Default by an underwriter: Overview, definition, and example
What is default by an underwriter?
Default by an underwriter refers to a situation in which an underwriter fails to fulfill their contractual obligations as specified in an underwriting agreement. Underwriting, in this context, typically refers to the process in which an underwriter evaluates and assumes the financial risk associated with securities offerings, insurance policies, loans, or other financial products. A default occurs if the underwriter does not meet the agreed-upon terms, such as failing to provide funding, purchase securities, or fulfill any other obligations under the terms of the agreement.
In the context of securities or insurance, an underwriter's default can have significant financial and legal consequences for the issuer or policyholder, as it may disrupt the transaction, cause delays, or lead to financial losses. Defaults by underwriters can result from various issues, including financial instability, failure to raise sufficient funds, or not adhering to the terms of the underwriting agreement.
Why is default by an underwriter important?
The default by an underwriter is important because it can affect the success of financial transactions, such as securities offerings or insurance deals. The underwriter's role is to assume certain risks and help facilitate the sale of securities or insurance policies. If the underwriter defaults, it can undermine the financial stability of the deal, cause delays, or lead to a complete collapse of the transaction.
For businesses or investors relying on the underwriter’s commitment, such a default can lead to missed opportunities, legal battles, and financial losses. For the underwriter, defaulting on an agreement can damage its reputation and lead to legal consequences, including claims for breach of contract and compensation for damages.
Understanding default by an underwriter through an example
Imagine a company plans to launch an initial public offering (IPO) of its stock and hires an underwriter to manage the sale. The underwriter agrees to buy a certain number of shares from the company and resell them to investors. However, due to unforeseen financial difficulties, the underwriter defaults by failing to purchase the agreed-upon shares, leaving the company without the expected funds and disrupting the IPO process.
In another example, an insurance company may hire an underwriter to evaluate and issue a set of insurance policies. If the underwriter defaults by not completing the underwriting process or failing to issue the policies, the insurance company may be exposed to risks and obligations it was relying on the underwriter to handle.
An example of a default by an underwriter clause
Here’s how a default by an underwriter clause might look in an underwriting agreement:
“In the event that the Underwriter defaults in the performance of its obligations under this Agreement, including failure to purchase the securities as specified, the Underwriter shall be liable for any losses, damages, or costs incurred by the Issuer as a result of such default. The Underwriter shall indemnify and hold the Issuer harmless against any direct or indirect losses resulting from the default. The Issuer reserves the right to terminate this Agreement and seek alternative underwriters or remedies as outlined in Section [Insert Section Number].”
Conclusion
Default by an underwriter occurs when an underwriter fails to meet its obligations under an underwriting agreement, leading to potential financial, legal, and operational consequences. Such defaults can disrupt important financial transactions, such as securities offerings, insurance policies, or loans, and can result in significant losses for the involved parties. It is essential for businesses and investors to understand the risks associated with underwriter defaults and include appropriate clauses in contracts to address potential defaults and mitigate damage.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.