith] in his dealings with his principal; and if he acts adversely to his employer in any part of the transaction, or omits to disclose any interest which would naturally influence his conduct in dealing with the subject of the employment, it amounts to such a fraud upon the principal as to forfeit any right to compensation for services.”); Feiger v. Iral Jewelry, Ltd., 41 N.Y.2d 928, 928-29 (N.Y. 1977) (“One who owes a duty of fidelity to a principal and who is faithless in the performance of his services is generally disentitled to recover his compensation, whether commissions or salary.”).
See Kaye v. Rosefielde, 121 A.3d 862, 864-65 (N.J. 2015) (“[W]e hold that the remedy of equitable disgorgement is available to a trial court even absent a finding that the employer sustained economic loss by virtue of the employee's disloyal conduct.”).
See Chelsea Indus. v. Gaffney, 449 N.E. 2d 320, 326-27 (Mass. 1983) (“The defendants acknowledge that there is substantial authority in Massachusetts that a corporate officer, director, or trusted agent or employee can be required to forfeit the right to retain or receive his compensation for conduct in violation of his fiduciary duties.”).
See Ctr. For Healthcare Educ. & Research, Inc. v. Int’l Cong. for Joint Rescontr., 57 Cal. Rptr. 3d 1108, 1128 (Cal. Ct. App. 2020) (“By breaching their fiduciary duties . . . . [COO] risked that some or all of their compensation would be disgorged.”); J.C. Peacock, Inc. v. Hasko, 16 Cal. Rptr. 518 (Cal. Ct. App. 1961) (affirming trial court’s judgment that employee is not entitled to retain bonuses advanced to them in light of the employee’s breach of fiduciary duty).
See Md. Credit Fin. Corp. v. Hagerty, 139 A. 2d 230, 235 (Md. Ct. App. 1958), cited in Brightview Group, LP v. Teeters, 2021 WL 1238501 (D. Md. Mar. 29, 2021) (Former employee was not entitled to receive a portion of the compensation “he otherwise would have been entitled to receive” because he willfully and materially breached his duty of loyalty to his employer.).
See Vinson v. E.W. Buschman Co., 323 S.E.2d 204, 207 (Ga. App. 1984) (“It is well established in this state, however, as well as in other jurisdictions, that such breach of fiduciary duty negates the unfaithful agent's right to any compensation and renders him liable to his principal for his dealings with the latter’s property.”).
See ABC Trans Nat’l Transport, Inc. v. Aeronautics Forwarders, Inc., 413 N.E.2d 1299, 1314 (Ill. App. 1980) (“Under the law of this State it has long been recognized that an agent is entitled to compensation only on a due and faithful performance of all his duties to his principal.” (citations and quotation marks omitted)).
See Zakibe v. Ahrens & McCarron, Inc., 28 S.W.3d 373, 396 (Mo. App. 2000) (“Regardless of contract terms, a corporate officer forfeits all rights to compensation, including his or her entitlement to bonuses, if that officer breaches his or her fiduciary duty to the corporation.”).
See Riggs Inv. Mgmt. Corp. v. Columbia Partners, L.L.C., 966 F. Supp. 1250, 1266 (D.D.C. 1997) (“As no compensation is owed an employee who has breached his duty of loyalty to his employer, plaintiff is entitled to its return.”).
See Phansalkar v. Anderson Weinroth & Co., L.P., 334 F.3d 184, 204 (2d. Cir. 2003) ("Early decisions by the New York Court of Appeals suggest that New York's law of forfeiture requires disloyal agents to forfeit all compensation, without limitation. More recent decisions by lower New York courts, however, have endorsed the principle that faithless servant forfeitures can be limited in specified circumstances.”).
See Astra USA, Inc. v. Bildman, 914 N.E.2d 36, 50 (Mass. 2009) (“Massachusetts permits a task-by-task apportionment of forfeiture”); cf. Chelsea Indus. v. Gaffney, 449 N.E. 2d 320, 327 (Mass. 1983) (finding that the defendants-employees failed to prove the value of their services to the employer and allowing the recovery of entire compensation paid)
For example, McDonald’s brought suit against its former CEO to clawback his compensation in 2021. See McDonald’s Corp. v. Easterbrook, No. 2020-0658-JRS., 2021 WL 351967 (Del. Ch. Feb. 2, 2021). The parties ultimately settled and McDonald’s was able to clawback $105 million from the former CEO. See Dan Managan, CNBC, That McDonald’s Clawback from Fallen CEO Easterbrook Is Huge – but Still Unusual Despite #MeToo era.