Malus and clawback

Incentive structures should have mechanisms in place that allow the company, in specified circumstances, to lapse all or part of a bonus or long-term incentive award before it has been paid or vests (‘malus’) or to recover sums already paid (‘clawback’).

What is the purpose of malus and clawback provisions?

Such provisions allow for the withholding of sums owed, or recovery of sums paid, in specified situations. Originating from the financial services sector, they are designed to discourage short-termism and excessive risk-taking, and to promote long-term sustainable performance and an alignment of interests between executives and other stakeholders.

Are such provisions mandatory?

Appropriate withholding and recovery provisions are mandatory for certain companies within the financial services sector. Since 2014, the UK Corporate Governance Code has recommended that all FTSE companies (with a premium listing) have such provisions in place, irrespective of sector. In our experience, almost all FTSE 350 companies – and many FTSE AIM companies – have now adopted such provisions.

What circumstances should such provisions cover?

When they were first introduced, malus and clawback provisions were typically limited to a small range of trigger events, including misconduct (by the participant) or a material misstatement of financial accounts.

Although these remain the most frequently documented triggers for malus and clawback, subsequent guidance from the FRC and proxy advisors such as the Investment Association (IA) has led many companies to adopt an expanded list of triggers including, for example, calculation error, serious reputational damage and corporate failure.

In 2024, the IA’s Principles of Remuneration were further updated to state that all companies should include malus and clawback provisions within their remuneration arrangements, fully disclose the triggers (which should be suitable for the specifics of the company), and provide detail on when these triggers can be applied. The updated guidance also states that companies should discuss and agree any recovery provisions with executives to ensure that these can be enforced effectively.

How long should provisions apply for?

UK financial institutions are required to make variable remuneration subject to clawback provisions for up to ten years for the most senior executives. However, companies in other sectors tend to apply shorter periods, typically 2-3 years from the payment/vesting date (and often to align with annual bonus deferral periods or LTIP post-vesting holding periods).

In the case of fraud or a misstatement of the accounts, it may take some time to undertake a full investigation, therefore some companies choose to link the time period to the release of the relevant audited report and accounts or allow for the period to be extended in the event of an ongoing investigation.

Do the provisions need to apply to all participants in an incentive plan?

Whilst specific requirements are in place for financial services companies, other companies are free to choose whether the provisions should apply to all participants in the incentive plan or only to select senior individuals.

In respect of annual bonus plans, provisions tend to be limited to the most senior management cadre. For long-term incentive plans, the provisions tend to cover all participants equally.

How do the provisions work?

For the provision to be invoked, one (or more) of the trigger criteria must be met. The Remuneration Committee (or other pay governance committee) will then need to determine the amount of pay that should be withheld (based on the severity of the trigger event) and whether it wishes to use the provision to recover sums and, if so, from whom (i.e. all participants or a select few, e.g. based on seniority or culpability).

Malus provisions are relatively easy to implement as, since the award has not yet been paid out, unvested amounts can simply be scaled-back.

In the case of clawback, amounts need to be recovered from participants. For those who are still in employment, this may be done by reducing other amounts due to them, for example by reducing future bonus payments or unvested LTIP awards (where permitted under the scheme rules). If the participant is no longer employed, it may be more difficult in practice to recover anything.

Due to the greater logistical problems with applying clawback, companies typically use malus to its greatest extent before also pursuing clawback.

How can companies ensure the enforceability of such provisions?

In order to help enable enforcement, it is critical that the terms of the provisions are clearly defined upfront and are understood by the participants in the incentive scheme. The IA recommends that executives agree to the triggers of malus and clawback applying to that award; and set out how and when these may be applied.

It is also important that the documentation of the provisions in the scheme rules, participant materials and the remuneration policy are all consistent.

The extent to which such provisions can be enforced for overseas participants will vary, and legal advice should be sought.

Is there anything else that remuneration committees should consider?

Committees should review their recovery provisions periodically to ensure that they remain appropriate and in line with prevailing market norms. Suitable documentation should also be in place to allow enforceability should the need arise.

Do malus and clawback provisions have ‘teeth’?

Whilst it remains unusual for malus and clawback provisions to actually be used, there are now multiple examples of FTSE executives having forfeited potential payments under variable incentive plans. This suggests that well-drafted recovery provisions can, in addition to other committee discretions, serve to prevent payments for serious failure.