Kathryn Bush, Blake, Cassels & Graydon LLP
1. INTRODUCTION
In recent years, particularly since the global financial crisis, the use of clawback
provisions in executive compensation plans has become more widespread in Canada.
Basically, clawbacks are arrangements under which an employee’s compensation that has previously been awarded is forfeited or ‘clawed back’. Canadian public companies listed in the United States are subject to statutory clawbacks for certain employees. As well, certain Canadian financial institutions regulated by the Office of the Superintendent of Financial Institutions (“OSFI”) have adopted clawbacks as an OSFI-recommended best practice. Other Canadian public companies are not required to adopt clawbacks, but may choose to do so by agreement with affected employees. The increasing use of these provisions in Canadian employment contracts raises a series of interesting and potentially difficult issues that should be kept in mind when designing executive
incentive plans. A potentially problematic example is the income tax consequences of compensation clawbacks in the context of the Canadian income tax laws. As will be discussed, the potentially harsh tax treatment of the clawed back amounts in Canada is an added layer of complexity that should be taken into account, particularly when using existing U.S. policies as a source for drafting Canadian clawback provisions.
As explained in the Blakes Bulletin “Clawbacks Coming to Canada”, clawback
provisions can take a variety of forms and be triggered by different types of events.1 They may apply to vested and unvested awards, affecting different forms of
compensation from annual bonuses to long term incentive awards of equity and
non-- 2 non--
equity compensation. Triggers range from fraudulent misconduct to bad faith behaviour and even the mere occurrence of a negative restatement of financial results.
2. U.S. STATUTORY CLAWBACKS
Specific types of clawbacks are statutorily mandated under the U.S. Sarbanes-Oxley Act of 2002 (“SOX”), and Dodd-Frank Wall Street Reform and Consumer Protection Act (“DFW”). These measures are relevant for Canadian corporations which are foreign private issuers under U.S. securities laws. These provisions are also of more general interest since the concepts introduced and developed in the U.S. statutory clawbacks are widely adopted by both US and Canadian issuers in drafting their contractual clawback policies.
The clawback provisions in SOX adopted the basic notion, incorporated in most current clawback policies, that executive bonuses based on materially inaccurate financial results that are subsequently subject to a negative revision should be forfeited. The forfeiture, or clawback, is conditioned on a finding of executive misconduct that has resulted in the material non-compliance in the financial results. These provisions apply to any incentive payments, covering both cash and equity awards, in the one-year period following the issue of the financial results that later had to be restated. The clawback is mandatory for U.S. public companies but only applies to the CEO and the CFO. However, the misconduct required to trigger the provision is not required to be that of the CEO or the CFO.2
The DFW introduced ‘bigger and better’ clawbacks that apply in a wider set of circumstances to a wider base of employees. Under these provisions, any material non-compliance with reporting requirements that necessitates a restatement of financial results triggers a clawback mechanism that applies to incentive awards received by all current or former executives. There is a three year look-back period, which means that incentive awards handed out during the three years preceding the date of restatement
1 J. Tuzyk, Blakes Bulletin on Securities “Clawbacks Coming to Canada?”, November 2011, available at
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are subject to recoupment. It is significant to note the absolute-liability nature of these provisions in that there is no misconduct requirement for the DFW clawbacks to be triggered.
DFW measures apply in addition to the already in place SOX provisions discussed above, yet they are in one aspect narrower: DFW clawbacks only apply to the excessive portion of the award that was received by the executive based on inaccurate financial results, whereas, under the SOX, the entire payment may be subject to forfeiture. This is probably an appropriate policy choice in light of the no-fault nature of DFW
clawbacks. Also unlike SOX, which tasks the SEC with enforcing the clawbacks by litigation, the DFW provisions are required to be enforced by the issuer, who should disclose its policies for doing so as part of its securities reporting requirements.3
3. FINANCIAL STABILITY BOARD (“FSB”) PRINCIPLES AND CANADIAN ADVISORY POLICIES
The FSB is an international organization co-ordinating national financial authorities of countries such as the U.S., and Canada. Bank of Canada, OSFI and the Federal Ministry of Finance are members of FSB, which has issued FSB Principles for Sound Compensation Practices – Implementation Standards. The Principles espouse the basic notion that executive incentives based on inaccurate financial results that are subsequently subject to downward revision should trigger some form of recoupment or clawback mechanism. Further, unvested portions of deferred compensation should also be clawed back based on the actual performance of the business in the year of vesting.
There are no regulatory or statutorily mandated clawbacks in Canada. However,
Canadian issuers which are subject to SEC listing requirements are subject to clawback provisions, and clawbacks following the general guidelines of FSB Principles are
recommended by OSFI as a best practice to the Canadian financial institutions that it
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regulates. As the OSFI-regulated entities are not subject to a specific legislative provision in this regard, there is no prescribed form of clawback as in the U.S.4
4. CONTRACTUAL CLAWBACKS IN CANADA AND THE U.S.
The Canadian clawback is therefore primarily a contractual measure. In drafting
contractual provisions, Canadian companies have tended to follow the U.S. precedent, which has a longer and more established history of using such provisions. The
historical use of U.S. contractual clawbacks has been directed at executive misconduct or bad behaviour, a common example being situations where employees left to join competitors.
Following the example of U.S. lawmakers, however, clawback provisions are increasingly being used to address a much more far reaching set of issues, going beyond ‘bad behaviour’ to include absolute liability-type situations where a negative restatement leads to disgorgement regardless of executive fault. This signals a new understanding of clawbacks as a risk-management mechanism and more generally a
“corporate governance tool to deter management from taking actions that could potentially harm the company’s financial position”.5
5. TYPES AND RELATIVE PREVALENCE OF CLAWBACKS IN U.S. AND CANADA
According to the HayGroup report, a survey conducted over 450 US public companies with revenues over $4 billion showed (i) more than half of them adopting some form of clawback; (ii) this figure is at 82% for Fortune 100 companies; (iii) clawbacks are applied to annual incentives as well as unexercised stock options and restricted stock/share units (RS/RSU), (iv) clawbacks are a much less frequent sight in Canada overall, apart from top tier banks and insurance companies which have been almost unanimous in adopting some form of recoupment policy since 2009, and (v) as in the
4 supra note 1
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U.S., a wide range of incentives are subject to disgorgement in Canada, with a typical look-back period of two to three years.6
Clawback provisions have been commonly categorized into the following three major categories:
(1) the first category covers “bad faith” conduct which includes the breach of non-compete policies, and more generally conduct that is not in good faith and goes against the best interests of the company.
(2) The second major category covers fraud, negligence or intentional misconduct, where the employee has unearned income as a result of fraudulent or negligent conduct leading to financial results that need to be revised at a later point.
(3) The third major categories are clawbacks that are triggered directly by a restatement of financial results, with no need for the company to show a causal link between the negative revision and employee misconduct.
Companies may adopt a combination or all of these measures in their clawback policies, and the following examples will demonstrate that companies may adopt
language that is not clearly caught by these categories. Overall, it seems however, that the inclusion of strict restatement clawbacks is increasingly common, particularly in Canadian entities that adopt such provisions.
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