What is Market Out Clause
A market out clause is a stipulation in an underwriting agreement that allows the underwriter to cancel the agreement without penalty. A market out clause can be activated for specific reasons such as souring market conditions or simply because the underwriter is having difficulty in selling the company's stock. However, though the reasons can be varied, they must be noted in the market out clause.
BREAKING DOWN Market Out Clause
A market out clause is all about reducing an underwriter's risks in a firm commitment underwriting. The underwriter for an IPO contracts with the issuing company to market and sell the company's stock to investors in the primary market. Of course, this entails a fair amount of risk resulting from overhype and other factors. Underwriters can suffer a major financial loss by being forced to underwrite an offering that it later discovers may have little interest to investors – either because of circumstances within the issuing company or because of declining market conditions. Hence, a market out clause is generally invoked when the market has hit a rough patch or other IPOs have underperformed.
A market out clause can also allow the underwriting syndicate to opt out of the underwriting agreement prior to the initial public offering (IPO) if, for example, trading in the company's securities is suspended, a material change adversely affects the issuer or other such occurrences make it impractical fo the securities to be sold at the agreed-upon price.
Counsel for an issuing company that is preparing an IPO underwriting agreement must carefully review the conditions in the agreement that will allow the market out clause to be activated. An overly broad market out clause will effectively negate the concept of a firm commitment underwriting. Such an overreaching clause will permit an underwriter to cancel the underwriting agreement for virtually any reason, effectively placing all the risk on the issuing company.
Sample Market Out Clause Language
"This Agreement shall be subject to termination in the absolute discretion of the Representatives, by notice given to the Company prior to delivery of and payment for the Securities, if at any time prior to such time (i) trading in the Company's Common Stock shall have been suspended by the Commission or the Nasdaq National Market or trading in securities generally on the New York Stock Exchange or the Nasdaq National Market shall have been suspended or limited or minimum prices shall have been established on such Exchange or the Nasdaq National Market, (ii) a banking moratorium shall have been declared either by Federal or New York State authorities or (iii) there shall have occurred any outbreak or escalation of hostilities, declaration by the United States of a national emergency or war, or other calamity or crisis the effect of which on financial markets is such as to make it, in the sole judgment of the Representatives, impractical or inadvisable to proceed with the offering or delivery of the Securities as contemplated by the Prospectus (exclusive of any supplement thereto)."