Severance agreements have recently made headlines in Michigan after it was reported that three high-ranking departing state officials were paid severance amounts ranging from slightly more than $11,000 up to $155,506.00.
In this regard, I was recently interviewed by the Detroit News reporter, Craig Mauger, about using severance agreements concerning the payout to Robert Gordo, the former state health department director. Here’s an excerpt of what I said:
… executive separation agreements usually include a release from potential future legal claims, compensation details and non-disparagement requirements, which bar the two sides from talking negatively about each other … separation deals within the government are not unheard of among high-level officials …. There are benefits to both parties to having it in place…
But the confidentiality terms often found in these agreements, while common in the private sector, are less so for governmental employees.
Clawing Back Payouts
If a company is paying out money – either as severance or bonuses – then a “clawback” provision should be used. For bonus payouts, that provision can foster long-term business goals and avoid rewarding bad behavior. And for severance situations, it is a means to recover money if the other party violates the agreement.
A clawback provision was recently described in The Economist, “How to design CEO pay to punish iniquity, not just reward virtue, “as follows:
If business had a Moses, “Thou shalt link pay to performance” would be on his tablet. Compensation committees have, however, tended to stick to a narrow reading of the commandment. Whereas they reward good behaviour, deterring the bad is an afterthought measures designed to ensure that misconduct does not pay are becoming central to the debate about how to craft bosses’ salary plans.
In other words, clawbacks are intended to balance long-term business goals against self-interested managers taking unsustainable shortcuts to get a bonus for short-term, individual gain.
Key Takeaways for adding a clawback to your employment agreement.
In our experience counseling businesses and managers on improving employment agreements, we routinely discuss these points:
- First, make sure your clawback provisions cover all areas of compensation that would be subject to recovery. This extends to cash bonuses, equity awards, or both.
- Second, if it has been some time since you’ve updated your employment agreements, “bad-conduct” may need to be expanded. For example, clawback provisions should not just cover criminal or financial misconduct. Instead, your business should extend the requirement to any conduct that might damage your business’s reputation. Examples include managers who create a toxic corporate culture, engage in sexual harassment, make racist comments, engage in sexual harassment, or engage in insurrection or similar domestic terrorism like that taking place on January 6 at the Capital.
- Third and building on the preceding point, make sure you carefully look at the definition “for cause” used in the agreement. “For cause” should define the conduct and circumstances when a bonus or other compensation is forfeited or must be returned.
At least for bonuses, another option is to lengthen deferral periods for paying cash bonuses or the vesting date for equity grants. This has the advantage of reducing the chance that your company will pay money before bad conduct is discovered.
Considerations for Individuals Negotiating Employment Agreements.
On the other hand, when we represent individuals in negotiating employment agreements, we focus on making sure clawbacks are not used as a backdoor way to avoid paying money otherwise owed.
And we also make it a point to negotiate language so a clawback provision does not become a punishment for a flawed decision or bad luck. On this point, it is essential to emphasize in negotiations that a heavy-handed, one-sided clawback provision is likely going to drive away talented individuals.
Another thing to consider is researching the company’s litigation history regarding paying bonuses, commissions, or similar matters. This may provide insight into the company’s trustworthiness (or lack thereof) for properly paying such compensation or trying to recover it.
Thank you for reading this post. Please use this link to contact Michigan attorney Jason Shinn if you have questions about this article. Since 2001, Mr. Shinn has represented companies and individuals in negotiating and litigating disputes over employment agreements.