Clawback Lawsuits

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 What Does "Clawback" Mean?

“Clawback” refers to a provision in a contract that allows money or benefits to be taken back under certain circumstances. If an insurance policy is canceled within a given period of time, the premiums can be refunded or clawed back. Clawback provisions can be found in many types of business contracts.

Clawback provisions have been criticized in many respects due to their connection with corporate abuses in the past. However, given the right conditions, clawback provisions can often benefit both the distributor and the recipient of the funds. Due to clawback provisions typically being part of a contract, both the distributor and the recipient will have mutually agreed upon the clawback provision in advance.

What Are Some Common Examples Involving Clawbacks?

There are many different types of claims that can be brought in a clawback lawsuit. Examples include:

  • Insurance premiums: Insurance policies often include a clawback provision allowing the premiums to be clawed back if the policy gets canceled before a set date
  • Purchase of securities: Some securities are linked to taxable benefits that depend on the holding period for the security. Benefits can be clawed back if an investment is sold before it reaches maturity
  • Employee bonuses: In some companies, highly-paid employees receive pay bonuses that are deferred (i.e., they can’t be spent immediately by the employee). If the employee performs poorly, the company might withhold the benefits. If the employee’s performance is not satisfactory, the firm can revoke or claw back the bonus and use the funds for company investments

As a result, most clawbacks are enforced to protect a company or corporation from financial crises or heavy losses. The company can recoup some of its funds by requiring parties to sign a clawback provision and use them for restructuring.

What Is a Clawback Lawsuit?

Claims over clawback provisions are the subject of clawback lawsuits. If a party agrees to a clawback provision but does not refund the monies when required, they could be sued by the company that distributed the benefits. Afterward, the recipient may need to refund the benefits, as well as pay for any additional losses they may have caused.

Alternatively, a person might sue a company if they believe it has abused its clawback rights or if its clawback policies constitute discrimination.

Several clawback practices have been questioned, especially those involving employee bonuses. However, suppose the employee has signed a contract involving a clawback provision. In that case, they will need to resort to contract laws to obtain a remedy (for example, if a breach of contract is involved).

Fraudulent Transfer Actions

By filing a fraudulent transfer action, defrauded people and trustees can void fraudulent transfers made between the defrauded person and the fraudster prior to filing for bankruptcy. In this context, “fraudulent transfers” refer to any transfers made to or from the fraudster to hinder, delay, or defraud a creditor or future creditor. Transfers may qualify as “constructive fraud” even without provable intent if:

  • Was made in exchange for less than its equivalent value
  • Was made while the debtor was insolvent
  • Was made to an insider of the debtor
  • Caused the debtor to become insolvent

Any property of a fraudster’s estate that was fraudulently conveyed to a third party can be recovered through a fraudulent transfer action. Trustees may use fraudulent transfer actions to void funds transferred by fraudsters to their customers to re-distribute those funds to the people who lost their principal investments.

Preference Actions

Trustees use preference actions to deal with transfers made by the fraudster 90 days before declaring bankruptcy. Trustees see these transfers as preferential and therefore unfair, and they seek to remedy that by recovering the money from the recipients of those transfers within the 90-day period.

Because the transfers were made when the fraudster was already insolvent, the recipients should not be automatically entitled to keep the funds (since allowing them to keep them simply because they were the last recipients of the scheme before it collapsed would be an unfair distribution of assets to some of the fraudster’s victims over others). By filing a preference lawsuit, bankruptcy trustees may attempt to avoid some types of transfers made during the 90-day pre-bankruptcy period.

Clawback Actions

When it comes to fraudulent transfer actions or preference actions, the unintended consequences for unwitting customers of fraudulent businesses or fraudster individuals could be severe. To make your case, you will need an exceptional bankruptcy attorney on your side, whether you intend to pursue a clawback action or defend against one.

Clawback Lawsuits After Ponzi Schemes

The felony case against Bernie Madoff ended with a 150-year prison sentence in 2009, but many of his victims still seek their money back from the largest Ponzi scheme in U.S. history. The majority of the money is not expected to come from the sale of Madoff’s assets or from Madoff himself. Other victims and those who benefited from Madoff’s Ponzi scheme are expected to pay the largest share of the losses.

In the past, clawback suits were rare since most Ponzi schemes go bust and leave little or no money behind. In recent years, however, there has been money to be recovered – not only from individual investors who may or may not have been privy to the scheme but also from charities, foundations, and other organizations that unwittingly invested and then withdrew what were believed to be profits but were actually deposits that later investors had made into the scheme.
Clawback suits to recover assets from Ponzi scheme victims are not without their critics.

Defendants in clawback lawsuits in the Madoff case have pointed out that they, too, are victims of the scam. They contend they had no knowledge of the fraud and had every reason to believe the money they withdrew from their investment accounts was legitimate profits. In addition, they say they lost money in the scam because their accounts had much less money in them than they were told, even if it was more than they initially invested. Some of these net winners rely on this money for living expenses. Repaying the money would leave some net winners – many of whom were individual investors – virtually penniless.

Claimant advocates argue that it doesn’t matter if net winners were also duped. The net money winners withdrew from their accounts likely belonged to the many investors who lost money. According to attorneys, any money transferred to investors before the Ponzi scheme collapsed was a fraudulent conveyance under bankruptcy law. Therefore, the money should be recovered in a clawback suit.

Targets of clawback suits in the Madoff case are fighting back, and many have appealed. According to them, the legal claims against them should be decided based on their final account statements (rather than on their original investment amount). The appeals courts could end clawback lawsuits if they rule in their favor. Interestingly, they may also be entitled to take legal action against the trustee to recover some of the money they lost in the scheme.

Should I Hire a Lawyer for Assistance with a Clawback Lawsuit?

Clawback provisions can often be difficult to understand without the assistance of a lawyer. You may need to hire an experienced contract lawyer for advice if you have any questions or disputes involving clawbacks. Your lawyer can help you understand your rights even before you sign a clawback provision. Alternatively, your lawyer can represent you at trial if a clawback lawsuit is required.

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