SPAC lawsuits are increasing in frequency. There was a big jump in the number of SPAC-related cases from 2020 to 2021. Five new securities class actions have already been filed against SPACs in 2022, just two months into the year. Several cases have gotten past a motion to dismiss.
One of the latest securities class actions, brought against the CEO and CFO of Fortress Value Acquisition Corp. (the SPAC) and the CEO and CFO of MP Materials Corp., a rare earth mining and processing company (the Target), was filed on February 22, 2022, in the District of Nevada.
The MP Materials lawsuit is similar to many others that came before it. It was filed after the merger was completed, followed a short seller report, involves officers of both the post-merger company and the SPAC, and alleges, among other things, that the defendants made materially false and misleading statements and that they did not do a good job with their due diligence of the target. This last allegation focusing on lack of proper diligence or willful ignorance of red flags is what is of interest.
It is of interest because although it might be too late for the defendants in this case, for the 600+ SPACs that are looking to find their targets right now, cases like this one should serve as a roadmap of how to avoid unnecessary litigation, how to find ways to refute similar allegations, and how to minimize losses.
Most SPAC teams are aware that well-structured D&O insurance policies at the time of the IPO and at the business combination could make a big difference for their balance sheet and the protection of their directors and officers. Many, however, are unaware that a representations and warranties insurance (RWI) policy could also go a long way towards refuting allegations of insufficient due diligence in addition to covering losses from a breach of representations in the merger agreement.
At its core, the RWI policy is designed to protect the buyer (in this case the SPAC) against two things: (i) the seller’s (in this case the Target’s) breaches of reps in the merger agreement and (ii) the Target’s fraud. However, a valuable side benefit of these policies, especially now that the number of SPAC cases alleging insufficient diligence is growing, is the insurer’s close examination of the SPAC team’s due diligence.