The enforceability of clawback clauses are strengthened in a recent High Court decision

Clawback is the recovery of variable remuneration, such as a performance-linked bonus or share award, which has already been paid to an employee or already vested. This may be invoked where there is a subsequent discovery (for example, employee misconduct), or consequent events occur (such as an error in calculating performance) which mean that an employer wants to recover amounts already paid to an employee.

From a practical point of view, clawback can be difficult to implement since it involves recouping money (or shares) that have already been paid or transferred to the employee. Further, it is particularly difficult to clawback a bonus or shares where the employee has left their employment.

For certain firms regulated by the Prudential Regulated Authority or Financial Conduct Authority operating in the financial services sector in the UK, clawback of bonuses is mandatory. Further, UK listed companies are expected to implement clawback provisions for executive directors' bonuses and share awards under investor guidelines. It is therefore a "hot topic" in remuneration.

Given their prevalence in senior managers' and executive directors' bonus agreements and share plans, it is therefore comforting for employers that in the recent High Court decision ofSteel v Spencer Road LLP(the Steel case) it was found that clawback provisions requiring pay-back of a bonus upon termination of employment were not an unreasonable restraint of trade.

What is restraint of trade?

Restraint of trade can occur where an employer restricts an employee from working by imposing, for example, post-termination restrictions on them such as a non-compete clause. To be enforceable an employer must demonstrate that the restraint is protecting a legitimate business interest and goes no further than is reasonably necessary to protect that interest.

What was the background to the Steel case?

Mr Steel participated in a discretionary bonus scheme. Payment of the bonus was conditional upon Mr Steel remaining in employment for three months after it was paid, and that he had not given or received notice to terminate his appointment during that period. Significantly, the clawback clause did not also say he could not work for a competitor or otherwise breach his restrictive covenants – Mr Steel simply could not resign.

In January 2022 Mr Steel was paid a bonus of £187,500 which was significantly higher than his £65,000 basic salary. Mr Steel gave notice of termination of his employment a month later. His employer requested the bonus repayment under the clawback provisions in his employment contract. Mr Steel refused and was served with a statutory demand. Mr Steel argued that the bonus clawback provisions in the contract operated as an unreasonable restraint of trade or were penalty clauses and were therefore unenforceable.

The High Court's decision considers an appeal by Mr Steel after his application was dismissed and he had repaid his bonus.

The High Court's decision

The central issue that the High Court had to consider was whether a bonus clawback which is conditional on remaining in employment for a certain period of time is a restraint of trade.

Following previous case law, the High Court recognised such a provision is a disincentive to the employee resigning. However, that doesn't turn the provision into a restraint of trade restricting the employee's ability to work after he left his current employer. Furthermore, this disincentive to resign and Mr Steel's additional three-month notice period, which effectively meant that he would have to remain working for six months to retain his bonus, did not further the argument of a restraint of trade.

值得注意的是,钢铁先生的雇佣合同控制ained other restrictive covenants which were not included within his grounds of appeal. The analysis was therefore not affected by the post-termination restrictive covenants – they were distinct from and separate from the clawback provisions.

这个决定echoes the verdict inTullett Prebon plc and others v BGC Brokers LP and others [2010]in which the High Court held that provisions requiring employees to repay certain loyalty bonuses if they resigned within a certain period were not in restraint of trade as they did not restrict the employees' activities after they left.

Implications for employers

Clawback provisions have become standard for many firms and companies so this decision is welcome news for such employers. On the basis of the Steel case, it is acceptable to include a clawback ground which prevents an employee from resigning within a reasonable period of time post-payment.

The question, which was not considered in the Steel case, is whether clawback can be implemented if there has been a post-termination breach of a restrictive covenant? Would this constitute an unlawful restraint of trade?

This very point was considered inMarshall v NM Financial Management[1997] in which a post-termination commission provision would cease if Mr Marshall went to work for a competitor. Here it was found there was a restraint of trade that restricted the claimant's freedom to carry on particular forms of trade after the termination of his appointment. It was reiterated in the Steel case that a clawback ground which goes further and prevents an employee from working for a competitor is distinct from simply preventing an employee from resigning.

This was reflective of the earlier decision inSadler v Imperial Life Assurance Company of Canada Ltd [1988], where an employee's right to receive post-termination commission was subject to a term that payments would cease immediately if the employee moved to a competitor. Again, this was held to be an unlawful restraint of trade.

These earlier cases are clearly distinguishable from the Steel case, on the basis that the facts in Steel said Mr Steel could not resign – the bonus clause did not go further and say he could not work for a competitor.

Employers should therefore continue to act with caution in imposing clawback grounds which restrict where an employee goes to work post-termination, and ensure that this restraint is protecting a legitimate interest in these cases.

There are a number of key legal and practical issues arising from clawback which employers should consider carefully including:

• With individuals who remain in employment, the drafting in a cash bonus or share scheme, should provide that deductions can be made from salary or any other payment which is outstanding or recovery is allowed by set-off against future bonuses or share awards.
• Clearly the above will not be possible for someone who is no longer an employee and there is also the risk that the individual does not have the resources to meet the clawback. The clause should provide that the employee must pay back a bonus post-termination. The only remedy here is to bring a claim for breach of contract. Our view is, whilst bringing a claim against an ex-employee is unattractive, such provisions in the very least act as a deterrent. Alternatively, if the risk of clawback post-termination is considered greater, an amount could be held in escrow for the period during which an individual should not work for a competitor. A further method would be deferral of the payment or a delayed payment conditional on relevant criteria having been satisfied. Whilst these methods could be implemented post-termination, it should be noted that the same issues would arise were the condition for receipt of payment to relate to not working for a competitor. Just because the sums are deferred conditional on not working for a competitor, rather than clawed back, this does not prevent the argument that there has been an unlawful restraint of trade (as was the case in Marshall where commission payments were deferred).
• There are other ways of ensuring departing employees relinquish their rights to bonuses or share awards. Well drafted good or bad leaver provisions can ensure that payments are not due in the first instance – for instance a bad leaver could simply be someone who resigns. This is only relevant where clawback relates to continued employment alone though.
• Where clawback needs to operate in other circumstances – such as a misstatement of financial results, error in calculating a performance target, corporate failure, causing reputational damage or subsequent misconduct on the part of the employee, such provisions are clearly not an unlawful restraint on trade. These types of clawback grounds are commonly included in listed companies' share and bonus schemes and also operate for certain FCA or PRA regulated firms.
• Finally, when considering clawback provisions a commonly asked question is whether the gross or net amount is repayable? HMRC published guidance which indicates that employees can potentially claim back taxes on a clawback sum, however, there remain ambiguities. Our view is therefore that clawback provisions should give employers the choice as to whether they claw back the net or gross amount (dependent on whether the employee can claim the tax paid on the bonus back from HMRC).

Further information

For more information of any of the issues raised in this briefing, please speak to your usual Ashurst contact or to any of the people whose contact details are given below.