Investopedia defines clawback as the money or benefits that are distributed and then taken back as a result of special circumstances, and a retraction of stock prices or of the market in general.
For example, purchasing certain investments provides taxable benefits contingent upon holding periods, and the benefits must be returned, when you sell these investments before they have reached maturity.
According to the guide to the Mod Clawback Clause (2011), there are two types of deferred payment (future consideration): “Planning Clawback” – which is triggered (usually) by the grant of planning permission, that is a payment arising from the enhancement in the value of an asset.
The enhanced value represents the difference in value between a Base Value ascribed to the property and the Market Value of the property subject to the planning permission. The percentage share of such difference in value is the Clawback payment.
One of the purposes is that clawback is more defensive in nature and grows out of the history of the NAO requirements that land should not be sold under value. Consequently, the clause protects against land gaining extra planning permissions than those predicted at the time of disposal of the land.
In a positive way, the clause can still be used to enable the buyer to be encouraged to invest in gaining enhanced planning permissions. Also, the clause may be used for purely defensive purposes where it is less certain that there might be a later planning gain, in certain circumstances. Thus, the shortened version of the clause might be utilised, in those particular cases; but his version should be regarded as the exception rather than the rule. On this guide also was answered the following questions: “By whom is planning clawback payable? When is planning clawback payable? When is the shortened version of the planning clawback used?” Is it payable by the Buyer, together with his successors in title, on the date a Trigger Event occurs? The shortened version of the clawback shouldn’t be used generally, only in very particular circumstances.
In terms of hedge funds, a clawback clause is a clause in a limited partnership agreement protecting the limited partners from paying more than the agreed upon carried interest percentage when factoring losses.
Ultimately, if the fund drops in value relative to its starting value for this period; the accrued performance fee, in that period, will have to be reversed.
For example, assuming a 20% performance fee accrues over a year and a general partner invests in 10 different transactions over a yeafundr; and 5 investments make total profits of $50 million and 5 investments lose $50 million. With no clawback, the general partner would be entitled to $100 million (20% of $500 million). However, with a clawback clause, the general partner would be entitled to nothing given the firm failed to make any cumulative profits over the accrual period.
Davitt Jones Bould Solicitors, 2011, ‘Guide to the Mod Clawback Clause’, Version 3.0