CURRENT MONTH (September 2022)
SPAC Extensions Create D&O Insurance Riddles
Those of you following the developments in the SPAC market have no doubt noticed the drama around DWAC’s quest for an extension earlier this month. DWAC, aka Digital World Acquisition Corp., aka “the Trump SPAC,” went through a few adjourned shareholder meetings to finally lock in a three-month extension on September 8, 2022.
While SPAC sponsors are typically aware that they need shareholder approval or additional funds to extend their investment period, most, unfortunately, don’t consider the added costs or difficulties of extending their directors and officers (D&O) insurance coverage to match. Many don’t realize that their SPAC’s D&O policy will likely not automatically extend to cover the additional few months and that, of course, creates additional risk for their directors and officers and a possibility of a hefty litigation bill that may need to be paid out of pocket. There are ways, however, to get ahead of these problems, and a few factors to consider.
How Does SPAC D&O Insurance Work?
The SPAC’s IPO D&O policy covers the SPAC and its directors and officers for things like securities class action settlements and defense costs related to SEC investigations and enforcement actions. This policy typically starts running at the IPO and tracks the SPAC’s initial investment period.
Because D&O policies are “claims made in nature,” if a claim is brought when the policy is no longer in force, even if that claim relates to actions that took place during the term of the policy, that claim will not be covered. So, if the SPAC team has extended its search period but neglected to extend its D&O policy and a claim is brought after the expiration of that policy, the SPAC will have to pay out of pocket for the expenses related to that claim. The way around that unfavorable scenario is to request a policy extension from the carrier.
How Will the Insurer React to an Extension Request?
The SPAC’s insurance broker can, of course, go back to the insurer and ask for the policy to be extended. However, many insurers that were happily writing these policies two years ago have since lived through several SPAC-related lawsuits and enforcement actions, and they’re not exactly jumping at the opportunity to offer extensions.
They’re also not too happy about the uncertainty caused by the Securities and Exchange Commission’s proposed rules, which will be finalized later this year. Additionally, insurers are concerned about the negative and disappointing performance of many SPACs.
How Can You Get Better Results?
First, if a possible extension is on the horizon, the SPAC and its insurance broker need to signal that possibility to the carrier as soon as possible to give that carrier an opportunity to ask questions about the team’s search efforts, the likelihood of a deal, the financial situation of the SPAC, and the financial terms of the extension.
If a deal has been announced, like in DWAC’s case, this conversation becomes much easier. Then the insurer may be open to offering a short (three- to four-month) extension at a monthly rate based on the original premium for the SPAC IPO’s D&O policy.
However, many carriers would balk at the idea of a premium rate from two years ago. In 2020, those rates were about four to five times lower than current market rates. For a SPAC that is mid-deal and running short on time, negotiation leverage might be thin, so a good SPAC insurance broker with strong carrier relationships will make all the difference.
If there is no deal on the table, the negotiation becomes more difficult, but proof of a viable letter of intent (LOI) or a well-thought-out investment search plan might do the trick.
What Could Cause Extension Problems?
It’s worth noting that insurers may refuse to grant an extension if factors surrounding the extension are extremely unfavorable. Some combination of the following is sure to cause them headaches:
- Last-minute timing of the request
- A flashy, controversial SPAC or target (e.g., the Trump SPAC)
- Suspicious behavior of the SPAC team
- Lack of information about the proposed deal or lack thereof
- Poor communication from the SPAC team
- Previous lawsuits, actions, or investigations related to the SPAC or its directors and officers
- Negative publicity around the proposed deal
- Drop in SPAC share price
- An extension request of six months or more
SPAC teams need to prepare for an extension by reaching out to their SPAC insurance broker, considering coverage alternatives, and budgeting for extra D&O insurance costs. The sooner they do so, the better off they will be.