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Managing D&O liability as UK attempts to become popular SPAC destination

With new rules for SPACs in the UK, there could be a rise in listings. We consider the impact this might have on D&O liability, and strategies to manage the risk.

Person's name and title

By Adele Magennis , 

Claims Advocate, FINPRO

25/02/2022 · 5 minutes read

The introduction of new special purpose acquisition company (SPAC) rules in the UK to strengthen investor protections could add to the country’s appeal as a jurisdiction where companies can list these vehicles.

The Financial Conduct Authority (FCA) has lowered the initial capital-raising threshold for new SPACs from £200 million to £100 million — a figure considered sufficient by the regulator to attract institutional investors, after listening to market feedback. The new safeguards offer investors greater control and flexibility by including a requirement for prior shareholder approval of any combination, and a redemption option to allow investors to redeem their SPAC shares before the acquisition completes.

However, an increase in listings will come with greater scrutiny from investors and regulators that could put directors and officers (D&O) at increased risk, in terms of their own liability.

US lawsuits reveal D&O exposure

A SPAC is essentially a “blank check” shell corporation, designed and set up to raise funds that will then be used to acquire existing privately-held companies, followed by a merger of the two entities — known as a “de-SPAC” process.

The US saw a surge of SPAC M&As during the COVID-19 pandemic, presenting seemingly high-reward investments with limited risk to sponsors, in contrast to the uncertainty and disruption that the pandemic caused the traditional initial public offering (IPO) process. However, investors opting for this route are invariably taking on more risk and investing without the same standards of disclosure required during an IPO.

In 2021, 613 SPACs were listed in the US, up from 248 in 2020. Last year, the FCA confirmed there are 33 SPACs listed in the UK, and of the estimated 20 SPACs with live listings, two have a size exceeding £100 million market capitalisation, while two thirds are worth around £5 million or less.

While the administration process appears more simple and efficient than an IPO, SPAC-related litigation has been on the rise in the US. In 2021, there were 31 federal court SPAC-related securities class lawsuits reported, representing around 14.7% of all federal court securities class action lawsuits filed. Examples of the types of legal proceedings include:

  • Allegations that SPACs were, in fact, investment companies that should have been registered under the US Investment Company Act 1940. Failure to do so would have allowed directors and sponsors of the SPACs to be disproportionately compensated with huge returns on companies’ securities.
  • Numerous SPAC-related lawsuits involved companies that announced disappointing financial results in their first financial reports after becoming a de-SPAC entity. With 613 SPACs listed in 2021, all needing to find merger targets within 18-24 months of their listing, these types of claims could significantly increase in the next two years. 
  •  SPAC-related securities suits filed in the wake of “short-seller attacks” — negative reports highlighting possible issues with public statements or practices of new public companies, in order to achieve a decline in share price.

These types of litigation in the US have exposed directors and officers of sponsors and targets to significant liabilities, potentially causing them to rethink the SPAC/de-SPAC route, going forward.  

In addition, there is a risk that the dramatic increase in SPACs has led to a depleting of appropriate and quality targets. Over-capacity could see SPACs’ management teams, which are incentivised to complete a deal, making poor investment choices to avoid having to liquidate the SPAC fund.  

Indeed, the same risks will exist for those involved in SPACs in the UK, and the trends seen in the US should be taken into account by companies considering involvement in UK SPACs. At the very least, thought should be given to how to protect executives from exposure to SPAC-related risks.

Directors and officers risk considerations

While UK SPAC activity may see an increase in the next few years, there is at least some comfort that the dramatic trajectory of SPAC-related claims in the US is unlikely to be mirrored in the UK, namely due to the more litigious culture of the US jurisdiction. That being said, directors and officers in the UK remain at risk, and are similarly liable as their counterparts in the US, and will undoubtedly face claims. In order to minimise those risks, they should consider the following: 

  1. Given the recent filings against both SPAC boards and sponsors, directors of the SPAC sponsor, SPAC board, and de-SPAC entity should ensure they all have appropriate D&O cover in place to help protect personal assets.
  2. Directors may be named as a defendant in two capacities — as a former officer of the SPAC and as a director of the go-forward company. Such anticipated dual capacity risk can present challenging D&O insurance issues, and could require numerous or differing insurance programmes.
  3. A failure to carry out appropriate due diligence could result in claims from investors and regulators against a number of different parties, pre-, during, and post-merger.
  4. The increased frequency of immediate claims against de-SPACs demonstrates the need for directors to properly assess the risks of using a SPAC to go public, including their readiness for the burdens and scrutiny of managing a public company.

While SPACs have been flourishing in the US over the past two years, and are set to rise in the UK, directors should remain mindful of the various risks associated with this route to a public listing. It is recommended to secure appropriate D&O cover to manage the potential exposures at each stage of the process. Cover will provide directors and officers with peace of mind that in the event their SPAC-related project does not go as smoothly as expected, they will at least have the comfort of knowing their defence costs will be covered in relation to SPAC claims. While directors and officers will remain personally liable for actions related to executive business, D&O cover transfers financial risk from personal assets to insurance.

To find out more about D&O cover, please contact your Marsh advisor.

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