Indemnification of the underwriters: Overview, definition, and example
What is indemnification of the underwriters?
Indemnification of the underwriters refers to a provision in a securities offering agreement where the issuer of securities (such as a company going public or issuing bonds) agrees to protect and compensate the underwriters from any losses, claims, damages, or legal liabilities that arise as a result of their involvement in the offering. Underwriters are typically investment banks or financial institutions that help the issuer sell securities to the public. The indemnification ensures that if the underwriters face legal challenges (such as securities violations, misstatements, or omissions in the prospectus) during or after the offering process, the issuer will cover the costs and liabilities associated with these claims.
Why is indemnification of the underwriters important?
Indemnification of the underwriters is important because it provides financial protection to the underwriters who take on significant risk when helping to facilitate a securities offering. Underwriters often rely on the issuer’s representations and warranties in the offering documents (such as the prospectus) and assume certain legal responsibilities in the transaction. Without indemnification, underwriters could face financial loss or legal exposure if a problem arises related to the offering. By agreeing to indemnify the underwriters, the issuer ensures that these parties can perform their services without the fear of unforeseen liabilities. It also clarifies the scope of responsibility and ensures that the underwriters are not left bearing the financial burden in case of an issue.
Understanding indemnification of the underwriters through an example
Imagine a company, Company A, is conducting an initial public offering (IPO) with the help of an investment bank, Bank X, which is acting as an underwriter. During the IPO, the company’s prospectus contains an error in financial projections, which leads to legal claims from investors who believe they were misled. Under the indemnification of the underwriters clause in the underwriting agreement, Company A agrees to compensate Bank X for any legal costs, damages, or settlements related to the claims that arise due to the error in the prospectus. This indemnification ensures that the underwriters are not financially responsible for the mistake and that they can focus on the transaction without worrying about potential losses.
In another example, a company issues bonds through an underwriting agreement. After the bonds are sold, a group of bondholders sues the underwriters, claiming that the company failed to disclose certain risks in the offering documents. The indemnification of the underwriters clause stipulates that the company will bear the costs of defending the underwriters against the lawsuit and will cover any damages or settlements that result from the bondholders' claims.
An example of indemnification of the underwriters clause
Here’s how an indemnification of the underwriters clause might appear in an underwriting agreement:
“The Company agrees to indemnify and hold harmless the Underwriters, their affiliates, and their respective officers, directors, and employees, from and against any and all losses, claims, damages, liabilities, or expenses, including reasonable attorneys’ fees, that arise out of or in connection with the offering, except where such losses are a result of the Underwriters’ own negligence or misconduct.”
Conclusion
Indemnification of the underwriters is a key provision in underwriting agreements, ensuring that underwriters are protected from financial losses or legal liabilities that may arise from their involvement in a securities offering. By agreeing to indemnify the underwriters, the issuer assumes responsibility for covering any legal costs, damages, or claims that might result from issues related to the offering documents or the offering process. This protection allows underwriters to conduct the transaction with greater confidence and helps maintain the integrity and 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.