PSPC Liquidations and Expansions Create D&O Insurance Conundrums: Part 2 | woodruff sawyer

In Part 1 of this blog series, I focused on the Directors and Officers (D&O) insurance issues that a SPAC needs to address before an extension. For Part 2, I discuss D&O insurance issues that arise in a liquidation context.

Similar to Bill Ackman’s SPAC which was liquidated in July, several other high profile SPAC sponsors have recently closed and liquidated their SPACs. SPACRearch reports 19 SPACs liquidated as of September 22, 2022. Word on the SPAC street is that many more will hit the market before the end of the year, now that there is a specter of the potential new excise tax that could hit SPACs in 2023. All SPACs considering liquidation should add the question of what happens to their D&D insurance coverage after liquidation to their to-do list.


Although SPAC’s sponsors are understandably distraught at the prospect of not finding a suitable merger target and having to liquidate SPAC, most know they must consult with their business and legal advisors to achieve an orderly distribution of SPAC funds and terminate the operations of SPAC. Most legal, financial and logistical issues are therefore resolved in a timely manner.

The issue of insurance coverage, however, is often overlooked. Many SPAC teams don’t stop to think about the possibility of risk for SPAC’s directors and officers once the liquidation is complete. Nor do they necessarily think about the fact that the D&O policy they purchased for their SPAC at the time of its IPO will end once they are liquidated.

How does D&O SPAC insurance work?

Almost all SPACs that have gone public and are looking for merger targets are covered by what I will call a “SPAC IPO D&O Policy”. This policy covers SPAC and its directors and officers for things like securities class action settlements as well as defense costs related to investigations and enforcement actions by the Securities and Exchange Commission (SEC). This policy usually starts running at the IPO and follows the initial investment period of the SPAC, which means that if the investment period of the SPAC was set at 24 months, the policy would expire at 24 months or if the SPAC is liquidated earlier, on the date of liquidation. The policy generally does not extend automatically over a longer period if the SPAC has to be liquidated.

The merger scenario

When SPAC teams purchased this policy, they most likely ran through the scenario where SPAC would merge with a target company and their D&O coverage would expand (via the tail) to cover their post-merger directors and officers. They also assumed that their directors and officers would receive compensation from the combined entity at the time of the merger, which is the market standard. With indemnity and tail coverage being paid out of the transaction costs of the merger, PSPC teams ensured that they would be covered in case they were sued post-merger.

The liquidation scenario

But in a liquidation scenario, there is no merger. There is no combined entity to offer compensation. There are no transaction funds to cover the cost of the SPAC tail. The original SPAC D&O policy expires unless the SPAC team chooses tail coverage. And that tail cover, which was typically pre-negotiated to cost between 200% and 400% of the initial SPAC IPO policy premium, now has to come out of the pockets of directors and officers.

The pre-negotiated costs of this tail cover are not negligible. Depending on how a SPAC’s IPO policy was structured and when it was purchased, tail costs could run into the millions of dollars. After losing their shirt on a failed SPAC, few SPAC team members are eager to go get another shirt to pay that tail bounty.

Is there a risk after liquidation?

A knee-jerk reaction of most teams I’ve spoken with is to not even care about the tail. And I can certainly understand where they come from. The usual refrain is: “if we return all the money to the investors plus interest and close up shop, why could we be sued?” That’s an excellent question.

The answer isn’t immediately clear, but most of us who’ve watched the SPAC space would probably agree that the risk of a lawsuit, even after an orderly liquidation, is far from zero. . Take, for example, the situation with FAST Acquisition Corp., which was well summarized by Kevin LaCroix in The D&O Journal.

In that case, a pre-liquidation lawsuit has emerged between SPAC and its shareholders, who accuse the SPAC team of breaching fiduciary duties by retaining termination fees after a failed merger. The shareholders asked the court to halt the liquidation until their claim is resolved. The circumstances of this case are a bit unusual, but it is an example of an unforeseen outcome and litigation that could arise in a liquidation scenario.

Over the past couple of years, we’ve seen all sorts of new dispute theories come before the courts against SPACs and their directors and officers. Now that the tide of liquidations is coming, we cannot assume that all shareholders will quietly walk away from every liquidation. Additionally, the threat of a regulator’s investigation into how a liquidation is being conducted is also not discounted.

The risk is certainly much lower than in a post-merger scenario, but it exists. This means that without tail cover in place, the directors and officers of a SPAC may need to cover the attorney’s fees related to this investigation or the costs of defending this litigation (even if frivolous) from their poached.

Can tail costs be managed?

For SPAC teams that don’t want to take this risk, there are ways to work with their SPAC insurance broker to minimize the cost of tail coverage.

First, a good insurance broker will be able to negotiate the cost of this pre-negotiated tail from 200% to 400% of the original policy premium to 100% to 150% or even less. Keep in mind that it would be a one-time cost to extend the coverage of this policy for six years after wind up. Many carriers are willing to discuss this reduction in the current market because they also agree that the risk of lawsuits or government action is lower.

Second, since the risk is potentially lower in a liquidation scenario than in a merger scenario, you might consider opting for a tail that could be a fraction of your original policy limit. So, for example, if your original D&O IPO policy had a total limit of $10 million, you might consider reducing it to $5 million, saving some of the costs of that tail.

All of this is possible, and a knowledgeable insurance broker will be able to guide you in taking these steps. But whichever way you decide to proceed, don’t wait until the last minute. If your team is considering liquidating, contact your insurance broker immediately to ensure you fully understand the options, risks and solutions that exist for your team.

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