Historically, bubbles are followed by suits. After the Dot-Com Boom came the Dot-Com Bust, along with years of shareholder litigation. Ditto for the Credit Crunch. As we emerge from The Lockdown, SPACs are enjoying roaring popularity in the capital markets. Presumably, at some point the market will turn. Some SPACs no doubt will perform well and become models of business success. For those SPACs that do not thrive after going public, one can anticipate that the plaintiffs’ securities bar will be innovative in devising claims. This article is not about that.
Rather, this article ponders what a wave of SPAC shareholder suits may mean for the Directors and Officers Liability Insurance industry. My hypothesis is that, in the coming years, we may experience a volume of coverage disputes not seen in the shareholder litigation world since the individual/entity allocation battles of the 1990s. These disputes may be, not just between insured and insurer, but also between the different towers of insurance implicated by the lawsuits. Before the wave comes ashore, it may be useful for future participants to contemplate which conflicts will emerge and how they might play out.
Dramatis Personae: Potential Defendants
I begin with an important caveat: contemplating who might be sued does not imply that any particular case should be brought or would be successful. That will depend on the individual circumstances, especially the disclosures that accompanied the SPAC and deSPAC transactions — which in general have been quite robust. Many SPAC shareholder suits will end when the court grants a motion to dismiss, on the basis that investors were fairly apprised of the risks that the company faced.
The sets of potential defendants who implicate D&O coverage are three: the original SPAC entity, together with its directors and officers (“the SPAC”); the private company that merges and goes public in the deSPAC transaction, together with its officers and directors (“the Target”); and the going-forward public company that emerges from the deSPAC transaction, together with its officers and directors (“Newco”). As we will discuss, some shareholder lawsuits may focus on only one or two of those sets. Others may include all three.
In particular cases, there may also be defendants who are not covered by D&O policies. Depending on the structure of the transactions, investment banks involved in the deal may be named as defendants. If the litigation involves audited financial statements, outside auditors may be named. To the extent that some directors represent venture capital or private equity funds, their organizations may be drawn in as well.
Dramatis Personae: Implicated Towers
Which groups of D&O carriers are involved in a particular suit will depend on the claims and defendants. Potentially, three separate Towers might be implicated. (For those readers less immersed in the D&O world, “tower” refers to the set of carriers that insure a given company and its directors and officers. These range from the primary policy up through multiple layers of excess insurance.)
One Tower is the insurance for the SPAC entity itself. This is the vehicle that raised capital in the public market for the purpose of merging with a private company and taking it public. The SPAC entity has its own D&O policy, insuring itself and its officers and directors. Typically, the SPAC’s policies provide coverage up to the time the merger closes. In connection with the merger, the parties usually purchase “tail coverage” for claims brought up to six or so years after the merger, based on events occurring up to the time the merger closes.
A second Tower is insurance that the Target maintained while a private company. This Tower protects the company and its directors and officers, but may have an exclusion for securities claims. Such “private-company policies” often have been in place for years before the SPAC events. The coverage provided by the Target’s policies typically ends at the time of the going-public merger. Again, the parties usually purchase a “tail” policy for some years after the merger.
A third Tower is for the Newco that emerges from the deSPAC transaction (which could be the same entity as the SPAC or Target or a new entity altogether). This insurance covers the entity and its directors and officers for events from the time of the merger forward. These are “claims-made” policies. They often contain exclusions for events that occurred before the merger closed.
In practice, there may be overlap among the participants in these various Towers. In addition, some carriers in the Towers may have passed off some of the risk to reinsurers, who themselves might be implicated at various points on various Towers for the same company.
Scenarios and Claims
The purpose of this article is not to catalogue the different SPAC lawsuits that might arise. A few scenarios illustrate the possibilities. For example, assume that a given company performs poorly after going public in the deSPAC transaction. Shareholders who acquired that company’s stock may sue because the actual results fell short of projections disclosed in the proxy materials (although such suits will face substantial legal impediments). Other lawsuits may focus on perceived conflicts of interest that a plaintiff alleges tainted the underlying transactions.
In general, the litigation could be of two types. Some claims will be brought as derivative lawsuits, alleging breach of fiduciary duty by participants in the transactions. Other claims will be brought as securities class actions, alleging inadequate disclosures in the transaction documents. Separately, some of the investors in the PIPE transactions that provide funding for the merger could conceivably bring individual, rather than collective, lawsuits.
Infusing all the claims will be the sophistication of the plaintiffs’ bar. Plaintiff lawyers are inventive and persistent. If one theory for attacking SPACs fails, they are likely to try others. For our purposes, what matters most is that plaintiff lawyers are attuned to insurance implications. The plaintiffs will understand the differences among the various insurance Towers. Some lawyers may attempt to fashion their complaints, not just to prevail, but also to implicate as many different insurance policies as they can. (Lest someone accuse this article of tipping off the plaintiffs’ bar to these implications, rest assured: they know these issues better than I, and are probably already thinking in terms of reaching as many Towers as possible.)
The viability of claims in a given lawsuit will vary as to different sets of defendants. The exposure of the different Towers will vary accordingly. Nevertheless, in significant suits, one can expect that complaints may be designed to implicate as much coverage as feasible.
The First Encounter: Fees
The initial salvo in the SPAC litigation battles will be: who pays defense fees? In the typical shareholder lawsuit, this is not an issue. There is one group of company defendants, protected by one Tower. Usually, there is one defense firm for all defendants. In this situation, the path is clear. Once the fees have exhausted the deductible amount, the primary carrier is on the hook.
