"Clawback of Bonuses: UK PRA’s Banking Proposals Cast Six-Year Shadow for Bad Actors and Their Supervisors and Line Managers"

by Skadden, Arps, Slate, Meagher & Flom LLP

On 13 March 2014, the Prudential Regulation Authority (PRA), the U.K. regulator responsible for prudential supervision of banks, insurers and large broker-dealers, issued a consultation paper on bonus clawback (CP6/14). The PRA paper can be found here.

The consultation is the latest proposal to align employee reward in the banking sector with the interests of shareholders and other bank stakeholders and remove the perception of payment for failure. There is clear political enthusiasm for measures to regulate bankers’ access to their annual bonuses, but the PRA’s proposal, which would allow the clawback of vested variable remuneration, will place strain on contractual agreements, employment relationships and tax rules. Employees in the U.K. have free-standing rights under both their existing contracts and employment law.

Assuming implementation of the proposals, all “Level 1” and “Level 2” PRA-authorised banks and investment firms will be required to amend employment contracts of “code staff” to ensure vested bonus awards can be clawed back for a period of up to six years from the date of payment or vesting. In line with PRA Remuneration Code provisions, the requirement will also apply to the employment contracts of “Code Staff” employed by non-U.K. branch offices and subsidiaries.

A firm would be required to clawback vested variable remuneration in any situation where:

  • 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 risk management failure.

Employees subject to such clawback are potentially a large group:

  • those directly culpable of malfeasance; or
  • those who could have been reasonably expected to be aware of the failure or misconduct at the time but failed to take adequate steps to promptly deal with it; or
  • those who 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.

Any existing awards that have been paid or vested before the expected 1 January 2015 implementation date will be grandfathered. However, the rules would apply to any awards made after that date (requiring employers to amend contracts of employment in many cases) and the PRA expects firms to take “all reasonable steps” to amend employment contracts to apply clawback to awards made prior to that date that vest subsequently. Therefore, the PRA proposes to apply clawback retrospectively to awards which have been freely negotiated and awarded in good faith. The PRA proposals will be a significant issue for current “Code Staff” employees and a particular concern for those affected employees who plan to retire after 1 January 2015 and whose retirement arrangements assume that paid bonuses will not subsequently be clawed back.

Employing firms’ ability to operate the required clawback provisions will be subject to U.K. employment law. Employees have free-standing employment rights, which include:

  • the terms of their individual contracts of employment. Any change to an employee’s contract will require the employee’s consent. An employer would need to dismiss and re-engage the employee on new terms if they do not agree to the proposed change to their bonus entitlement, with attendant risk of unfair dismissal claims;
  • a prohibition on deductions from wages (which includes in this context bonus and other cash payments) unless the employee has agreed, in writing, to the deduction before the relevant deduction is made.  If employers want the ability to clawback the amount from future wages (as a practical  alternative to a separate repayment) they will need to review existing deduction provisions in their contracts to ensure that a clawback is explicitly covered; and
  • even in cases where the employee has agreed to a deduction or that the payment can be repaid, the clawback may not be enforceable if it is regarded as a penalty clause: the terms of the clawback would need to be well-drafted and the clawback should be limited to a genuine estimate of the employing firm’s loss as a result of the employee’s conduct.

Given the onerous nature of a clawback provision, an affected employee’s contract will require explicit wording and firms will need to include clear provisions in their contracts for new hires to enable them to clawback any remuneration.

In practice, senior individuals’ employment contracts are usually structured so that (i) each bonus award is wholly discretionary and, accordingly, (ii) the employer may impose conditions when the award is made. Provided there is a degree of flexibility in current contracts it should not, therefore, be too difficult from a U.K. perspective to impose clawback provisions on future grants to existing affected employees. However, this will not necessarily be the case for affected employees who are based in non-U.K. jurisdictions and whose employment contracts are subject to other local laws.

However, the position in respect of awards made before 1 January 2015 that will vest after that date is more problematic. In such cases it is very unlikely that provision for clawback would have been included in the conditions of the award. Therefore, unless the affected employee agrees to amend his or her contract to include a clawback provision, the firm will be unable to do so. Other than a formal request of its affected employees, it is difficult to envisage what “reasonable steps” the PRA expects firms to take in such a scenario. In practice, therefore, the firm’s duty in this respect may prove somewhat light. It is possible that the PRA recognises this, because the proposed transitional arrangements state that where employment contract amendment is not possible, firms must put in place specific and effective arrangements, processes and mechanisms to manage the risks raised by their inability to apply clawback.

Tax also has to be considered. In keeping with other recent regulatory proposals, the consultation paper does not immediately offer a mechanism to mitigate any consequences of clawback under U.K. tax law. Vested bonuses in cash or securities are very likely to be taxed either when awarded or, if later, vested. The employer also will suffer national insurance costs at that point, too. However, it is not clear that subsequent clawback creates the right post-tax result under existing U.K. tax law, as was debated in a 2013 case (Julian Martin v HMRC [2013] UKFTT 040 (TC), still under appeal). Clawback of cash bonuses might, as in that case, create “negative earnings,” which are deductible, but there are limits to carry-back (12 months, plus the new limit of £50,000 or 25% of income on reliefs) if not absorbed by certain other income in the clawback year, and the relief must be claimed within a certain timeframe. Equity that is clawed back gives rise to even greater complexity and in many cases may never give rise to a useful deductible item for income tax purposes, given the relevant statutory wording currently in force.

Given that the intention of the proposals is to curb excessive risk-taking and short-termism, as opposed to anything punitive, the PRA may be obliged to discuss these proposals with HMRC, as indeed happened with the FCA’s 2013 implementation of AIFMD remuneration requirements.

The consultation period concludes on 13 May 2014. Affected firms should consider the impact of these proposals from both a legal and an HR perspective and respond to the PRA either directly or through an industry group before that date.

Download PDF


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Skadden, Arps, Slate, Meagher & Flom LLP | Attorney Advertising

Written by:

Skadden, Arps, Slate, Meagher & Flom LLP

Skadden, Arps, Slate, Meagher & Flom LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.