What are malus and clawback?

Malus is sometimes referred to as a negative bonus; it allows a company to reduce or cancel unpaid variable remuneration before it has vested. Clawback provisions require repayment of variable remuneration that has already vested or been paid.

What are the Code provisions on malus and clawback?   

The Code provides as follows:

37 Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes. Directors’ contracts and/or other agreements or documents which cover director remuneration should include malus and clawback provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so.

38 The annual report on remuneration should include a description of its malus and clawback provisions, including:

• the circumstances in which malus and clawback provisions could be used;
• a description of the period for malus and clawback and why the selected period is best suited to the organisation; and
• whether the provisions were used in the last reporting period. If so, a clear explanation of the reason should be provided in the annual report.

Guidance to the Code provides as follows:

331 Schemes should also include malus and clawback provisions in certain specified circumstances. Such circumstances might include payments based on erroneous or misleading data, misconduct, misstatement of accounts, serious reputational damage and corporate failure

Who is responsible for malus and clawback policies?

As with most policy matters ultimate responsibility for the introduction and operation of malus and clawback arrangements sits with the board. In practice, detailed policy on such matters will typically be delegated to the Nomination Committee. The Risk Committee also plays a crucial role due to the clear links between a company’s risk profile and the remuneration of key individuals.

Companies should not underestimate the policy challenges presented by malus and clawback.  None of the non-exhaustive list of circumstances envisaged in the Code guidance are easy to implement, albeit some may be easier than others; events such as ‘misstatement of accounts’ or ‘corporate failure’ may be clearer concepts of failure to identify and take account of when designing service contracts. Assessing an individual’s behaviour against concepts like ‘serious reputational damage’ or ‘misconduct’ can be particularly challenging due to varying interpretations in different contexts. Thus, both qualitative and quantitative judgments are inevitably required. Outcomes may even differ across industries due to sector-specific sensitivities. As with other governance areas, difficult cases will demand careful and reasoned judgment.

For example, how should a company respond to a situation where its CEO is accused of gender-based bullying? Can it be reasonably classified as ‘misconduct’? Has it caused ‘serious reputational damage’ to the company? A scenario where a CEO is found by compliance to have used a company computer to view pornography may be easier to judge.

It is impossible for companies to develop an exhaustive list of behaviours that trigger the test, but they must carefully ensure they adequately capture behaviours likely to cross the boundary. Designing effective policies will require significant input from the company's Risk function and the experience of the People Team.

Employment and service contracts

Employment and service contracts will need to be amended to take account of malus and clawback. Such changes are likely to have substantial impact on an individual’s terms of service.

There are too many issues to list in an article of this type but likely impacts on contracts include whether relevant payments to an individual should be withheld during a period in which that individual is being investigated for a potential breach.

There will likely be a need for detailed guidelines on how a company should calculate deductions resulting from a breach, including what factors might mitigate or aggravate the situation and how these will be considered when determining the amount. Deciding on appropriate actions is never straightforward, and it becomes even more complex if the individual has left the company, as relevant misconduct may take years to surface.

In conclusion, the introduction of malus and clawback provisions in the 2024 UK Corporate Governance Code represents a significant step towards strengthening corporate accountability and aligning executive remuneration with long-term company performance. Boards must navigate the complexities of implementing these provisions, ensuring policies are robust, clear, and adaptable to various scenarios. This will require a concerted effort involving the Nomination and Risk Committees, as well as the broader governance and risk management functions of the board. By thoughtfully addressing these challenges, companies can foster a culture of integrity and responsibility, ultimately enhancing trust and stability in the corporate sector.