Defaulting underwriter: Overview, definition, and example
What is a defaulting underwriter?
A defaulting underwriter refers to an underwriter involved in a securities offering who fails to fulfill their obligations under an underwriting agreement. Underwriters are typically financial institutions or firms that agree to buy a company’s securities (such as stocks or bonds) and then sell them to the public or institutional investors. They are responsible for ensuring that the offering proceeds smoothly. When an underwriter defaults, it means that they fail to buy the agreed-upon amount of securities, do not provide the necessary funds, or otherwise breach the terms of the underwriting agreement. This can lead to delays or complications in the offering process and can negatively impact the issuer and other parties involved.
For example, if an underwriter is unable to raise the funds required to complete the transaction or fails to meet its commitments to purchase the securities, they would be considered a defaulting underwriter.
Why is a defaulting underwriter important?
A defaulting underwriter is important because their failure to meet their obligations can disrupt the entire securities offering process. The issuer may face delays, financial losses, or reputational damage. Additionally, the default can trigger legal consequences, such as the need to seek damages or renegotiate the terms of the agreement. In some cases, it may result in the cancellation of the offering, leaving the issuer without the capital they sought to raise. The possibility of defaulting underwriters is why underwriting agreements often contain provisions to protect the issuer, such as allowing the issuer to terminate the agreement or seek alternative underwriters.
Understanding a defaulting underwriter through an example
Let’s say a company plans to go public and hires several underwriters to help with its initial public offering (IPO). One of the underwriters, a major investment bank, commits to purchasing a large portion of the shares. However, just before the offering is scheduled to launch, the underwriter fails to meet its financial obligations or is unable to raise the necessary capital. As a result, the company’s IPO is delayed, and the other underwriters are forced to step in to cover the shortfall. The underwriter who failed to fulfill their commitments would be considered a defaulting underwriter.
In another example, a company issues bonds and secures underwriters to facilitate the sale. One of the underwriters fails to purchase the full amount of bonds they agreed to, leaving the company unable to raise the expected funds. This could lead to financial losses or require the company to renegotiate the terms of the offering.
An example of a defaulting underwriter clause
Here’s how a defaulting underwriter clause might appear in an underwriting agreement:
“In the event that any Underwriter fails to fulfill its obligations under this Agreement, including failing to purchase the agreed number of securities or provide the necessary funds, such Underwriter shall be deemed a Defaulting Underwriter. The Company shall have the right to terminate this Agreement or seek alternate arrangements to complete the offering, including replacing the Defaulting Underwriter with another underwriter or reallocating the securities to the remaining underwriters. Any financial losses resulting from the Defaulting Underwriter’s actions will be the responsibility of the Defaulting Underwriter.”
Conclusion
A defaulting underwriter can have serious consequences for a securities offering, including delays, financial losses, and legal complications. It is essential for both issuers and underwriters to understand their obligations under an underwriting agreement to prevent defaults and ensure the offering is completed smoothly. In the event of a default, there are typically legal and financial provisions in place to protect the issuer and address the issue, but the disruption can still impact the overall success of the offering.
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.