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As SPAC Activity Heats Up, Directors and Officers Must Consider Their Personal Liability

SPAC directors and officers must consider the potential risks they face and how to appropriately protect their personal assets in the event of a claim.

11/14/2018 · 3 minute read

Over the last decade, individuals and corporate sponsors have increasingly used special purpose acquisition companies (SPACs) as a means to raise capital and provide the public with the opportunity to invest in private equity-style transactions. Often described as “blank check” companies, SPACs raise capital from the public via initial public offerings (IPOs), which is then held in trusts used to complete the acquisition of existing privately held entities.

The use of SPACs has reached a fever pitch: Through the first three quarters of 2018, 32 SPAC IPOs were listed on US exchanges, raising a total of $7.65 billion, according to Bloomberg BNA, putting 2018 on track to exceed the record activity seen in 2017. But with this increase in offerings comes greater scrutiny from investors — and, ultimately, the plaintiffs’ bar. SPAC directors and officers must consider the potential risks they face and how to appropriately protect their personal assets in the event of a claim.

Risks for Directors and Officers

Unlike traditional businesses, SPACs generally do not have robust balance sheets that can indemnify directors and officers in the event they are named in litigation. The 32 SPACs that have completed IPOs so far this year had an average of just over $1 million in cash on hand, according to a Marsh analysis of public S-1 filings. That’s well below the average settlement and defense costs for a traditional securities class action. SPAC trusts also cannot be used to indemnify directors and officers, meaning that directors and officers could be forced to dip into their own pockets to cover such costs.

More than 300 federal securities class actions were filed through the third quarter of 2018, according to NERA Economic Consulting. These lawsuits highlight the liabilities that SPACs and their directors and officers could face arising from:

  • Representations made within IPO road shows, S-1s, and quarterly and annual filings.
  • Due diligence and business combination proxy filings.
  • Ongoing operations of post-combination entities.

Building an Effective D&O Program

A properly crafted directors and officers (D&O) liability policy can protect the personal assets of directors and officers when a SPAC is unable to indemnify them. In building a D&O program specifically for a SPAC, directors and officers should seek to obtain:

  • Broad personal assets protection coverage.
  • Coverage for alleged violations of the Securities Act of 1933, Securities Exchange Act of1934, Dodd-Frank, and Sarbanes-Oxley.
  • Coverage for regulatory investigations.
  • Policy terms that line up with a SPAC’s due diligence period.
  • Pre-negotiated tail coverage for claims against the SPAC brought after completion of a business combination.
  • Coverage for indemnity owed to sponsor entities and underwriters named in suits.
  • Coverage for claims brought by prospective targets and PIPE investors.

As the use of SPACs as a means to deploy capital continues to grow, it’s important for directors and officers to consider the implications for them personally. A well-crafted D&O policy can address potential liabilities and exposures, allowing organizations to use SPACs with confidence and continue to take advantage of the bull market.

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