SPACs (special purpose acquisition companies) had a banner year in 2020, raising more funds in the public market and doing more business combinations than ever before. As they go through their IPO and the subsequent M&A process, SPACs face many regulatory, legal, and business hurdles, including obtaining the appropriate amount and type of insurance for each stage of their life cycle. But with some smart preparation and the expertise of the right advisors, insurance can go from being a necessary hurdle to a strategic asset.
Topics in the Guide:
SPAC Life Cycle
When thinking about insurance for a SPAC, it is helpful to think in terms of the SPAC’s life cycle. From an insurance perspective, there are three main phases:
Phase One: IPO
As it goes through the IPO process, the main assets of a SPAC are its management team, the management team’s investment strategy, and the SEC’s approval of the SPAC Form S-1 registration statement.
5 Forms of Private Litigation Against SPACs
Potential SPAC-related private litigation has five forms:
- Plaintiffs can allege liability for damages for material misrepresentations or omissions of facts in the SPAC’s S-1 registration statement.
- Plaintiffs can bring a suit challenging the completeness of the proxy statement filed in connection with the SPAC’s acquisition of an operating company during its de-SPAC transaction.
- Plaintiffs can sue after the merger transaction because they are unhappy with the resulting company, alleging that SPAC shareholders learned of the true nature of the target company only after the merger was completed.
- Plaintiffs can bring a securities class action suit against the newly public operating company after the SPAC combination.
- Directors of a SPAC that purchases a target company which subsequently becomes bankrupt may be sued by the bankrupt company’s creditors.
The vulnerability associated with being a public company creates a need for directors and officers liability insurance coverage for the SPAC’s management team and its board. Moreover, a majority of a SPAC’s board must consist of independent board members to satisfy stock exchange listing rules. Professionals who serve as independent board members typically do not accept a board appointment without good D&O insurance already in place.
D&O Costs for SPAC IPOs are Increasing
The general litigation environment has deteriorated recently, in part as a consequence of a 2018 Supreme Court decision, Cyan v. Beaver County Employees Retirement Fund. Lawsuits are now brought in multiple jurisdictions, including federal and state courts. Plaintiff law firms have been quick to capitalize on the Supreme Court’s ruling, which has in turn driven up the cost of D&O insurance dramatically for new IPO companies compared to the cost for mature public companies. The increases in non-SPAC IPO D&O insurance premiums coupled with the recent surge of SPAC IPOs and the scarcity of insurers who are willing to write D&O coverage for SPACs have significantly pushed up SPAC IPO D&O premiums in the last quarter of 2020. Premium pricing will remain higher than pre-2020 levels going into 2021.
There may be some relief on the horizon due to some positive litigation outcomes in the Delaware Supreme Court case, Sciabaccuchi, as well as in a critical California state court case, Restoration Robotics. D&O insurance carriers have so far not lowered prices on the basis of these two decisions. If they do, it will only be for companies that have federal choice of forum provisions in their charter documents. Be sure to discuss this with your securities counsel.
Get a Sense of Pricing—from a SPAC Insurance Expert
For now, the pricing for D&O insurance for SPAC IPOs remains volatile. In the course of 2020, the cost of a good-size D&O insurance program for a typical SPAC more than doubled. Given how dynamic the current D&O insurance market is, you will want to be sure to talk to your insurance broker to get an indication of current pricing sooner than later. It has to be said: if you are asking this question of someone who does not place a lot of D&O insurance for SPACs, you are at risk for having asked for pricing information from someone who does not realize that they do not know the answer to your question.
Read more in the full guide about 2021 pricing and the three risk factors underwriters will be examining. (More details on underwriters factors are covered in our blog post, D&O Insurance for SPAC IPOs: Costs and Underwriting Factors.)
Ideally in advance of the first filing of your confidential Form S-1 registration statement, your broker will launch the process by sending non-disclosure agreements to the relevant insurance carriers. The chart below highlights the D&O insurance process.
For a more detailed look at this process, check out our Guide to D&O Insurance for IPOs and Direct Listings.
Remember, it is critical that your insurance broker considers and guides the SPAC management team through the milestones of the SPAC’s life cycle.
Phase Two: SPAC Business Combination
After the IPO, the SPAC has the funds to purchase or merge with another company. The SPAC’s management team must find an attractive target company and complete the merger or acquisition (sometimes known as the “de-SPAC” transaction), typically within 18 to 24 months after the IPO. When the management team approaches potential acquisition targets, which are typically private companies, M&A representations and warranties insurance (RWI) comes into play. A well-designed RWI policy allows a SPAC to offer the same purchase price to a target company, but with minimal or no seller indemnity and with minimal or no escrow. Because RWI is now almost a market standard in auction processes, it is likely to be offered and used by the rest of the competition. Excluding RWI from its offer effectively puts a buyer at a serious disadvantage. In addition, the management team must also consider and plan for D&O insurance coverage of the post-business combination entity. We examine each of these one at a time in our full Guide.
Read more about trends in RWI minimum limits and policy premiums, and find out how these factors have created the environment in which SPAC management teams can now fully take advantage of the RWI market with guidance from a knowledgeable insurance broker that specializes in SPAC representations and warranties policies. Woodruff Sawyer’s RWI placement process is highlighted below.
RWI Insurance Placement Process
Placement of an RWI policy can be accomplished in about two weeks.
D&O Insurance Coverage for the Business Combination (de-SPAC) Transaction
The D&O and the RWI insurance policies need to be approached in concert. As soon as the parties close on the business combination, the D&O coverage of the SPAC and that of the target entity are no longer in effect. The new entity’s directors and officers must be covered by a new D&O insurance policy.
Specifically, there are up to three different D&O policies that may need to be placed before the transaction closes: (1) a tail policy for the SPAC company’s D&O policy, (2) a tail policy for the target company’s D&O policy, and (3) the D&O insurance that needs to be put in place for the new combined entity (which is, of course, a new publicly traded company).
Covering Claims That May Occur Post-Transaction
The D&O policy for the going-forward public company will cover the newly combined company for claims based on actions taking place after that transaction closes. This looks and feels like the D&O insurance policy of any new, publicly traded operating company. It is important to start this process well before the deal will close. The cost of the D&O insurance policy for the new public company may be less than that of a traditional IPO company, but these costs are trending upwards.
Phase Three: SPAC Operations/New Public Company
At this point, the combined company is up and running—and carrying with it all of the attendant risks of an operating public company. As such, the company needs to be ready for public company scrutiny, which calls not only for ongoing compliance with all necessary regulations but for a review and usually an upgrade of the company’s overall insurance coverage. This can mean upgrading everything from the company’s property insurance to the company’s cyber liability insurance.
Ongoing D&O Coverage
The operating company must establish a process around its annual D&O insurance renewal. Starting the renewal process with an expert D&O insurance broker early saves time, averts potential frustration, and can save on costs. Companies are able to optimize the renewal process by being prepared and taking a focused approach to their D&O insurance renewal.
It is in your best interest to choose a broker that has the experience and expertise to be able to recommend the most strategic insurance program placement options, as well as one with extensive experience managing claims for SPAC-related claims. Check out the full Guide for questions to ask potential D&O insurance brokers before you choose one.
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The pricing of directors and officers (D&O) insurance coverage for the SPAC at its IPO is one area that does not seem to be getting the full level of disclosure.