The SPAC market is finally making a comeback. As we enter a period of the long-awaited SPAC revival, some liability dangers persist.
Two common questions that keep being raised by our clients are:
- How much liability should the SPAC’s sponsor expect?
- How can we protect against it?
These questions are not at all surprising. Most new SPAC IPOs are being helmed by experienced SPAC teams and sponsors who have seen SPAC litigation and enforcement over the last four years. They’ve experienced it either first-hand with their earlier SPACs or have watched their SPAC colleagues suffer through it, sometimes very painfully, without adequate insurance coverage.
The private litigation and regulatory enforcement actions reaching their resolutions now are based mostly on SPAC activity that goes as far back as 2021 and 2022. As we all know, protracted litigation or government inquiries are usually accompanied by very large attorney fees. Some of the recent settlements have also been quite significant. SPAC sponsors have been pulled into many of these costly legal actions over the last few years, which is why it is not at all surprising for them to ask these questions and to look for reasonable solutions. 
An interesting takeaway from the data is that between 2019 and 2024, SPAC sponsors have been named as defendants in approximately 86% of all SPAC-related merger & acquisition (M&A) lawsuits in Delaware Chancery Court and in nearly 13% of all SPAC-related securities class actions.
What Problems Are PE and VC Fund SPAC Sponsors Facing?
Many sponsors are affiliated with private equity (PE) or venture capital (VC) firms. Members of these firms often form a separate sponsor vehicle that invests in a SPAC. But when plaintiffs sue that SPAC or the post-de-SPAC company, they don’t necessarily limit their claims to the SPAC and its directors and officers. They often look for deep pockets that happen to be affiliated with the SPAC, especially if the de-SPACed company is not doing well financially.
Readers of this blog know that the SPAC and its directors and officers, as well as the combined, post-de-SPACed entity and its directors and officers, typically buy directors and officers (D&O) insurance to assist with the costs of SPAC- or de-SPAC-related lawsuits or government investigations. But depending on how these insurance policies are negotiated and worded, they may not necessarily cover the SPAC’s sponsor entity or the sponsor’s directors and officers. This certainly has been the case in previous years.
Over the last few years, many PE and VC individuals and entities affiliated with a SPAC sponsor found themselves in a precarious situation where the SPAC’s D&O insurance coverage did not extend to them. They were faced with three options:
- Cover the litigation/investigation costs out of their own pockets
- Demand indemnification from the SPAC, which in most cases was insolvent or no longer around
- Hope their PE/VC fund insurance policies would somehow extend to cover their costs
From the PE/VC fund insurance side of the equation, over the past 24 months, we’ve seen an uptick in claims activity related to PE and VC firms that have directly sponsored a SPAC. We have also seen an uptick in claims involving firms that are direct investors (typically via a fund) in the target company that has merged with a SPAC.
Wouldn’t the Fund’s GPL Policy Cover Its SPAC-Related Activities?
Traditionally, a PE or a VC fund manager will purchase a blended D&O/errors & omissions (E&O) policy, also referred to as a general partnership liability (GPL) policy. This policy protects the PE or VC firm and its employees at the management company level. It also covers liability at the fund level for negligence in managing or providing professional services to or on behalf of the private funds they manage. This policy will typically also include protection for any exposure these funds or their employees may encounter from the funds’ outside limited partner (LP) investors. This kind of coverage will also typically have a regulatory component, which would offer protection in cases where a governmental entity initiates an investigation against the firm or its funds for violations of securities laws or otherwise.
These policies strive to offer comprehensive coverage that extends to, among others, the management company, its subsidiaries, the investment holding company, the private funds that the insured sponsors/manages, and the general partner (GP) entity.
Basically, if you have management control, this kind of GPL policy should cover the problems you might encounter while managing the PE or VC fund. This is why many SPAC sponsor teams assume that the GPL coverage they have under their PE or VC fund also covers them for any issues they may run into when sponsoring a SPAC. That assumption, however, is incorrect in most cases.
