Claws Out: The Rise of Clawback Provisions in Legal Employment Contracts

Photo by Jossuha Théophile on Unsplash

Margot Tierney, Associate Member, University of Cincinnati Law Review

I. Introduction

When agreeing to an employment contract, new employees often find themselves parsing through dense and confusing lines of the contract’s various provisions before signing on the dotted line. While reading through the terms of these contracts, fledgling lawyers often find that their employment contracts contain clawback provisions. Clawback provisions have risen in popularity in recent years, increasing from being present in 3% of employment contracts to 85% between 2005 and 2010.[1] Law firms have participated in this phenomena in an attempt to keep new talent confined to the firm and, ultimately, to prevent lateral movement across firms.

II. Background

Clawback provisions are clauses in contracts typically used to protect the contracting organization’s interests.[2] The implementation of clawback provisions has its roots in agency law,[3] specifically in the faithless servant doctrine.[4] The faithless servant doctrine holds that “an agent is obliged to be loyal to his employer and is prohibited from acting in any manner inconsistent with his agency or trust and is at all times bound to exercise the utmost faith and loyalty in the performance of his duties.”[5] Under the faithless servant doctrine, however, the principal, or the employer, was entitled to refund all of the wages paid to the employee following the employee’s disloyalty, including wages earned while loyally performing assigned tasks.[6]

However, clawback provisions in modern contracts are less intense than the unfaithful servant doctrine. With the financial crisis of 2008 serving as an impetus, the Securities Exchange Commission (SEC) allowed clawback provisions in more situations in order to deter dishonest business practices.[7] In investment situations, investors are entitled to “claw back” or take back the money they invested should the situation go awry.[8] Clawback provisions can be used in the employment contracts to deter employees from taking unapproved actions.[9] Much like how an investor is able to have their investment returned to them through a clawback provision, employers can utilize clawback provisions in employment contracts to have signing bonuses and other benefits returned to them if the employee, for example, leaves the company prior to the end of the employee’s contract term.[10] However, not all forms of compensation are subject to clawback provisions, such as 401k plans and employee wages.[11] In situations where these provisions do apply, clawback provisions often require that the employee pay a fee in addition to returning the bonus or other benefit.[12] Therefore, because of the harsh consequences of breaching the contract that clawback provisions provide, these provisions are often used to ensure that valuable employees are retained.[13]

These provisions are used across various industries in all kinds of agreements.[14] The legal industry is just one professional field that implements clawback provisions in its employment contracts. Law firms have increasingly added clawback provisions to employment contracts for both their new associates as well as their partners.[15] Since January of 2022, three of the largest thirty law firms in the country have implemented clawback provisions into their partners’ employment contracts in an attempt to prevent these partners from seeking opportunities at other firms.[16] These provisions typically call for a return of yearly bonuses if the partners choose to leave the firm.[17] Therefore, these provisions essentially serve as a proxy for restrictive covenants, which are difficult to properly enforce in lawyers’ employment contracts.[18] While these clawback provisions have proven to save firms money by forcing departing partners to abandon their would be bonuses when seeking new opportunities, clawback provisions also pose various risks to these firms.  

III. Discussion

When implementing claw back provisions, employers must consider the pros and cons of applying such a policy. One major drawback to implementing clawback provisions in employment contracts is that potential new employees may seek employment at another firm. The sight of a clawback provision in a new associate’s contract may be daunting for these attorneys who fear being locked into the first job they accept. Approximately forty to fifty percent of attorneys stay at their first job for five years or less.[19] Many new attorneys follow an informal plan called “three years and out plan” where they put in three years at a large law firm and then switch to a different, perhaps less strenuous section of the legal field.[20] Therefore, a new attorney looking to go into “big law” out of law school may opt to work for a firm that does not utilize clawback provisions in its employment contracts.

Another drawback that an employer may face when writing clawback provisions into contracts is the cost of litigation. Because the payments that the employer is attempting to regain have already been paid out to the employee, the employer may need to file suit against the former employee to regain the bonuses or other incentives covered by the clawback provision.[21] Additionally, other legal issues may arise in attempting to regain these benefits from the former employee, such as whether the terms of the clawback provision are even enforceable against the employee.[22] Despite the fact that these individuals are attorneys, they still bear the monetary and temporal cost of potential litigation.

