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18 Mar 2014

PRA issues Consultation on Clawback

Employment alert email

On 13 March 2014, the Prudential Regulation Authority (PRA) issued a consultation on its proposals to extend the scope of the Remuneration Code to apply clawback to vested variable remuneration on a group-wide basis.

Summary of proposals
All firms authorised by the PRA will be required to amend employment contracts to provide employers with a right to clawback vested variable remuneration, including bonus awards. Clawback is to apply for up to six years following vesting.

In line with the existing Remuneration Code requirements on malus, clawback should apply when:

* there is reasonable evidence of employee misbehaviour or material error; or
* the firm or the relevant business unit suffers a material downturn in its financial performance; or
* the firm or the relevant business unit suffers a material failure of risk management.

As for malus, clawback should not be limited to employees directly culpable of malfeasance. Firms should consider applying clawback (in cases involving, for example, a failure of risk management or misconduct) to employees who:

* could reasonably have been expected to be aware of the failure or misconduct at the time but failed to take adequate steps to promptly identify, assess, report, escalate or address it; or
* by virtue of their role or seniority could be deemed indirectly responsible or accountable for the failure or misconduct, including senior staff in charge of setting the firm's culture and strategy.

Implementation time frame
It is proposed that the new provisions will come into force on 1 January 2015. The PRA expects firms to amend employment contracts to allow for clawback of vested awards after the new provisions come into force. It also expects firms to take all reasonable steps to amend employment contracts to apply clawback to awards made prior to 1 January 2015, but which vest after that date.

Scope and time frame of consultation
The PRA is inviting comments on its proposals by 13 May 2014 and, in particular, in relation to the proposals:

* that the grounds for applying clawback should be as wide as the grounds for malus; and
* to limit the application of clawback to a period of six years from the point of vesting.

What does this mean for employers?
There are a number of aspects which either have not been specifically dealt with or will require further consideration. These include:

* How leavers will be treated.
* Whether it is the employment contract which should be amended or the documentation governing bonus and variable pay arrangements or both.
* An inconsistency in the proposed amendments to the Remuneration Code as to whether the six years runs from the date remuneration is paid or vests. This may not be the same date depending on how the arrangement has been structured.

The proposals also present a number of potential problems for employers, such as:

* What if employees refuse to consent to changes to bonus terms (particularly those entered into before 1 January 2015)? Terminating and immediately re-employing employees on the new terms may be the only viable option if express consent is not forthcoming - but what if they have already left employment?
* Clawback provisions may amount to unenforceable penalty clauses if they do not represent a genuine pre-estimate of potential losses flowing from any breach, or where the predominant purpose of the clause is to deter the employee from, or penalise the employee for, a breach of contract.
* Similarly, clawback provisions that seek to restrict an employee's freedom to work after they leave employment may amount to unenforceable restraints of trade unless employers can show a legitimate proprietary interest that requires protection, and that the protection sought goes no further than is reasonably necessary to protect that interest.


Barbara Allen

Barbara Allen

T:  +44 20 7809 2231 M:  +44 7771 531 553 Email Barbara | Vcard Office:  London