What Is Forfeiture? Definition and How It Works in Investing

What Is Forfeiture?

Forfeiture is the loss of any property without compensation as a result of defaulting on contractual obligations, or as a penalty for illegal conduct. Forfeiture, under the terms of a contract, refers to the requirement by the defaulting party to give up ownership of an asset, or cash flows from an asset, as compensation for the resulting losses to the other party.

When mandated by law, as a punishment for illegal activity or prohibited activities, forfeiture proceedings may be either criminal or civil. The process of forfeiture often involves proceedings in a court of law.

Forfeiture Explained

When there is nonperformance or a breach of contract duty, forfeiture of money, assets, or anything else of value that is defined in a contract will result in order to compensate the adversely impacted party. For example, forfeiture of a deposit for not closing a purchase transaction is a common stipulation in a real estate sales contract.

In investing, an owner may be required to forfeit shares they hold if they are unable to meet a call on an option. Funds raised by the forfeit are paid to the counterparty. Owners can also lose shares if they try to sell them during a restricted trading period. Share forfeitures return to the issuer of the shares.

Many times, when a company offers employees stock options (ESOs) or shares of the company as an incentive, they will have limitations on when and how those holdings can be sold by the employee. In some cases, if the employee leaves the company before a specified term has elapsed, they may be required to forfeit the company stock they were allocated.

Many real estate contracts also contain a forfeiture clause. This clause states that when a person buys a property, the contract is an obligation to make installment payments on the note. If the borrower should fail to uphold their end of the purchase contract, the seller may end the agreement and seize the property. The forfeiture of real estate is different than the foreclosure of the property.

Forfeiture of Ill-Gotten Gains

With respect to illegal activity, forfeiture is synonymous with disgorgement for practical purposes—ill-gotten gains are forced to be given up by the perpetrator. The Securities and Exchange Commission (SEC) goes after insider traders who profit from non-public material information. Limited by resources, the SEC can only catch some of the insider traders, but when it does and is able to successfully prosecute those cases, it enforces forfeiture of any trading profits along with civil penalties and possible jail time.

The Department of Justice (DOJ) runs a comprehensive asset forfeiture program that involves major government agencies. The involved agencies include the Bureau of Alcohol, Tobacco, Firearms and Explosives, Drug Enforcement Administration, Federal Bureau of Investigations and the U.S. Attorneys Offices.

Agencies outside the DOJ are empowered to impose penalties of forfeiture as well. The U.S. Postal Inspection Service is active in cases involving mail fraud, money laundering, and drug trafficking through the mail system. The Food and Drug Administration has an Office of Criminal Investigations to seize assets and money generated from health care fraud schemes and production and sale of counterfeit drugs.