It is increasingly common for bonuses to come with strings attached. Often there will be a contractual term requiring the employee to repay the bonus if, for example, they give notice of resignation or are fired for gross misconduct shortly after it is received.
For regulated and/or listed companies, there will be further requirements arising under law, for example the FCA/PRA Remuneration Codes for banks and insurers.
This is a complex area of law with many myths and misconceptions surrounding whether, and when, an employer can “claw back” a bonus from an employee. However, a recent case has highlighted some of the key principles.
What do employers need to know?
1. What are the relevant legal principles?
There are a number of grounds on which an employee may challenge a demand for the clawback (or repayment) of a bonus payment:
- Is the clawback provision sufficiently well drafted? The employee may challenge the clause which their employer has invoked on the basis that it is vague and uncertain, meaning a court will refuse to uphold it for lack of certainty. Is it clear how long it lasts for, the circumstances in which it is triggered and how much will be paid back?
- Is the clawback provision engaged on the facts? There may be a dispute as to how the clause is interpreted. For example, is it triggered by the employee giving notice of resignation or by the termination of their employment? If the clawback period expires in between the two dates, then there may be a dispute as to whether the situation is within scope of the employer’s right to claw back the bonus at all.
- The penalty doctrine: Although a party to a contract can, in principle, specify what happens if the other party breaches the contract – for example a payment of liquidated damages to the innocent party – there are limits to this. A court will refuse to enforce this type of clause if its terms are exorbitant or out of all proportion to the innocent party’s legitimate interest. An employee may often argue that this is the case with draconian clawback terms, but very often the penalty doctrine will not apply at all, since it is only relevant to breaches of contract. Clawback clauses are more often triggered by actions which do not involve a breach, for example giving notice of resignation.
- Improper exercise of discretion: The law will prevent an employer from exercising a contractual discretion against an employee in a way which is capricious or arbitrary or otherwise irrational. If a clawback provision confers a discretion on the employer on whether or not to require repayment of the bonus, and the employer exercises it in bad faith or only in respect of certain former employees, then the individual could argue that the decision is invalid. Similarly, there may also be a challenge under the Equality Act if the decision of the employer was tainted by discrimination on the basis of a protected characteristic.
- Repudiatory breach of contract: A key principle in the general law of contract is if one party repudiates a contract, for example by committing a fundamental breach of its terms or by renouncing its obligations before the time comes to perform them, then the other party can elect to terminate the contract. If that occurs, then both parties are released from their future obligations and the contract comes to an end, although the innocent party can still sue for damages. If an employer commits a material breach of its obligations to the employee (such as the implied term of trust and confidence), then the employee might argue that they have a right to terminate the contract and to consider themselves constructively dismissed, with the consequence that the clawback cannot be enforced.
- Restraint of trade: This is perhaps the most common argument an employee may use to challenge a clawback clause. The recent case of Steel v Spencer Road LLP [2023] provides a good example of this. In that case, the employee resigned about a month after receiving a discretionary bonus of £187,500, which led the employer to require repayment of the bonus as it was caught by a clawback provision which applied for three months after the payment of the bonus. The court upheld the clawback clause, since although it acted as a disincentive to resignation, it was not an unlawful restraint of trade.
2. What should the clawback clauses look like?
Given the many grounds on which they can be challenged, employers should ensure that their clawback clauses are detailed and well drafted, making sure that:
- the period of time during which the clawback applies is clear;
- the employee has expressly agreed to the contractual clawback term;
- the terms make adequate provision for how tax is dealt with, in particular whether the employee is required to return only the amounts received after tax, or return the full gross amount and seek a rebate from HMRC;
- the clawback is not only triggered by breaches of contract (such as if the employee competes with the firm whilst still employed), since that might fall foul of the penalty doctrine;
- ideally, the clause characterises the bonus as a “payment for loyalty” which is to be returned if the employee resigns – which is easier to enforce and may not be considered a restraint of trade at all – than one which is to be returned if the employee engages in competition after employment;
- the terms are not inconsistent with any applicable remuneration policies which apply to the company; and
- the terms are not so long in duration as to risk being void as a restraint of trade.
3. How do employers introduce clawback terms?
In most cases, an employer will not be entitled to clawback any part of a bonus unless such an entitlement is provided for in the bonus arrangement from the outset. However, if the bonus payment is purely or significantly at the discretion of the employer, there may be scope for an employer to introduce a clawback provision as a new condition before or at the time that the bonus is awarded, but the employee must expressly agree to the clawback clause.
Employers should ensure that if bonuses in the future are to be subject to clawback, the employee’s binding agreement is obtained to that effect, for example by requiring their signature on a side letter.
Employers should, in order to minimise the prospect of a clawback provision being challenged, consider whether there should be a tapering mechanism in the clause. For example, if the employee resigns within a short period the full bonus is repayable, but if they resign further in the future only half is repayable.
Employers should also consider what it is that triggers the clawback, for example, resignation, disciplinary outcomes, post-termination activities in competition with the firm, or failure to meet performance targets. How the terms are drafted will impact the prospect of their being enforceable.
For example, if the clawback provision is triggered by an employee breaching a restrictive covenant, then the provision may be a restriction of trade and therefore void. In Sadler v Imperial Life Insurance Company of Canada (1988), an employee’s right to post-termination commission was subject to the proviso that his entitlement to the payments would cease in the event that he moved to another employer in the same industry. This was deemed to be an unlawful restraint of trade as it restricted the future freedom of the employee. The forfeiture clause was therefore severed from the agreement by the court.
In contrast, a provision requiring an employee to repay a ‘golden hello’ and loyalty bonus if they resigned within a certain period was found to be enforceable in Tullett Prebon v BGC Brokers (2010). The provision was not a restriction of trade because it did not affect the employee’s activities once the employee had left the employer. Nor was it a penalty clause, because the clawback was not reliant on the employee breaching his contract.
4. What can the employee do about it?
A. Legal challenge
As discussed above, there are a number of legal bases on which to challenge a clawback clause.
Unless the bonus arrangements are carefully drafted and the circumstances in which an employer can clawback a bonus are objective and reasonable, the employer may find itself facing an action for breach of contract (including breach of the implied term of trust and confidence) or unlawful deduction of wages if it seeks to recover an employee’s bonus.
To recover the bonus from a reluctant employee the employer may need to take formal action, such as the service of a statutory demand (as occurred in the Steel case) or a court claim in the civil courts.
B. Negotiation
Since court action is unpalatable for both sides, in many cases there is likely to be scope for the parties to reach a negotiated settlement, perhaps where the individual pays back a lower amount of the bonus demanded in return for the employer’s agreement not to sue.
It is important for both sides that this is recorded in a formal and binding settlement agreement, particularly since the employer could argue that the return of part of the bonus does not fully discharge the individual’s obligation under the contract clause.
C. Arrange a buy-out by the new employer
Another common approach is for an individual seeking to move to a new employer to agree with their new business that they will be bought out of the bonus which they have to pay back to their current employer if they decide to leave.
Again, it is important that these arrangements are properly documented, particularly since there will be significant sums at stake.
Contact us
If you have any questions about these issues in relation to your own organisation, please contact a member of the team or speak to your usual Fox Williams contact.
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