Underwriting Of Right Issues
Although there have been examples of rights issues done at a deep discount to the prevailing market price and not underwritten, it is more common for rights issues to be underwritten. Underwriting performs the function of ensuring that the company receives all of the capital intended to be raised by the rights issue even if it is not fully subscribed by the existing shareholders:An underwriting agreement means an agreement entered into before the shares are brought before the public that in the event of the public not taking up the whole of them, or the number mentioned in the agreement, the underwriter will, for an agreed commission, take an allotment of such part of the shares as the public has not applied for.
In return for a percentage fee the underwriter undertakes to take up any of the shares offered which have not been applied for by the closing date.In practice the underwriter normally passes on most of the obligation to take the shares if they are not subscribed by the public to sub-underwriters who are typically institutions such as pension funds and insurance companies. The process of passing on the risk to sub-underwriters came under judicial scrutiny in Eagle Trust pic v SBC Securities Ltd. In this case SBC, the underwriter of a rights issue, accepted a director of the company as a sub-underwriter
The director used company money to pay for the shares and was later convicted of theft. The company sought to make SBC liable to repay the money which had been mis-applied by its former director. The claim failed but, in coming to that conclusion, the court analysed closely the role of the underwriter and the duties to which it is subject when arranging sub-underwriting. Arden J concluded that an underwriter acts in its own interests when arranging subunderwriting and that it is under no duty to the company to choose any particular type of sub-underwriter for the benefit of the company. Unless specifically agreed with the company to the contrary, the underwriter is therefore free to accept a director as a sub-underwriter.
This is the position even where, as is common, the underwriter not only undertakes the obligation to take the shares as a last resort but also acts as financial adviser to the company in relation to the issue because the underwriting function, including related matters such as sub-underwriting, is distinct and separate from the function of the financial adviser.
In the Eagle Trust case the further argument that SBC had acted in breach of its duty of care as financial adviser by failing to disclose the fact that it had accepted a director as a sub-underwriter to the issuing company's board was also rejected on the facts.
For many years underwriting commissions on rights issues in the UK mar ket were fixed at the fairly standard level of 2 per cent of the proceeds of the issue divided up as follows: 0.25 per cent to the broker; 0.5 per cent to the lead underwriter; and 1.25 per cent to the sub-underwriters. An extra 0.125 per cent was charged for each seven days or part of seven days for which the underwriting continued beyond the initial thirty days. Underwriting commissions at these levels were tolerated by the investment committees of the Association of British Insurers and the National Association of Pension Funds and were well within the limits on lawful commissions out of capital prescribed by the Companies Act 1985. Section 97 of that Act allows a commission to be paid provided payment is authorised by the company's articles and the amount paid does not exceed the amount or rate authorised by the articles or 10 per cent of the issue price, whichever is the less. .
