Default by one or more of the underwriters: Overview, definition, and example
What is default by one or more of the underwriters?
Default by one or more of the underwriters refers to a situation where one or more underwriters fail to fulfill their obligations under an underwriting agreement. Underwriters are typically financial institutions or entities that agree to purchase securities from an issuer and sell them to investors, assuming the risk of the securities not being fully subscribed. If an underwriter defaults, it means that they fail to perform their duties, which may include not purchasing the securities they committed to or not fulfilling other terms of the underwriting agreement.
In the context of a public offering or debt issuance, a default by one or more underwriters can create complications, including delays or disruptions in the offering process, and it may lead to financial or legal consequences.
Why is default by one or more of the underwriters important?
The occurrence of a default by one or more of the underwriters is important because it can affect the entire underwriting process and potentially impact the success of the offering. It introduces risk and uncertainty for both the issuer and the other underwriters involved. If an underwriter defaults, the issuer might not be able to raise the expected amount of capital, and other underwriters may need to step in to cover the shortfall or renegotiate the terms of the agreement.
For businesses or issuers, understanding the risks of underwriter defaults is important to ensure that appropriate safeguards are in place, such as having backup underwriters or including provisions in the underwriting agreement that outline the steps to take in the event of a default. For underwriters, the risk of default can damage their reputation and lead to legal and financial consequences.
Understanding default by one or more of the underwriters through an example
Imagine a company is launching an initial public offering (IPO) and has engaged five underwriters to purchase and distribute the shares. One of the underwriters, due to financial difficulties, defaults on its commitment and fails to buy the number of shares it originally agreed to purchase. As a result, the company must either find another underwriter to cover the shortfall or adjust the terms of the offering, which could delay the IPO and reduce the amount of capital raised.
In another example, a company planning to issue corporate bonds hires several underwriters to assist in selling the bonds. One of the underwriters defaults by failing to purchase its agreed share of the bonds. The remaining underwriters may step in to cover the shortfall, but this could require renegotiating the pricing or terms of the bond issuance, potentially leading to financial implications for the issuer.
An example of a default by one or more of the underwriters clause
Here’s how a default by one or more of the underwriters clause might appear in an underwriting agreement:
“In the event that one or more of the Underwriters default in their obligations under this Agreement, the remaining Underwriters shall have the right, but not the obligation, to take up the defaulted portion of the Offering. If the remaining Underwriters are unable to cover the default, the Issuer may, at its discretion, either terminate the Agreement or seek an alternative arrangement to fulfill the terms of the Offering.”
Conclusion
Default by one or more of the underwriters can create significant challenges in financial transactions such as public offerings, bond issuances, or securities sales. It can lead to delays, financial loss, and reputational damage for both the issuer and the underwriters involved. Clear provisions within the underwriting agreement to address defaults are essential for mitigating these risks and ensuring that the offering can proceed smoothly despite any complications. By including steps for remedying defaults, the parties involved can better manage the risks associated with the underwriting process.
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.