A clawback mechanism is a legal provision in a contract or financial agreement that allows an entity to recover funds from the other (who has been paid) because the receiver of the money purposefully lied or hid facts from the former that could have resulted in zero or reduced payment.
This mechanism is commonly used to ensure accountability in various areas, such as crypto, finance, insurance, investment, regulation, and employment.
Working
Trigger Events
Clawbacks are typically triggered by specific events, such as fraud, misrepresentation, misconduct, or a violation of company policies.
Additionally, if a company finds that an employee or an executive’s performance metrics were mis-stated, a clawback may be enacted.
Repayment Terms
Clawback provisions detail the amount to be returned, the repayment period, and any penalties or interest that apply.
Enforcement
Usually enforced through legal action, this mechanism often includes provisions for mediation or arbitration if disputes arise. A case must be filed in a competent court.
Usage of Clawback Mechanisms in Crypto
Among large, well-known entities, the case of FTX stands apart.
FTX vs Binance
FTX used the clawback mechanism to demand $1.76 billion from Binance claiming that the former was already bankrupt when Binance sold its FTX shares to FTX using the buyback route.
According to FTX’s lawyers, the then CEO, Sam Bankman Fried, made those transfers to benefit Binance without caring about the position of his own exchange, which ultimately declared bankruptcy on 9 November 2024.
The application of clawback in this case will only be considered valid if FTX proves that Binance knew of FTX’s bankruptcy.
FTX filed this case after the bankruptcy courts removed its former executives and appointed new ones to help speed up the bankruptcy case’s resolution.
High Chances of Failure in Clawback Cases
Legal challenges can arise, especially if clawbacks are enforced retroactively or if employees claim that the provisions were unclear.
In regulated industries, clawback clauses may need to comply with specific laws, such as the Sarbanes-Oxley Act in the U.S., which mandates clawbacks for executives involved in misconduct leading to financial restatements.
Further, the onus to prove that a certain clawback claim is valid is on the filing company.
All of these contribute to the high chances of failure in such cases.
