October 27, 2021

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Significance and effect of lock agreements in the USA

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This article is written by Ashwin Balachandran, pursuing Diploma in US Contract Drafting and Paralegal Studies from LawSikho. The article has been edited by Smriti Katiyar (Associate, LawSikho).

Table of Contents

With this article, we will briefly look into the significance and effect of lock agreements in the United States. Before getting into the details, it is essential to know what a lock-up agreement is. A lock-up agreement is an agreement that is entered between the insiders of a company and the underwriter of the company before the private company or a corporation issues its stocks to the public through Initial Public Offering (IPO). In essence, the lock-up agreement temporarily prohibits the insiders of a company from selling their shares for a specified time period. This prohibition ensures protection to the investors against any pressure to sell shares the insiders may generate. Insiders can be anyone associated with the company ranging from its top officials to employees. The most common duration of the Lock-Up Agreement is 180 days, and it is subject to change according to the market conditions and parties involved.

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The purpose of a ‘lock-up’ agreement is to keep the company’s stock stable for the first several months after the initial public offering. Following the IPO, the ‘Lock-Up’ Agreement ensures order in the market with respect to the company’s shares and it gives the market enough time to figure out the stock’s true value. Further, it also guarantees that the insiders act in accordance with the company’s goals. 

In a situation wherein insiders make public, an exaggerated share, and issue the same to unsuspecting investors. It will likely result in investors losing their investment and insiders making a profit. The execution of the ‘lock-up’ agreement would prevent such a situation and would reduce fluctuations in a share price when the stock is issued to the market. Thus, lock-up agreements potentially reduce the risk of stock price plummets at an earlier interval. Further, when the lock period ends, the sale of stocks by the insiders would set a benchmark for the price of shares, that is if the insiders hold onto their shares, the market may perceive that the price of shares will rise and the dumping of shares would suggest a reduction in the price of the shares. So, diligent investors would only seek to invest after the ending of the lock-up period. 

The lock-up agreement is not limited to shares of private companies/corporations but is also applicable to the controlled sale of stakes and companies under hostile takeovers. It is pertinent to note that there is no federal law in place that necessitates the requirement of a lock-up agreement when entering into the IPO process however US federal securities laws, as well as state securities law (known as the “Blue Sky Laws”), are always on a lookout for fraudulent practices and activities. 

  1. Insiders Definition Clause. The agreement should define and identify the private company’s insiders who will be prohibited from selling shares during the lock-up period.
  2. Duration Clause. The duration clause should detail the lock-up period that is the exact number of days the lock-up would last for.
  3. Restrictions Clause. The agreement should list the actions that the insiders are prohibited from taking during the lock-up period.
  4. Exceptions Clause. The exceptions to lock-up restrictions imposed during the lock-up period are known as carve-outs. The carve-outs or the exceptions to the lock-up period should be detailed in the lock-up agreement.
  5. Release of Lock-Up period Clause. The agreement should specify the period upon which the lock-up ends and the subsequent compliances to be followed.
  6. Rights and Duties Clause. The rights and duties clause would ensure that the insiders act in accordance with the company’s interests.

The following are the factors that need to be addressed by the drafter while drafting a lock-up agreement. 

  1. The drafting of the lock-up agreement. The drafting of the lock-up agreement should be customised to convey the specific situations pertaining to the company or around the facts surrounding it. The formation of the agreement should address the concerns, necessities of the insiders and the companies as well.
  2. Duration of the lock-up period. The extent of the lock-up period can vary between different parties. Most investors may prefer shorter lockups as they can make a profit at the earliest. Whereas the underwriter may prefer long duration as it prevents a drop in share price. 
  3. Exceptions or carve-outs. The exceptions or carveouts need to be detailed exhaustively as the clause provides for permitted transfers during the lock-up period.
  4. Releases from lock-up. The drafter should also explain the rights and responsibilities of the insiders once the lock period release.
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Lock-up agreement 

This LOCK-UP Agreement (“the Agreement”) is entered on the 26th day of September 2021 (“Effective Date”) by and between ROCKSTAR, INC a Delaware corporation (the “Company”) and ___________ (the “Stockholder”)

WHEREAS the Company is offering its shares through Initial Public Offering.

