In October 2022, the US Securities and Exchange Commission (the SEC) adopted the final executive compensation “clawback rules” (the Final SEC Rules). In response to the Final SEC Rules’ instruction, on February 22, 2023, the New York Stock Exchange and Nasdaq Stock Market LLC released their respective proposed listing standards (the Proposed Exchange Rules) that require most listed companies to adopt and implement a clawback policy providing for the recoupment of excess incentive-based compensation received by current or former executive officers due to certain misstatements of the company’s financial reports, regardless of any actual misconduct. Depending on when the SEC approves the Proposed Exchanged Rules, companies may need to have in place compliant clawback policies as early as June 26, 2023. Companies that fail to comply with the new standards may be delisted. See more on the Final SEC Rules and the Proposed Exchange Rules (together, the US Clawback Rules) here and here.
Unlike most SEC governance and US stock exchange requirements, the US Clawback Rules apply to non-US companies (foreign private issuers) that are listed on a US exchange. Once the clawback policy has been triggered, very limited discretion is left to the company over whether to seek recovery. The company must make reasonable efforts to seek recovery, except in limited circumstances where recovery would be impracticable because of cost, home country laws, or interference with tax qualification of plans.
This post explores the scope of the home country law exemption, provides an overview of the global landscape of clawback enforceability, and offers practical tips for foreign private issuers.
Home country law exemption
Non-US companies are exempt from the requirement to recover incentive-based compensation if recovery would violate home country law where that law was adopted prior to November 28, 2022. Before concluding that it would be impracticable to recover any amount of erroneously awarded compensation based on violation of home country law, the company must obtain an opinion of home country counsel acceptable to the relevant stock exchange that recovery would result in such violation.
It is notable that home country here refers to the home country of the company, rather than of the executive whose compensation is the subject of recovery. This means that even if the jurisdiction in which the executive is based prohibits recovery, so long as recovery is enforceable in the country in which the company is incorporated, the company would be required by the US Clawback Rules to pursue recovery.
So how easy is it to enforce clawback in jurisdictions outside the US?
Enforceability of clawback
The following chart provides a sense of where some of the key jurisdictions outside the US lie in terms of the likelihood of enforceability. To discuss enforceability in a particular jurisdiction, please contact your usual Freshfields contact, or any member of the Freshfields People & Reward team.
Jurisdictions generally vary in their approach to clawback enforceability depending on the types of payments that are being sought to be recovered, whether or not executives have agreed to the clawback terms, and the tax implications of clawback.
Discretionary payments are more likely to be able to be clawed back than contractually required payments. In some jurisdictions, clawback is allowed in respect of incentives that are voluntarily provided by the employer, such as bonuses and stock options; whereas if the incentive-based payment is deemed to have been granted as part of an “employment benefit” or is an “acquired right” recoupment is likely to be prohibited. Discretionary payments generally refer to payments that do not arise from mandatory or statutory rights and operate outside express contractual terms. For example, bonuses may be contractual if employees have an entitlement to participate in a bonus plan according to a prescribed formula, or if an employment contract includes a guaranteed amount of bonus payable. In contrast, bonuses may be discretionary if they are paid as and when and in an amount the employer decides. In most cases, however, the distinction may not be so clear-cut, and the way the employer describes a particular incentive payment to its employees, the frequency and the pattern of such payment, and the form in which the payment is documented, will be crucial.
Clawback terms expressly agreed between employer and executives are more likely to be enforceable. In jurisdictions where courts do not permit recovery of contractual payments, voluntary express agreements will not make any difference. Even in jurisdictions where recovery of discretionary payments is permitted, clawback terms should be clearly set out in the rules of the incentive arrangements, in the employment agreement and/or in a standalone policy, and executives’ written agreements to such should be obtained. Clawback terms should set out the instances and the extent to which recovery may be sought, the timeframe within which an incentive payment may be subject to clawback, and the executives’ voluntary agreement to such terms. Employers should keep a careful record of executives’ agreements to the terms, make sure that the clawback terms contained in various documents are consistent, and keep executives updated of any amendments to clawback policies.
The presence of clawback requirements does not guarantee enforceability. In the EU, the Capital Requirements Directive 2013/36/EU (CRD4) requires financial institutions to make discretionary remuneration awarded to employees subject to clawback, and individual states are required to implement CRD4 through their own legislations. In response, France has introduced a statute that expressly states that the clawback provisions in the financial sectors constitute an exception to the general rule in the French Labour Code that prohibits financial sanctions against employees. However, clawback legislation in many other countries often does not give clear guidance on the potential conflict with employment laws or is explicit that the clawback legislation is without prejudice to the general rules of employment law.
Jurisdictions differ on whether clawback should be on a pre- or post-tax basis. While some jurisdictions permit clawback from the gross amount (i.e., pre-tax) of compensation, other jurisdictions limit recovery on a net salary basis (i.e., post-tax). The US Clawback Rules require that the amount to be recovered should be computed without regard any taxes already paid. Even in jurisdictions where the courts’ position is aligned with the US Clawback Rules, in practice, it is administratively burdensome to recover the overpaid taxes on the amount recovered, and some tax leakage is likely.
As described, enforceability remains untested and questionable in many jurisdictions. However, there are some practical steps that companies may consider to ensure compliance with the US Clawback Rules:
- Structure incentive compensation as discretionary arrangements, rather than contractual benefits, by reviewing the way the compensation is paid, communicated and documented.
- Ensure that the clawback policy is drafted clearly and remains easily accessible to executives.
- Obtain executives’ express written agreements to the clawback policy and keep such consent up to date. Companies may consider periodic refresh of such consent.
- In addition to the clawback policy, have a detailed implementation policy for internal guidance to mitigate any risk of executives challenging recovery and to demonstrate that the board has acted reasonably in seeking recovery.
- Consider using a deferral and/or nominee arrangement whereby the incentive compensation is set aside until the end of the clawback look-back period to help facilitate recovery.
- If clawback is determined to be required pursuant to the US Clawback Rules, and the company’s home country does permit enforceability of clawback, notwithstanding the unenforceability in the jurisdiction in which the executive is based, make a reasonable attempt to recover the excess incentive compensation, even if the executive is likely to challenge such recovery. The company may subsequently conclude and demonstrate to the relevant US exchange that the pursuit is impracticable because the direct expense paid to a third party to assist in enforcing the policy would exceed the amount to be recovered.