Litigation stemming from the meteoric rise of Special Purpose Acquisition Company (SPAC) transactions means Directors and Officers (D&O) insurance coverage requires heighted attention. Unlike a traditional IPO, where the private company converts its existing D&O program into a public company program, in a SPAC combination there are three main insurance programs at issue: the SPACs, the target’s, and the go-forward public company. Coordinating and understanding coverage is crucial. Key coverage questions for SPACs, target companies, and their respective directors and officers are:
- What D&O Insurance Programs are at Play?
- Does the Target’s D&O Policy Provide Adequate Coverage?
- Should the Target’s Private D&O Policy Be Placed into Run-Off?
- What Are the Coverage Options for the SPAC (and Sponsor)?
- Will the Public Company D&O Policy Cover Prior Acts?
Reviewing your coverage and options is key. Below, we’ve outlined our insights gained from advising SPACs and target companies on coverage to help mitigate risk.
1. What D&O Insurance Programs are at Play?
There are three main programs: (i) the SPAC’s public company D&O coverage, (ii) the target company’s private company D&O coverage, and (iii) the go-forward public company’s D&O coverage. (Each of these programs may also have Side A excess coverage.)
- SPAC: The SPAC likely obtains public company D&O coverage for the company and its directors and officers at the time of its IPO. Protection against claims from its efforts to identify and merge with a target company, the typical coverage period is two years and is generally placed into run-off as the de-SPAC transaction closes. Because this is public company D&O coverage, it typicallyincludes three “sides:” Side A coverage for individual directors and officers in the event the company is unable or unwilling to indemnify the individuals; Side B reimbursement coverage for the company for its indemnification of directors and officers; and Side C coverage for the company against securities claims. In addition, this policy should include coverage for the SPAC sponsor LLC and its directors.
- Target Company: The target likely has a private company D&O policy that can cover a range of alleged wrongful acts committed by the company, but typically excludes coverage for securities claims. This exclusion often appears without any modifications in policies that were obtained before the company was considering a de-SPAC transaction.
- Go-Forward Public Company: Leading up to the de-SPAC transaction, the company will obtain public company D&O insurance to incept on the first day of trading. This coverage often is the typical public company D&O insurance, providing coverage to the company for securities claims only. Premiums for these policies have been increasing dramatically, with primary insurers requiring much higher self-insured retentions. A key coverage term to address prior to binding is coverage for prior acts—that is, will the D&O insurance apply to claims that are based on alleged wrongful acts of the target company and/or SPAC prior to going public.
These policies cover different insureds and arguably different risks. In the event of a claim—including a securities lawsuit alleging misstatements prior to the business combination—all three programs may provide coverage.
2. Does the Target’s D&O Policy Provide Adequate Coverage?
Many SPAC targets do not have a robust D&O insurance program—especially in overall coverage limits and substantive coverage—compared to a public company or late-stage private company going public. Some have basic, off-the-shelf D&O policies first obtained at an early development stage, but often we see these not being refreshed as a company’s transactional plans and goals evolve. Reviewing the scope of securities exclusions in coverage is crucial, but a review of all terms and conditions, including defense coverage, is key. Purchasing Side A coverage for directors and officers can also be considered.
Private company D&O insurance should cover the private company and directors and officers against claims alleging misconduct prior to going public, including claims of aiding and abetting misrepresentations by the SPAC to its investors. Claims made after going public alleging misconduct while a private company would be covered if run-off coverage is purchased (discussed next). As a target company contemplates a de-SPAC transaction, it should absolutely review its existing coverage to see whether it should be modified.
3. Should the Target’s Private D&O Policy Be Placed into Run-Off?
D&O insurance is “claims-made” coverage, meaning it only applies to third-party claims (e.g., civil lawsuits) made during the policy period, and policies typically providing that coverage ceases upon a change in control. Therefore, the private company’s D&O policy will need to be placed into run-off to provide coverage after going public for claims alleging wrongful acts that occurred prior to the transaction. We most often see this “tail” coverage come into play when claims allege false statements were made by the target company and its officers prior to the transaction. And as discussed below, if the go-forward public company D&O insurance has a prior acts exclusion, without tail coverage, there may not be a policy in place to cover claims of alleged misstatements prior to going public.
4. What Are the Coverage Options for the SPAC (and Sponsor)?
Given the increasing premium cost plus the high retention of full public company D&O coverage (with the three sides of coverage discussed above), some SPACs are considering purchasing Side A coverage only to protect their individual directors or officers in the event the SPAC is unable to indemnify them. This coverage may be placed into run-off upon the de-SPAC transaction. This option may make sense for the SPAC and its directors and officers, but policyholders should also recognize the risk of not having D&O insurance to defend the company against a securities lawsuit filed before the de-SPAC. With either type of D&O insurance, the SPAC should review the definition of insured person prior to binding coverage.
The sponsor of the SPAC should also carefully consider D&O coverage, including whether it is covered by the SPAC policy. Securities lawsuits are increasingly naming the SPAC sponsor as a defendant. In addition to seeking coverage under the policy issued to the SPAC, these sponsor entities should review whether their parent company’s D&O insurance may provide coverage.
5. Will the Public Company D&O Policy Cover Prior Acts?
With the rise in securities lawsuits against companies going public through de-SPAC transactions, careful evaluation of D&O policies is required to determine if you are covered for claims arising out of alleged prior wrongful acts—including alleged misstatements by the SPAC, the target company, and their respective officers prior to the combination. Some insurers may provide full prior acts coverage, while others may insist on some form of an exclusion. In that situation, you can and should work with your coverage counsel and broker to negotiate with the insurer the terms of an exclusion. When the time comes, it is not difficult to imagine an insurer arguing that a prior acts exclusion bars coverage for a securities lawsuit because it includes allegations of alleged misrepresentations prior to de-SPAC.
D&O coverage is changing along with the rise in SPAC-related litigation. Companies and directors and officers would benefit from a careful review of the existing D&O coverage and consideration of proposed policy language before binding.