The US Securities and Exchange Commission (SEC) has adopted new and amended rules, effective January 27, 2023, governing the recovery or clawback of certain awarded incentive-based compensation from current and former executive officers. Additionally, amendments have been proposed to the Canada Business Corporations Act (CBCA) relating to the disclosure of clawback policies. As more companies adopt clawback policies, it is important to consider what a clawback policy is, the purpose of such a policy, requirements to adopt a clawback policy, legal restrictions related to clawing back of compensation and best practices.

What is a clawback policy?

A clawback policy allows an employer to reclaim compensation previously paid to certain executives. Clawback policies typically relate to compensation paid under incentive-based plans and provide for recovery of compensation paid based on fraudulent or inaccurate financial measures. Generally, these policies are used by public companies as a risk mitigation tool to promote the integrity and accountability of personnel. Executive officers are customarily subject to these policies, but companies can choose to extend a policy’s scope to other key employees, notably those involved in the preparation of financial statements. Such policies are typically administered by a company’s compensation committee or board of directors.

Purpose

The purpose of a clawback policy is typically to enable a company to recoup incentive-based compensation paid to an executive based on certain financial metrics, but it later turns out that the financial statements containing such metrics were flawed, resulting in an overpayment. The recoupment may also extend to incentive-based compensation based on non-financial results of the company (i.e. safety, retention, production, etc.). Some companies may structure their recoupment policies as a “double trigger,” requiring both: (a) a restatement of financial statements/correction to non-financial metrics; and (b) misconduct on the part of the recipient. We note that the new SEC rules require recovery (absent limited circumstances) in the event of a restatement of financial statements regardless of any misconduct.

Are they required?

While issuers on US stock exchanges are required to have clawback policies for certain executives, there are currently no such requirements in Canada. Under Canadian securities legislation, issuers are required to disclose any policies and decisions related to recovery of compensation in their annual information circular. A similar requirement has been contemplated for companies governed by the CBCA. In June 2019, Federal Parliament adopted amendments to the CBCA, which will require a company to disclose prescribed information about the “recovery of incentive benefits or other benefits” paid to directors and employees who are “members of senior management.” However, these amendments have not yet been proclaimed in force, nor have the regulations been published.

Nonetheless, the Innovation, Science and Economic Development (ISED) department provided further guidance on the prescribed information outlined in the proposed CBCA amendments. ISED proposed that the prescribed information should follow a “disclose or explain” regime where companies indicate whether or not they have a clawback policy, and if not, the reasons why they have not adopted one. If the company does have a policy, it will be required to disclose the policy’s objectives and key provisions.

Although clawback policies are not currently required in Canada, they are supported by proxy advisory firms (i.e. Glass Lewis and International Shareholder Services (ISS)). The Canadian Coalition for Good Governance also encourages the use of such policies to monitor performance based compensation. As such, some consider it good corporate governance for issuers to voluntarily implement a clawback policy.¹

Cash based compensation vs. security based compensation

Incentive based compensation typically comes in three forms: (a) cash; (b) securities of the company (or an affiliated company); or (c) a combination of cash and securities. It is important that clawback policies that extend to employees governed by Canadian employment laws clearly make this distinction or qualify the policies by application to “compliance with applicable law.”

Generally speaking, provincial employment standards legislation prescribes specific requirements that must be met in order for an employer to legally clawback an employee’s compensation. The prohibition against impermissible clawback of compensation applies to anything that is considered “wages” as defined by the applicable provincial employment standards legislation. For example, in Ontario “wages” is defined broadly to include any monetary remuneration that is payable by an employer to an employee under the terms of an employment contract. Cash based compensation clearly falls within this definition, whereas security based compensation is not addressed in Ontario’s employment standards legislation, and therefore the analysis will depend on the specific wording of the contract/plan.

The requirements that must be met to lawfully clawback an employee’s compensation also vary from province to province. For example, under Ontario’s employment standards legislation, an employer generally requires an employee’s written authorization to make a deduction from the employee’s wages. Such authorization must refer to a specific amount or provide a formula that enables the employee to calculate the specific amount to be deducted from their wages. If the requirements prescribed in the applicable provincial employment standards legislation are not met, then recovery is not permissible.

We note that clawback requirements under the new SEC rules do not distinguish between cash and security based compensation. However, the new SEC rules grant a safe harbor for companies where the recovery would violate the company’s “home country”² law, provided the home country law must have been adopted prior to the date of publication of the new SEC rules in the Federal Register of Rule 10D-1 (November 28, 2022).³ 

These new SEC rules may leave a company in a difficult situation in the event that:

1. Laws in the company’s home country are adopted after November 28, 2022; or
2. A person subject to the company’s compensation recovery policies is subject to the laws of a jurisdiction that is not the company’s home country and such jurisdiction’s laws,

do not allow compensation recovery in the manner required by the new SEC rules.⁴ In such circumstances, companies may not be able to comply with all applicable laws and may have to choose which laws to follow or seek exemptive relief from the relevant regulatory authority. Therefore, any companies that are subject to SEC rules and have employees governed by Ontario employment law, but are not privy to the “home country” safe harbor, should be mindful to ensure that performance based compensation subject to clawback under the new SEC rules be entirely security based. Alternatively, employers can incorporate language into employment agreements that requires employees to return compensation in prescribed circumstances. Notably, such language may not permit clawback of amounts from wages (if the province-specific requirements are complied with) but would at least give the employer the legal basis to commence a claim against the employee to recover these amounts.

Dentons Insight

Clawback policies are becoming more common among Canadian public companies and with clawback rules in effect in other jurisdictions, support for clawback policies from proxy advisory firms and proposed amendments to clawback disclosure requirements under the CBCA, it seems like the adoption of clawback policies in Canada may only be further accelerated. Companies adopting clawback policies (or having clawback policies already in place) should consider all laws applicable to the company and tailor their policies and practices accordingly to ensure requisite compliance while still maintaining good governance practices.

Should you have any questions about clawback policies, please do not hesitate to contact co-authors Ben Iscoe, Jason Saltzman, Meaghen Russell, Martin J Moderson, M. Phillip Moderson, Emeleigh Moulton and Larysa Workewych.

The authors would like to thank Anthony Berlingieri for his assistance in connection with this article.

1. Canadian Coalition for Good Governance: “If a company pays a bonus to an executive on the apparent achievement of performance metrics in a particular year, and it later becomes clear that the metrics were not achieved, the company should ensure it has a specific right to require the return of the bonus and to cancel unvested compensation awards”. ↩
2. While the SEC refrained from defining “home country” in its new clawback rules, the term presumably has the same meaning set forth by the SEC in Form 20-F, which clarifies that “home country” refers to the jurisdiction in which the company is legally organized, incorporated or established and, if different, the jurisdiction where it has its principal listing. Thus, the concept of “home country” may not include a jurisdiction where the company (or a principal of the company) operates and is subject to the laws (including the employment laws) of such jurisdiction.↩
3. If relying on the home country exception, a company must submit an opinion of home country counsel (acceptable to the applicable securities exchange or association) that recovery would result in a violation of home country law.↩
4. For example, a US issuer subject to the new SEC rules has an executive employee subject to the employment laws of Ontario.↩