No short sales: Overview, definition, and example
What is a no short sales clause?
A no short sales clause is a contractual provision that prohibits a party from engaging in short sales of a particular stock, security, or asset. A short sale occurs when an investor sells borrowed securities with the intention of buying them back later at a lower price, profiting from a decline in value. This clause is commonly included in investment agreements, stock purchase agreements, and lending contracts to prevent downward pressure on stock prices.
For example, if a company grants stock options to an executive, the agreement may include a no short sales clause to prevent the executive from betting against the company’s stock.
Why is a no short sales clause important?
A no short sales clause protects the stability of a stock or security by preventing certain investors or insiders from engaging in short selling, which could artificially drive down its price. This is particularly relevant for companies issuing stock options, private investors, or lenders concerned about market manipulation.
For businesses, including a no short sales clause ensures that key shareholders, employees, or investors do not undermine the value of a security while holding an interest in it. For investors, such clauses may be a condition of participating in a private offering or financing agreement.
Understanding no short sales through an example
Imagine a startup raises capital from private investors. As part of the investment agreement, the startup includes a no short sales clause preventing investors from short-selling company stock for a specified period. This prevents early investors from betting against the company’s success while they still hold shares.
In another scenario, a company offers stock options to executives as part of their compensation. The employment agreement prohibits the executives from engaging in short sales of company stock to ensure they do not profit from a decline in stock value while employed.
An example of a no short sales clause
Here’s how a no short sales clause might appear in a contract:
“The Investor agrees that, for the duration of this Agreement and for a period of [X] months thereafter, they shall not engage in any short sale, hedge, or other transaction that could result in a financial benefit from a decline in the value of the securities issued under this Agreement.”
Conclusion
A no short sales clause prevents parties from profiting from the decline of a security’s value, ensuring market stability and investor confidence. This clause is particularly relevant in stock purchase agreements, investment contracts, and executive compensation plans. By restricting short sales, businesses and investors can maintain fair market practices and align shareholder interests with long-term growth.
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.