What is a Market Out Clause?

A market out clause is a provision that allows an underwriter to withdraw from a stock underwriting contract.

How Does a Market Out Clause Work?

When an investment bank serves as an underwriter for an initial public offering (IPO), it has a contract with the issuing company to market and sell new shares of stock to investors in the primary market. A market out clause specifies the circumstances under which an underwriting brokerage house may withdraw from its obligations and avoid paying a penalty to the issuing company.

For example, a market out clause may state that an underwriter has the right to cancel its contractual obligations to an issuing company if it experiences sustained difficulty in profitably selling a company's stock.

Why Does a Market Out Clause Matter?

A market out clause is specific in terms of when an underwriter may withdraw from its contractual obligations. In other words, it does not give the underwriter the right to withdraw from the contract at any time. To this extent, when an underwriter opts to cancel a contract for reasons inconsistent with the circumstances prescribed, it can result in a heavy fine to the issuing company.