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A dividend clawback is a situation when investors pay back part of their dividends to make up for cash deficiencies in a particular project. Such a provision helps keep the investors personally vested in the project, both for the short term and the long term. There are a number of reasons why an investor may agree to such a stipulation.
A dividend clawback situation usually only occurs when a capital project is being constructed. In many cases, there may be a chance for a dividend payment in this timeframe. As long as the project is going fine with no substantial overruns, those dividends will be paid on schedule. However, if there are overruns, then the dividend clawback will be used to offset those overruns.
This is done by allowing the dividends from previous investments to be used to pay for any cost overruns. As long as the project remains on budget there will never be a need for a dividend clawback. Further, dividends will continue as normal any time they are due as long as the project is in good standing.
The dividend clawback helps keep all investors interested in the project. There is strength in numbers so the more people who keep a watchful eye on a situation, and the more pressure that can be brought to bear on things, the better off the project will likely be. Therefore, a dividend clawback creates an attitude that all investors have something to risk and gain.
It should be noted that many projects often include a contingency budget, perhaps 10 to 15 percent of the total project cost. Such overruns will likely not call for a dividend clawback to be put into effect simply because those additional expenses, while unforeseen, have been put within the budget. Therefore, in some cases it may take a major cost overrun before a dividend clawback is needed as the contingency budget would be spent before a dividend clawback was required. if a dividend clawback is required, it can only be used to pay for costs associated with the project currently underway and cannot be used for other projects.
Though dividends are normally paid each quarter, investors who fear a clawback may want to use caution before cashing them out. It may be better to save them in a bank until the entire project is completed. Otherwise, the investor could find himself in a difficult situation where assets must be liquidated to pay for a dividend clawback. It should be noted that an equity investor cannot be held accountable to pay any more than the previous dividends totaled.
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