A well-crafted GPL policy can indeed extend to a SPAC sponsor entity and any individuals whom the PE or VC fund appoints to sit on the board of the SPAC or the de-SPACed entity. This should provide added protection in addition to the protection offered by the D&O policies of the SPAC and the de-SPACed entity. Depending on the claim, coverage may respond either in a primary or “double excess capacity.” Double excess means that for any individual, the policy will sit excess of any other insurance or indemnification provided at the SPAC or de-SPAC level.
The devil, however, is in the details and in the specific wording and endorsements of each GPL policy. Some of these policies might not extend coverage to all “SPAC-related” activities, and some GPL carriers may outright exclude all SPAC-related exposure.
Where Do Fund GPL Policies Fall Short?
While you could argue that an “off-the-shelf” GPL policy should extend coverage to any SPAC sponsor vehicle, the reality is that any seasoned financial institution underwriter is going to do their research and ask whether the insured under the GPL policy currently sponsors or is entertaining the idea of sponsoring a SPAC in the near future. If the answer to that question is yes, the underwriter will likely either slap an outright exclusion on any SPAC-related activities of the insured or push for specific coverage for the SPAC sponsor that will come with a higher retention—and most likely additional premium.
Furthermore, the original limit amount under the GPL policy may not be adequate to cover the securities class action lawsuit, ever-mounting legal defense costs, and other costly problems that a SPAC may encounter. However, a knowledgeable GPL insurance broker specializing in SPAC-related risk will be able to determine whether existing coverage limits are sufficient or whether they would need to be adjusted. The SPAC sponsor would need to understand the extent of the coverage they currently have and, with the help of their insurance broker, align the GPL policy and the SPAC D&O policy limits and wording before the SPAC completes its IPO.
Tips for Well-Designed and Well-Executed Insurance Coverage
First and foremost, you should be talking with your insurance advisor if you have sponsored or are entertaining the idea of sponsoring a SPAC vehicle. Ideally, you’d be looking for a seasoned insurance broker and advisor experienced with structuring and placing both PE/VC fund GPL and SPAC D&O insurance policies. They will understand the nuances involved and the underwriting questions you’ll need to answer, and can prepare you ahead of your IPO, de-SPAC, or GPL renewal. They will also know the insurance carriers best equipped and open to tackling these more complex exposures.
Next, be prepared for additional questions from GPL insurance underwriters around the fund’s exposures and the controls in place to mitigate SPAC-related exposure. Not surprisingly, those questions will aim to uncover potential risks related to disclosure, financial incentives and payouts, conflicts of interest, and dilution all of which the Securities & Exchange Commission has been focused on for the last couple of years. You will also encounter similar questions from the D&O underwriters evaluating your SPAC or de-SPAC and considering whether they can offer sponsor coverage in addition to the SPAC/de-SPAC coverage you are seeking.
So, what can you expect as part of the GPL and D&O policy negotiation and placement? For one, there is a narrower universe of carriers that will consider these expanded coverages. Fewer carrier options can translate into higher insurance rates and less attractive coverage terms. Higher retention amounts may also be on the table to help address added exposure. That’s where having a trusted and expert insurance advisor comes into play. It is incredibly important to have an advisor who understands the intersection between these kinds of coverages, litigation, and the claims related to them, and is flexible and creative enough to achieve results in a limited carrier marketplace.
Get Everyone on Board with Insurance Strategy Nice and Early
It is important to discuss the sponsor’s and the SPAC teams’ concerns and limitations as far ahead of the SPAC IPO or de-SPAC as possible. The fact that the SPAC sponsor, the SPAC’s management team, and the SPAC’s directors need to discuss their overall insurance coverage strategy seems obvious, but in reality, it is very often overlooked.
When the target company comes into the picture, all parties need to once again get on the same page about insurance coverage and not leave it to the last moment before closing. Experienced attorneys supporting these parties know to flag and act on these questions, and to bring in experienced insurance brokers early on in the process. Not having a well-thought-out insurance coverage strategy can lead to multi-million-dollar out-of-pocket costs and a lot of headaches for everyone involved.
