We have previously commented on the lock-up requirement in connection with IPOs and noted that it has become somewhat more frequent for underwriters to release issuers and/or their shareholders (including directors and officers) from their lock-up requirements early. Generally, this has been the case where the IPO has performed well and there is interest in selling additional primary or secondary (selling security holder) shares in a follow-on offering before the expiry of the 180-day period. In prior posts, we have noted that the FINRA rules require public disclosure of an early lock up. We also have discussed the importance of disclosing in any prospectus exceptions to the lock-up requirements, and giving thought to which members of the underwriting syndicate will have the authority to release parties from the lock-up.
Recently, courts have been asked to consider claims arising in connection with lock-up releases. For example, in a recent Delaware Chancery Court case, a claim by shareholders for breach of fiduciary duty against an issuer’s board of directors for its waiver of a post-IPO lock-up as to certain existing shareholders survived a motion to dismiss. The court in that particular case dismissed aiding and abetting claim against the underwriters. Noting that the requisite underlying requirements of existence of a fiduciary relationship and its breach existed, the Court held that the element of “knowing participation in the breach by the non-fiduciary defendants” was missing. In waiving the lock-ups, there were insufficient facts alleged to demonstrate that the underwriters knowingly participated in the directors’ (alleged) breach of fiduciary duty or that they extracted “unreasonable” compensation or an “improper side deal” in order to consent to the selective lock-up waivers.
In other instances, where an early lock-up release has permitted a follow-on offering to proceed or has enabled shareholders to sell into the market, shareholders have sought to bring a class action in connection with losses suffered as a result of the drop in the issuer’s stock price.
In planning for an IPO and the capital-raising transactions that inevitably will follow, it will be important for companies and their boards to consider the terms of any lock-up agreement, and, if locked-up shareholders are to be treated differently, the rationale for doing so. If directors are participating in a follow-on transaction occurring during the lock-up period, it will be important to make sure a majority consisting of disinterested directors approves the transaction and their participation. And analyze such disinterestedness on the record. If it is a potentially “hot stock” with or without a disproportionately small public float, consider building in staggered lock-up releases from the beginning. Lock-ups are a lesser concern in follow-on offerings because typically only directors, officers and a select number of larger shareholders will be locked up. And, of course, never assume that stock prices can only go up.