“Bad Boy” and “claw back” clauses in executive compensation plans can be an important component of an employer’s protection of its business from unfair competition. A “Bad Boy” clause offers an employee a benefit in exchange for an agreement to not compete or solicit after employment. The employee then chooses between competing or the benefit. If the employee competes, the unpaid benefit amount is forfeited. A “claw back” is the right of the company to go after monies paid if a violation occurs during the restriction period. In some states where post-employment restrictive covenants are severely restricted, such clauses may be enforced because of the employee’s choice. If such clauses are part of an ERISA plan, even in states where post-employment restrictions are prohibited, the carrot of an executive compensation plan’s “Bad Boy” and “claw back” clauses will be enforced. As an ERISA plan, such as a top-hat or severance plan, state law is preempted and the “Bad Boy” and “claw back” clauses will generally be enforced. In Marsh USA Inc. v. Cook, the Texas Supreme Court recently upheld a restrictive covenant in a stock option agreement case, noting that when the executive exercised the options he became an owner. The court found it enforceable, ruling: “[t]he stock options are reasonably related to the protection of this business goodwill. Thus, this covenant not to compete is ancillary to an otherwise enforceable agreement.”
Employers will often seek to impose post employment restrictive covenants in separation agreements, which are, for the most part, untested under most state law. Even in states hospitable to restrictive covenants, the focus of an enforcement action — whether the covenant is ancillary to a valid employment agreement — will almost certainly be a state’s threshold requirement. A company can improve the enforcement prospects by making the ”Bad Boy” and “claw back” clauses part of an ERISA severance plan. While severance plans often have wider applicability at a company, it is possible to have a single person severance plan under ERISA. An ERISA plan can be drafted to give complete interpretive and decision-making discretion to the plan administrator, and courts must give deference to the determination. A company that does not take advantage of executive compensation arrangements to augment its arsenal of protections is leaving money on the table.