AND WHEREAS the Stockholder is prohibited from selling his 200,000 shares of the Company during the Lock-Up Period 

NOW, THEREFORE, in consideration of the foregoing premises and the mutual covenants contained herein, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows:

  1. LOCK-UP PERIOD. The Lock-Up period shall commence from the Effective Date and end 180 days from the Effective Date (the Lock-Up Period).
  2. RELEASE OF LOCK-UP PERIOD. The Lock-Up Period shall end on ________.
  3. RESTRICTION. The Stockholder here agrees that he will not during the Lock-Up Period sell, contract to sell, grant any option to purchase, transfer or dispose of any of the Company’s shares directly or indirectly to any other person. The Stockholder further agrees that by his action he will not take part in any economic activity that would result in the transfer of ownership of the shares. 
  4. PERMITTED TRANSFER. Notwithstanding the foregoing and upon ascertaining written consent of the Company the Stockholder may transfer shares during the Lock-Up Period as a gift, by will or for the benefit of family, subject to the condition that the transferee complies to the Lock-Up Period pending if any.
  5. STANDSTILL. The Shareholder represents and warrants that he does not have any beneficial ownership of shares or rights or options there attached to acquire any such shares of the Company other than that which is retained. 
  6. RELEASES. The Lock-Up will come to end (i) if the company merges or consolidates with that of another company or any such entity and (ii) Dissolution, liquidation or winding up of the affairs of the Company.
  7. RIGHTS OF THE SHAREHOLDER. The Shareholder shall retain ownership of the retained shares including the voting rights.
  8. NO OTHER RIGHTS. The Stockholder acknowledges and agrees that the Company has no obligation to record or register any sale, or such disposition of shares under the Securities Act.
  9. SPECIFIC PERFORMANCE. The Stock Holder agrees that a material breach in of any provisions of this Agreement could result in irreparable harm to the Company and in the instance of such an event of a breach monetary damages will be insufficient to compensate the Company then the Company shall be entitled to compel specific performance of the obligations provided under this Agreement or such other relief as the court deems appropriate to any other remedy that may be available to it.
  10. JURISDICTION. The enforceability or interpretation of this Agreement shall be governed by the statutory laws of Delaware State, and the courts of Delaware shall have original jurisdiction in respect of any action to contest the validity, interpretation, enforceability of this Agreement. Notwithstanding the foregoing, the parties agree that prior to initiation of any proceeding, action, law or any such legal remedy in connection with the disputes arising out of this Agreement; the Parties shall first negotiate in good faith with each other regarding such dispute. 
  11. SEVERABILITY.  If any terms of this Agreement are to be held invalid, illegal, unjust or unenforceable by the law then the remaining provisions shall be deemed to be written, construed, and enforced as so limited.
  12. AMENDMENT. Any terms of the Agreement can be subject to Amendment with the written consent of the parties. 
  13. NOTICE. Every notice required or contemplated by this Agreement by any party shall be delivered by postage prepaid, registered airmail, addressed to the other party at its address specified below or at such other address as the intended recipient previously shall have designated by written notice and such notice shall become effective ten days after the date of dispatch of such notice.

Rockstar Inc

___________________

______________, Delaware.

Stock Holder 

___________

____________, State 

IN WITNESS WHEREOF, the parties hereto have duly executed this Lock-Up Agreement effective as of the first date set forth above 

ROCKSTAR INC ` Mr/Mrs/Miss_________

Title: ________________ Title: _______________ 

Signature: ____________                           Signature: ___________

The US legislature does not mandate the requirement of a lock-up agreement nor it is necessitated by any regulatory bodies or exchanges. The lock-up agreement entered into is thus voluntary, therefore, it is necessary to draft the lock-up agreement with utmost diligence. A well-drafted lock-up agreement would ensure safety to the investors as well as the company. Any variance in the interpretation would result in dire economic loss as the insiders may exploit the lacuna.  

  1. https://ihsmarkit.com/research-analysis/ipo-lockup-agreements.html
  2. https://www.sec.gov/Archives/edgar/data/1538217/000155335014001524/scri_ex10z35.htm
  3. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/lock-up-agreement/
  4. https://www.investopedia.com/terms/l/lockup.asp#:~:text=A%20lock%2Dup%20agreement%20temporarily,excessive%20selling%20pressure%20by%20insiders.&text=Depending%20on%20the%20fundamentals%20of,buy%20in%20at%20lower%20prices

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