What is a Clawback?

Clawbacks are usually understood to be a financial mechanism that allows for the collection of revenue that was previously issued to investors and other parties, as a means of covering costs associated with the particular business or investment venture. In a sense, this means that the clawback involves the extension of benefits followed by the retrieval of those benefits in order to keep the project moving forward.

There are several examples of how a clawback functions. One is known as the dividend clawback. This has to do with the way that the project is structured and what responsibilities both the sponsor and the investors assume with the project. If the sponsors have agreed to return any previously earned benefits to the project in the event that the venture lacks enough cash to cover expenses, a clawback is possible. This would mean that dividends may be issued in one quarter when cash flow is sufficient to cover all obligations, but those same dividends will be recalled during the next quarter when cash flow is not sufficient.

A second example is the general partner clawback. This approach is a common element is a private partnership. The partnership may be formed for a specific project, such as a group of investors who wish to jointly play the stock market. General partners are equals in the venture, and thus carry equal responsibility. When a benefit is realized from activity on the various stock markets, all share equally in the profit. At the same time, when a loss is incurred, all partners return a portion of their previously acquired benefits to cover the loss.

With a limited partner clawback, the partnership arrangement is slightly different. The partnership may include some participants who are listed as general partners, while others are listed as limited partners. General partners contribute more to the venture, and thus may earn greater shares of any generated revenue. Limited partners will receive benefits based on the amount of the contributions they have committed to the project. When a clawback is called, the general partners will return a larger portion of their received benefits, while the limited partner will return a smaller amount.