Despite the potential shortcomings of clawback provisions, there are also significant incentives to use these provisions in employment contracts. Perhaps the most obvious incentive is that these provisions keep the talent within the firm.[23] The perks of keeping the same employees versus having to constantly turn over new employees are numerous. First, hiring a new employee is expensive.[24] Firms have to use their financial resources, as well as devote a substantial amount of time to recruiting these employees.[25] Once the employee is recruited and hired, then the firm must spend additional money on training and managing them.[26] All of these costs, paired with the opportunity costs of losing a talented attorney to a potential competitor, provide law firms with incentive to retain their original hires via clawback provisions.

Additionally, maintaining a constant workforce composed of primarily the same people from year to year builds a better sense of community both within the firm and for the firm’s clients.[27] When employees remain with a firm for an extended period of time, those employees are able to build stronger relationships with their co-workers as well as their clients.[28] Firms that are able to retain employees are able to function more efficiently because employees are familiar with the ways in which the firm works as well as with the ways in which their coworkers work.[29] This, in turn, can lead to increased employee satisfaction.[30] Put simply, when an attorney knows who will be in the office next to them, who to ask about a particular legal issue, or even who to go to the next ballgame with, their job satisfaction increases. A key part of the community building is maintaining a stable work force, and clawback provisions serve as one means of achieving this.

IV. Conclusion

As the legal world becomes increasingly competitive, firms will take affirmative steps to ensure that they are able to perform optimally. Clawback provisions are just one of the mechanisms through which these firms are able to retain talented attorneys; however, this effort to preserve current talent and keep a consistent work environment may come at the cost of deterring new attorneys from seeking employment opportunities at these firms. These agreements will add a level of complexity to the legal field going forward. As the legal field becomes increasingly mobile, clawback provisions represent a potentially potent tool for firms to retain talented lawyers.

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[1] The number of clawback provisions in contracts has increased from 3% to 85% from 2005 to 2010. Arnold and Clifford, What are Clawback Provisions?, Arnold and Clifford LLP (May 12, 2020), https://www.arnlaw.com/blog/2020/05/what-are-clawback-provisions/.

[2] Id.

[3] Neal H. Klausner, Keeping the Faith…less Servant Doctrine Alive, Davis and Gilbert Law (May 3, 2021), https://www.dglaw.com/keeping-the-faithless-servant-doctrine-alive/.

[4] Id.

[5] Id.

[6] Id.

[7] Gary Gensler, Statement on Rules Regarding Clawbacks of Erroneously Awarded Compensation, U.S. Securities and Exchange Commission (Oct. 14, 2021), https://www.sec.gov/news/public-statement/gensler-clawbacks-2021-10-14.

[8] Arnold and Clifford, supra note 1.

[9] Paycor, Clauses: Everything Your Business Needs to Know, Paycor (May 24, 2021), https://www.paycor.com/resource-center/articles/clawback-clauses/.

[10] Id.

[11] Arnold and Clifford, supra note 1.

[12] Id.

[13] Id.

[14] Id.

[15] Zack Needles, Law Firms Increasingly Using Clawback to Quell Lateral Departures, The Morning Minute (Mar. 23, 2022), https://www.law.com/2022/03/23/law-firms-increasingly-using-clawbacks-to-quell-lateral-departures-the-morning-minute/.

[16] Id.

[17] Id.

[18] Robert I. Steiner, Clawback Provisions as an Alternative to Traditional Restrictive Covenants – Enforcement and Practical Considerations, Kelly, Drye and Warran LLP (May 2015).

[19] Needles, supra note 15.

[20] Joshua Holt, The Three Years and Out Plan, Biglaw Investor (Oct. 20, 2021), https://www.biglawinvestor.com/the-three-years-and-out-plan/.

[21] Gretchen Harders, Bonus Compensation and Clawbacks: What Employers  Need to Know, Epstein, Becker, Green (Jun. 12, 2009), https://www.ebglaw.com/insights/bonus-compensation-and-clawbacks-what-employers-need-to-know/.

[22] Id.

[23] Needles, supra note 15.

[24] Marc Holliday, 10 Benefits of Employee Retention for Business, Oracle Netsuite (Feb. 23, 2021) https://www.netsuite.com/portal/resource/articles/human-resources/employee-retention-benefits.shtml.

[25] Id.

[26] Id.

[27] Id.

[28] Id.

[29] Id.

[30] Id.