How to Successfully Negotiate Economic Incentive Clawback Provisions

Many profess that state and local governments should eliminate economic incentives for various reasons. They may believe governmental agencies should not be offering subsidies or that they create an unfair preference for certain taxpayers or that many investments would occur without economic incentives. Whether one likes it or not, economic incentives are here to stay. Just the sheer number of articles addressing economic incentives on a daily basis is proof that knowledge of and participation in various programs is growing.

The global landscape for economic incentives has continued to mature. With the rise of onshoring activities, due in large part to wage pressures and transportation costs, jurisdictions outside the United States have started expanding and adapting many of their programs to compete for business. Thus, the United States must continue to offer tax credits and economic incentives to attract desirable investments. This is also true at the state and local levels, where competition can be even fiercer for targeted industries, job creation, and large capital investments.  

But all of this competition comes with a catch: “clawbacks.” A clawback provision in an economic development agreement can result in a company being forced to repay any incentives it benefited from for which it did not meet certain performance thresholds, such as job targets, capital investment levels, or project timelines. If a company fails to meet its performance commitments, a jurisdiction may require the business to repay cash grants or rebates and/or impose retroactive property, sales, or income tax liability (potentially with interest and penalties). Alternatively, a jurisdiction may elect to prospectively stop all future benefits once a company fails to meet its contractual obligations. After all, an economic development agreement is a legal contract that demands performance for consideration. If one party does not perform according to the terms of the contract, then there will be no consideration (i.e., incentive). 

Expanded use of clawbacks

The existence of clawback provisions is not new, but these provisions are being used more often and becoming more stringent. Citizens of communities want to have confidence that their tax revenues are being used to provide benefits only when a company keeps up its end of the bargain, thus political bodies are being forced to prove the economic benefits derived from incentivized investments. These provisions are often overlooked because they usually trail an economic incentives package, which has been informally offered and/or approved. At this point in the process, hopefully, the company and the jurisdiction both feel they have a win-win situation for the community and are excited and focused on getting the project started. However, there is still work to do because the city attorney and the company’s legal representative will draft the economic development agreement to memorialize the terms of the package negotiated. Site Selection Group recommends the following considerations be contemplated when drafting clawback provisions to ensure the company does not encounter any unwelcomed surprises and ultimately receives the benefits granted.

What to consider when drafting clawback provisions

• Ensure the parties who actually negotiated the terms of the economic incentives offer are involved in the drafting/reviewing of the economic development agreement legal representatives for both parties may not know the underlying intent of the proposed package and it is vital to make sure there are no contract terms that are contrary to any prior conversations and/or understandings of company representatives and economic development officials.
• Clearly define and understand all key terms
  • Something as simple as “person” versus “position” can make a huge difference in hiring or retaining job credits/grants. If a position exists for two years but is filled by five different people, is the incentive provided for the one position created or the five new people hired?
  • The level of required capital expenditures may be based on assessed value, taxable value, cost, or fair market value, which may vary based on jurisdiction.
• Set a reasonable project timeline
  • Allow for flexibility in timing in the event there are items outside the company’s control that affect the start of operations, hiring of employees, or purchase of assets. For example, a contractor may be running behind due to unforeseen weather conditions or perhaps labor union contract negotiations.
• Include a Force Majeure provision (“Act of God” provision)
  • This may be more relevant in certain regions of the world, but to the extent, there is a natural disaster, sudden flood, or unforeseen circumstances by both parties, this clause will help prevent a company from being in default.
• Negotiate pro rata clawback provisions
  • To the extent a jurisdiction will accept it, a pro-rata clawback provision will enable the company to benefit from the jobs and investment that it did in fact create, without being penalized by a wholesale repeal.
• Include a renegotiation clause
  • The earlier a company can make the jurisdiction aware that it may not meet its contractual obligations, whether due to changes in internal operations, fluctuations in the economy, or due to a merger or acquisition, the easier it may be for the jurisdiction to renegotiate an existing economic development agreement.