The situation becomes more complex when a complaint arguably implicates coverage by different Towers. Which Tower goes first on covering defense expenses? One can expect a fair amount of controversy even at this initial stage: “the claims mainly implicate your policy, so you should pick up the expenses.” An additional dimension of complexity will arise when personnel from different stages of the company’s existence are named as defendants. Is each covered only by the policy for that stage? What if a particular individual was involved at multiple stages? For example, assume that an officer of the SPAC goes onto the board of directors of Newco. Who covers her defense? How does one allocate coverage among the different Towers for that person? And what if she is jointly defended with others who only participate at one stage or another?
This may not be an insuperable problem where the company is financially viable. There, the corporation could fund the defense, with the respective burdens sorted out down the road. Imagine a situation, however, in which the company is broke. Then the funding issue cannot be kicked down the road. Someone needs to pay for the defense. It may be that the Towers work out an interim arrangement, which they will true-up at the conclusion of the litigation. In some situations, however, this uncertainty as to responsibility may trigger a round of declaratory-judgment suits at the very outset of the litigation. A final layer of complexity is added by the ability of one Tower to assert subrogation claims against the others.
The Easy Case: Victory
The least troubling situation, from an insurance perspective, will be one in which the defendants prevail. Many of the SPAC suits will end with a successful motion to dismiss. The disclosure documents that accompany many of the deSPAC transactions are exemplary. The legal protections provided by the Private Securities Litigation Reform Act — particularly with respect to forward-looking statements — will often be hard for plaintiffs to overcome. Because of the segmented nature of the transactions, standing may be a significant challenge for plaintiffs, both with respect to class and derivative claims.
When the defendants win, I suspect that the Tower versus Tower abrasions will soon heal. Exposure will have been capped. Industry participants familiar with each other, and interacting across many claims, should be able to split the check. Indeed, within the insurance industry, certain generally accepted principles may evolve for divvying up defense expenses across the multiple SPAC Towers.
The Complex Case: Settlement
Much more difficult will be inter-Tower tension at the settlement stage. Plaintiffs often request that all the carriers on a Tower attend a mediation, even where the case is likely to settle for less than the available limits. This often triggers pre-mediation jockeying over which carriers will show up.
Now imagine the situation where two or three Towers may be implicated, not just one. Plaintiffs often will demand that all the Towers participate. Some of the Towers may take the position that they have no meaningful exposure on the relevant plaintiff claims and therefore will not attend. “That Tower is in play, not mine.” Getting to the mediation table will become more challenging. Moreover, the mediation itself may expend as much energy on inter-Tower battles as on the merits of the underlying claims.
In some cases, the mediation will result in a deal between the plaintiffs and defendants, with the split among the Towers to be resolved later. But in some cases — particularly those with greater exposure — the “which Tower” issue may preclude settlement until after the relative coverage issues are settled. Net net: the presence of multiple Towers may make SPAC cases harder to settle.
The Worst Case: Bankruptcy
In the D&O world, bankruptcy is a four-letter word. The operative principle in a bankruptcy situation often appears to be: grab all the money you can. Bankruptcy judges sometimes overlook the niceties of coverage and allocation issues in order to assemble the largest pot of cash for creditors. It is in such situations that the theoretical availability of three distinct Towers presents the gravest risk to all the carriers. Complicating the analysis: some of the defendant entities may be bankrupt, but not others. In all likelihood, the “worst” law, from the standpoint of carriers, regarding which Tower is responsible for which claims will emerge from the carnage of bankrupt SPACs.
Conflicts on the Insurer Side
A final factor that could transform these scenarios into four-dimensional chess is the participation of a given carrier at different attachment points on the different Towers in play. Given the finite number of players in the US D&O market, some carriers likely will be on the slip for different entities in a particular lawsuit. The game-theoretic implications are mind-boggling. A carrier that is higher up in the Tower for the Newco may try to push more of the exposure to the SPAC or private-Target Tower. You get the idea.
Moreover, for outside coverage counsel for the carriers, one can imagine uncomfortable situations in which you are representing one piece of a given Tower, and your partner is representing a different carrier on a different Tower. Apart from legal conflicts, the potential business conflicts could be awkward.
Potential Dispute-Resolution Mechanisms
In the world of legal writing, the last part of an article is supposed to present “The Solution.” Regrettably, I don’t have one to proffer here. The suits are at too early a stage. The inter-Tower conflicts haven’t yet started to ripen. What is clear, however, are two things. First, this is not an imaginary situation. The diverse nature of the potential defendants makes it nearly certain that Tower versus Tower tension will emerge in many suits. Second, it is not too early for the industry to start thinking through principles and mechanisms for resolving those disputes. Those are two different things. Principles will be case-neutral doctrines that the carriers generally accept to sort out which Tower bears responsibility for which types of claims. Mechanisms will be procedures or forums for resolving inter-Tower SPAC disagreements, without jeopardizing the defense of the case, the insureds’ interests, or timely settlement of the litigation. Of course, these principles and mechanisms cannot bind the insureds or the plaintiffs. Nevertheless, the existence and general embrace of such principles and mechanisms will be an important step in addressing the coming round of SPAC suits.
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Boris Feldman is a partner at Freshfields Bruckhaus Deringer US LLP. This article reflects his personal views, not those of his law firm or its clients.