Market Out Clause

What Is a Market Out Clause?

A market out clause is a limitation in a underwriting agreement that permits the underwriter to cancel the agreement without penalty. A market out clause can be activated for specific reasons, for example, souring market conditions or essentially on the grounds that the underwriter is experiencing issues in selling the company's stock. Nonetheless, however the reasons can be shifted, they must be noted in the market out clause.

Figuring out a Market Out Clause

A market out clause is tied in with lessening an underwriter's risks in a firm commitment underwriting. The underwriter for an IPO contracts with the responsible company to market and sell the company's stock to investors in the primary market. With a firm commitment underwriting, the underwriter consents to expect all inventory risk and buy all securities for a initial public offering (IPO) straight from the issuer to sell to the public.

Of course, this involves a fair amount of risk coming about because of overhype and other factors. Underwriters can experience a major financial loss by being forced to guarantee an offering that it later discovers might have little interest to investors - either as a result of conditions inside the responsible company or due to declining market conditions. Subsequently, a market out clause is generally conjured when the market has run into a difficult time or other IPOs have failed to meet expectations.

A market out clause can likewise permit the underwriting syndicate to opt-out of the underwriting agreement prior to the initial public offering (IPO) if, for instance, trading in the company's securities is suspended, a material change adversely influences the issuer or other such events make it unreasonable for the securities to be sold at the agreed-upon price.

Counsel for a responsible company that is setting up an IPO underwriting agreement must carefully audit the conditions in the agreement that will permit the market out clause to be activated. An overly broad market out clause will effectively nullify the concept of a firm commitment underwriting. Such an overreaching clause will permit an underwriter to cancel the underwriting agreement for essentially any explanation, effectively putting all the risk on the responsible company.

Sample Market Out Clause Language

Here is a section from an underwriting agreement between Rackable Systems and its underwriters to sell 2.6 million shares of the company's common stock.

(l) Subsequent to the execution and delivery of this Agreement there will not have happened any of the accompanying: (I) trading in securities generally on the New York Stock Exchange or the American Stock Exchange or in the over-the-counter market, or trading in any securities of the Company on any exchange or in the over-the-counter market, will have been suspended or the settlement of such trading generally will have been materially upset or least prices will have been laid out on any such exchange or such market by the Commission, by such exchange or by some other regulatory body or governmental authority having jurisdiction, (ii) a banking moratorium will have been declared by Federal or state specialists, (iii) the United States will have become participated in threats, there will have been a heightening in threats including the United States or there will have been a declaration of a national emergency or war by the United States or (iv) there will have happened such a material adverse change in everyday economic, political or financial conditions, including without limitation because of psychological militant activities after the date in this regard, (or the effect of international conditions on the financial markets in the United States will be, for example, to make it, in the judgment of the Representatives, unfeasible or unwise to continue with the public offering or delivery of the Stock being delivered on such Delivery Date based on the conditions and in the way pondered in the Prospectus.

Features

• Such agreements are normally put in place in a firm commitment underwriting, in which an agreement has been made for the underwriter to expect all inventory risk and buy all securities for an IPO to be sold to the public.
• The market out clause needs to state specifically what conditions must happen for the underwriter to be permitted to institute the clause.
• With a market out clause, an underwriter that has agreed to market and sell a company's stocks can cancel that agreement without suffering a consequence.
• The market out clause can get going because of reasons that remember a change or decline for market conditions or to free an underwriter from the financial burden of holding stock that won't sell.