How Does a Clawback Provision Work in NJ?

A clawback provision is a contractual agreement where an employee, under certain circumstances, may be required to return the money he or she has already received from the employer.

Contracts seem simple in concept. People agree to do or not do certain things. For example, an employer hires an employee and agrees to pay for and maintain employment. In return, an employee agrees to perform their job as the employer requires. Along with this basic agreement come other conditions of employment. The employer agrees to timely payment, fair treatment, and employment benefits and opportunities, namely, stock options or other deferred compensation. In exchange, an employee may promise to perform their work up to specific standards and within specific guidelines. They may also agree not to reveal trade secrets of the company they work for or to compete with the company after they leave and work elsewhere. And all contracts contain clauses that address what happens when one party to the agreement breaches the agreement and causes the other damages.

How Does Compensation Work in a Clawback Agreement in NJ?

Damages for breaches of contract are primarily compensatory, meaning the party who failed to keep their promise pays the wronged party their economic losses due to the breach. So, if a gym enthusiast buys 10 hours of personal training from a fitness coach for $300.00, $30.00 per one-hour session, and the fitness coach breaks the contract before the first session, they owe the gym enthusiast $300.00. And if the gym enthusiast incurred other damages from the breach, say, paying a higher price to the only other fitness coach within a reasonable distance, a court could include the additional cost as damages. In other words, the damages must be what the person lost due to the broken promise.

In the context of employment agreements, employers who offer stock options or other compensation as an employment incentive include contractual provisions that punish misbehavior. For example, a contract may contain a provision prohibiting an employee from working for a competing employer. It may state that should the employee breach a contract provision, such as working for a competitor in violation of a non-compete clause, they owe the employer the value of the employee’s stock compensation. In essence, they want their employment incentive back. These provisions are called clawbacks. However, clawback provisions are not only in employment contracts but also in executive packages and separation agreements.

Clawback Provision Use in High Paid Positions in New Jersey

Typically, highly paid executives receive stock options and other perquisites in addition to their salary. And it makes sense that employers want those they entrust, such as CEOs, CFO’s, company presidents, and others who know the intimate details of how a business operates, to promise not to undermine the company upon their leaving for a competitor. Thus, the non-compete clause in executive compensation plans is commonplace. The clawback, however, is not as common and may not be enforceable in a court of law. The clawback agreement is an attempt to cover anticipated damages upon a high-level employee’s taking their acquired knowledge and experience elsewhere.

What is a Liquidated Damages Clause?

A more common contract provision is the liquidated damages clause, which is an agreed damages sum a breaching party would pay. The liquidation clause covers damages that would be hard to prove if one of the parties breached the contract. So, if a senior vice president of a multimillion-dollar paint company took their fifteen years of experience and business relationships to another paint company, the employer paint company would have difficulty quantifying how much money they would lose to the new employer. Thus, a liquidated damages clause allows the employer a specific sum in the event of a contract breach. The law requires that the amount be a reasonable estimate of the damages the breach would cause. So, it cannot be a penalty above what actual damages would be.

What is the Difference Between a Clawback Provision and a Liquidated Damages Clause?

The clawback provision is often a penalty unrelated to actual damages, unlike liquidated damages clauses. Thus, the law requires that liquidated damages and clawback provisions are a realistic snapshot of the future damages resulting from a breach at the time of entering the contract.

The 2011 New Jersey appellate court case, Schiavi v. AT&T Corp, applied the reasoning in Wasserman’s Inc. v. Township of Middletown, 134 N.J. 478 (1993), regarding reasonably ascertainable damages amounts in liquidated damages provision to clawback clauses. Since clawback provisions do not reflect an agreed-to actual damages amount, they are typically unenforceable in New Jersey.

Is a Clawback Provision Enforceable in NJ?

Thus, a clawback clause that requires an employee to return the company stock value at the breach can either be a windfall or bust for the employer. It depends on the value of the stock and company performance. Conceivably, a senior vice president who breaches an employment contract 15 years after its start date could pay millions of dollars or nothing for violating a noncompete clause or some other inconsequential clause. So, the paint executive could pay nothing if the stock option they received as compensation 15 years ago is worth nothing, even if they cause hundreds of thousands of dollars in lost revenues to the employer for taking customers away, a clear breach. Likewise, the same V.P. could pay millions of dollars for the breach of submitting reports late. The arbitrariness of the outcome lies in the unreasonableness of the calculation method.

How Can An Attorney Help You with Clawback Provisions?

To safeguard against such provisions, employers and employees should consult with a knowledgeable employment law attorney who understands the nuances of these cases in New Jersey. Depending on the circumstances, your attorney might advise you as an employee not to agree to a clawback provision. If that is not an option, your best course of action might be to attach the clawback provision to a more specific breach and corresponding dollar amount. So, for instance, the employer might specify a bonus the employee must forfeit in the event of a breach. For employers, having a skilled employment lawyer is equally crucial. You may be a legal professional familiar with the state wage and hour, non-compete, and other employment laws to ensure the provision does not violate them and the tax consequences. In addition, the terms of repayment might be spelled out in the agreement or left to the discretion of the employer or other agreed-to third-party mediator. In sum, the clawback provision may be tailored to an ascertainable, reasonable amount in the future to make it enforceable.

Consult our Employment Lawyers about your Clawback Concerns in Ocean and Monmouth County NJ

Are you considering or wondering about the enforceability of a clawback provision in any type of employment contract scenario? Make sure you seek help from a seasoned New Jersey employment lawyer. With the right counsel, you can better the odds that the clawback provision serves your interests, and you can appropriately assess your legal options when issues related to clawbacks arise.

As an employee or an employer in Monmouth or Ocean County, Chamlin, Uliano & Walsh can advise and assist you with all of the questions, concerns, and challenges that you may face in relation to a clawback provision. With local offices in West Long Branch, we offer personalized guidance and representation for clients in Red Bank, Long Branch, Eatontown, Holmdel, Asbury Park, Ocean Township, and surrounding towns in Southern New Jersey.

Contact us online or call us at 732-440-3950 or toll-free at 888-328-9131 for a free and confidential consultation to discuss your case.