The Special Purpose Acquisition Company (“SPAC”) phenomenon has allowed private companies to become publicly traded entities without the attendant logistical requirements of a traditional initial public offering (“IPO”) or a direct listing on a stock exchange. From a directors and officers (“D&O”) liability insurance perspective, there are three potential insurance programs that could be impacted by securities claims emanating from such transactions. These include lawsuits brought against (1) the publicly traded SPAC; (2) the (former) private company that merges with the SPAC via the “de-SPAC transaction;” and (3) the (new) publicly traded company (“Newco”). The directors and officers of each of the three entities described above could also be named as defendants in these claims, and there is a possibility that Insured Persons as defined within the respective D&O programs could have wrongful act allegations made against them in more than one capacity. For example, former directors and officers of the SPAC could be named alongside former directors and officers of the private company if both sets of individuals are currently serving as directors and officers of Newco.
In order to understand the interplay of the various D&O insurance programs, it is helpful to understand the mechanics of each entity in particular. First, the SPAC D&O program incepts upon the IPO of the SPAC (a shell entity with no operations, often described as a “blank check” company) and generally has a two year policy period. This two year period is intended to provide sufficient time for an acquisition target/private company to be identified by the SPAC for a de-SPAC transaction. The target/private company usually has its own D&O program in place prior to being identified by the SPAC. The private company D&O program, however, will often have an exclusion for securities claims. Upon consummation of the de-SPAC transaction, both the SPAC D&O program as well as the private company D&O program convert to “runoff” or “tail” insurance. This means that D&O coverage will be provided for claims arising in the future that relate to alleged wrongful acts that occurred prior to the transaction. Newco’s “go-forward” public company D&O program incepts concurrently with the two runoff programs and is intended to provide coverage for alleged wrongful acts against Newco occurring after the transaction.
Some of the above-described insurance program complexity can be mitigated if the Newco D&O program can be negotiated to include prior acts coverage for the private company, which will eliminate the need for the private company runoff program. In any event, it is critical that D&O policy language is reviewed in detail in order to provide coverage for the various entities and Insured Persons as defined within the various insurance policies. This includes coverage for legacy capacities and current capacities as well as pre-transaction and post-transaction alleged wrongful acts. However, even with careful policy drafting, coverage disputes can arise when individuals are named in separate capacities (e.g., as directors and officers of the SPAC as well as Newco) and for pre-transaction and post-transaction alleged wrongful acts. These “straddle claims” can be difficult to negotiate and resolve when more than one D&O insurance program is involved.
Many of the securities cases brought against one or more of the entities described above involve financial projections of the formerly private company that were utilized in proxy statements or other pre-transaction documentation. If post-merger performance does not live up to pre-merger projections and expectations, wrongful act allegations may be leveled against directors and officers of the SPAC, the private company and Newco, as well as the entities themselves. The implication of more than one D&O insurance program in such situations may make these cases more difficult to settle, especially if a particular insurer participates on more than one of the D&O programs.
Heightened scrutiny of SPAC entities as well as de-SPAC transactions by the United States Securities & Exchange Commission (“SEC”) over the past couple of months has potentially increased the risk of securities litigation against these entities and their respective directors and officers. In addition to the well-publicized scrutiny by the SEC of how warrants issued by SPACs are to be accounted for, another concern for potential liability centers around the “safe harbor” for forward-looking financial statements and projections made in conjunction with de-SPAC transactions. The safe harbor provision was a component of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). One of the perceived advantages of SPAC/de-SPAC transactions when compared with a traditional IPO is that the safe harbor applies to a de-SPAC scenario but not to a standard IPO. A Public Statement from the SEC on April 8, 2021 challenged this perception, noting that the PSLRA provided a safe harbor for forward-looking statements made by “established, publicly traded, reporting companies.” The Public Statement also noted that the PSLRA specifically excludes from the safe harbor statements made in conjunction with an offering of securities by a blank check company as well as those made in conjunction with an IPO (which may include de-SPAC transactions). This analysis concluded by stating that de-SPAC transactions have “no more of a track record of publicly-disclosed historical information than private companies that go through a conventional IPO.”
Heightened SEC scrutiny of the SPAC/de-SPAC environment, coupled with “hard” market conditions in the current D&O marketplace (characterized by limited insurance capacity, high retentions and expensive premiums), may make it difficult for SPACs and de-SPACS to procure broad insurance coverage at reasonable cost in terms or risk transfer. Alternatively, the potential inability in the future to rely upon the safe harbor for forward-looking statements may serve to reduce securities claims exposure risk for Newco publicly traded entities. Such a development could serve to increase D&O insurance marketplace appetite for “quality” underwriting opportunities. Under either scenario, the potential implication of multiple D&O insurance programs in conjunction with securities claims continues to present an inherent risk to the insurance underwriting community.