An underwriting agreement is entered into between a company issuing shares and an underwriter. An underwriter, in this agreement, promises to meet any shortfall of minimum subscription when the company issues securities. In return, the company pays the underwriters a fee that is based on a percentage of the total shares underwritten. These securities taken over by the underwriter are later sold in the open market. Any profit generated as a result of such sale, in addition to their fee, is an income for the underwriters.
Statutory provisions for an IPO require that the public subscribe to at least 90% of the issued shares before a company gets its certificate for commencement of business. Companies enter into an agreement with underwriters in case the minimum subscription is not met. Underwriters promise to purchase the shortfall of that minimum subscription.
There are several types of underwriting agreements based on the underwriters and underwriters’ commitment to purchase the shares. For instance, insurance underwriter, security underwriters, and standby underwriting involve analyzing the potential risk of clients wherein the underwriters guarantee reimbursements in the case of damage or financial loss. Thus, the standard clauses for such an agreement template could vary.
What Is Insurance Underwriting or What Is Underwriting in Insurance?
It involves undertaking risks and establishing pricing. It helps to set forth fair loan rates, establish appropriate premiums, and creates a market for securities, Underwriters usually work in insurance categories like health, life, and home. Such insurers review applications for insurance, analyze risks and decide whether the company will offer coverage.
Some of them are
- Firm Commitment Agreement: Under this contract, the underwriter promises to purchase all or a defined number of securities irrespective of the public subscription
- Best Efforts Agreement: An investment banking company, or an underwriter, promises to sell all the securities offered by the issuer. However, they need not buy the entire stock meant for issue. These underwriters can only purchase securities to meet public demand. These agreements relieve underwriters’ obligations in the issue. Besides, since underwriters are generally paid a flat fee for it, their risk is minimized
- Min-Max Agreement: In this agreement, the underwriters’ are obligated to sell the securities only after a certain number of securities have been sold.
- All-or-none Or Part-or-none Agreements: In this contract, the issuer sets the minimum proceeds that are to be received as part of the sale. If the underwriters are unable to meet the minimum requirement, then the issue is canceled and the amount is returned to the investor.
- Standby Agreement: This is the general form of underwriting that most companies enter into. In this form of contract, the underwriters promise to purchase shares that are falling short of minimum subscription. These shares are then resold in the open market.
Who Takes the Underwriting Agreement?
There are two parties involved in an underwriting agreement: The issuing company and the underwriters. These underwriters could be investment banks or a syndicate of banks that assist the company in meeting statutory minimum subscription during an IPO.
Purpose of an Underwriting Agreement
When an issuing company is unsure of meeting its subscription, it approaches an underwriter to complete the issue. These underwriters then purchase the stock to meet the requirement if any. Underwriting agreements outline the roles and responsibilities of each party to identify the exact scope of the terms of engagement. It provides an assurance to the company that their subscription will be met even if the public does not subscribe to their IPO. When a company engages underwriters, it creates investor confidence regarding the performance of the company.
How to Draft Underwriting Agreement?
A standard underwriting agreement template contains the following terms:
- The details of the company whose shares would be underwritten
- The details of the securities that would be underwritten
- Any warranties and indemnifications that each party promises the other through the contract
- Provisions for either party to engage sub-underwriters to minimize their risk
- The obligations of the underwriter regarding the subscription and subsequent sale of the securities
- The details and breakup of commission that would be paid to the underwriters — whether as a percentage or a flat fee.
- The obligations of the company towards the underwriters
- Details of dispute resolution and legal recourse available to both the parties in case of a breach of contract.
- Provisions to deal with defaults by the underwriters and the method of grievance redressal for the same.
- Details of termination of contract and the circumstances under which it is warranted.
- Details of timely reports or any legal notices due to either party for various contractual performance (or non-performance there to).
When deciding on commission, both parties should agree on the method of calculation and the rate of commission. Along with the rights and liabilities, the contract should also lay out the provisions for making any changes to the contract in the future.
Default By Underwriters, Notices, Termination
If the Underwriter fails to purchase and pay for the portion of the Warrants on the assigned date, the Representative can use reasonable efforts to procure within the stated time, one or more other Underwriters, or any others, to purchase from the Selling Security Holder.
Notices: All communications shall be in writing except as otherwise provided herein. They can be mailed, delivered, faxed, telecopied or telegraphed.
Termination: This Agreement shall be terminated by notice to the Company and the Selling Security Holder, prior to the Closing Date in case of
- Any outbreak, hostilities, national emergency or national or international calamity or crisis (including, without limitation, an act of terrorism) or change in economic or political condition.
- Suspension of trading in securities generally on the Exchange or limitation on prices (other than limitations on hours or numbers of days of trading) for securities.
The negotiation in this contract will be regarding the commission that is due to the underwriters. The fee that is agreed upon should not increase the pre-incorporation expenses unduly, nor should it underrepresented the underwriters’ interests. Parties may also negotiate on the warranties and representations that is expected of each party. Both parties try to minimize their liability in the contract. So when negotiating this agreement, parties should ensure all the statutory requirements are met.
Benefits and Drawbacks of Underwriting Agreement:
Following are the benefits of the agreements:
- Insurance underwriting hedges against the uncertainty that the minimum subscription might not be met.
- If the shares of the company do well in the market, the underwriters stand to gain a significant amount of profit on selling the securities.
- Underwriting of securities provides a boost in public confidence. It provides financial recognition to the company whose shares are issued to the public.
Following are the disadvantages of underwriting agreement:
- The preparation of the agreement is time taking.
- It is also a costly affair as the underwriter’s charge a substantive amount as commission.
- Conflict in case of underwriting may lead to fail of subscription.
- Companies might not require the services of underwriters if the minimum subscription is met. Even if it is, they are expected to pay the underwriters a certain commission.
What Happens in Case of Violation?
In case of violation of underwriting agreement, following remedies are available to parties:
- Damages: The parties can claim damages for breach of terms of agreement.
- Remedy for breach of warranty: The Parties may also claim remedy for breach of warranty by any party.
- Specific Performance: The Court can also award specific performance for payment of commission to the underwriters.
This agreement provides safety for those corporations who are issuing their securities to the public for the first time. It tries to balance the interests of both parties so that contractual obligations are performed as agreed. It is mandatory for every unlisted company going for public issue of securities to get their issue underwritten.
Sample Underwriting Agreement
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