Unscrupulous Behavior by Certain Brokers
It is also worth noting that some unscrupulous D&O insurance brokers have started suggesting to SPACs that they should purchase their tail from new carriers instead of adhering to the pre-negotiated tail terms they agreed to at the time of the SPAC IPO. Unlike in a traditional M&A context, this practice is heavily frowned upon in the SPAC context. Recall that carriers who wrote the SPAC IPO policy did it with the expectation of their ultimate receipt of the full premium. The first portion of the SPAC D&O policy premium is paid at the time of the initial IPO, with the second portion paid when the business combination closes.
Indeed, to offset high upfront costs for working capital–poor SPACs, most carriers have historically agreed to under-charge at the time of the IPO because they understand that the tail will be purchased from them. SPAC directors and officers who choose to ignore this understanding may find it difficult, if not impossible, to get good terms for their next SPAC. Unsurprisingly, insurance carriers keep close track of which SPAC teams are “shopping” the tail.
D&O Insurance Carriers Are Concerned about Conflicts of Interest
Another MultiPlan case theme that insurance carriers are monitoring closely is the issue of conflicts of interest. Vice Chancellor Will discusses at length the conflicts of interest existing in this case among the SPAC, its CEO and Chairman Michael Klein, and his affiliate, The Klein Group LLC. The SPAC’s board selected The Klein Group LLC as its financial advisor and paid it $30.5 million in connection with the merger and its financing. These interrelations led Vice Chancellor Will to conclude that the less defendant-friendly “entire fairness standard” rather thanthe more common “business judgement rule” standard should be applied in this case. This determination essentially made winning a motion to dismiss impossible for the defendants.
Judge Will’s conclusions intersect with insurance carrier concerns in two different ways. One is that D&O insurance underwriters have become highly sensitive to potential conflicts of interest between SPAC teams, their sponsors, and directors on one hand; and public shareholders on the other. It is standard now for an insurance underwriter to ask multiple follow-up questions and request to see extensive disclosure around all potential conflicts of interest. If these questions and requests are not satisfied, and in some cases even if they are, many insurers are unwilling to offer coverage for claims arising out of transactions with affiliated entities of the SPAC or will only do so at elevated pricing.
Insurance carriers are also interested in the issue of whether claims in MultiPlan are direct or derivative. Direct cases are easier to bring because, unlike the derivative ones, they do not need to go through an extra step of satisfying demand futility requirements. In MultiPlan, Vice Chancellor Will decided that the claims are direct because “the plaintiffs are not suing because Churchill did not combine with MultiPlan on more favorable terms. They are suing because the defendants, purportedly for self-serving purposes, induced Class A stockholders to forgo the opportunity to convert their Churchill shares into a guaranteed $10.04 per share in favor of investing in” the combined entity.
From a D&O insurance perspective, there is a real consequence to the direct versus derivative distinction because of the way the insurance agreements work. The “Side A” part of the ABC D&O insurance program responds on a first-dollar basis, but only to non-indemnifiable claims. Settlements of derivative suits are usually not indemnifiable under Delaware corporate law, while direct suits are indemnifiable. While many SPAC D&O insurance programs are structured as traditional “ABC” programs, some SPAC teams, as a cost-saving alternative, are choosing to structure their programs as “Side A” only.
To the extent that a SPAC purchased a Side A–only policy, and the lawsuit is determined, like in MultiPlan, to be a direct one, there may be no D&O insurance response for a settlement (outside of a corporate bankruptcy).
For more about the various insurance agreements for a D&O insurance policy, you can refer to this article: Side A Insurance Overview for Directors & Officers. As a reminder, as long as a company is solvent, defense costs are always indemnifiable, which is to say not covered by a Side A–only D&O insurance program.
The Potential Effects of the Multiplan Case on the D&O Insurance Market
D&O insurance carriers, along with the rest of the SPAC market, are worried that cases like MultiPlan are easier to bring because they are direct and not derivative cases. If plaintiffs decide that this is a lucrative venue for them, litigation frequency will, of course, go up. If litigation frequency increases, SPACs will be more difficult to insure, and rates for D&O insurance for SPACs, which are already quite high, will surely rise.
Some have suggested that the MultiPlan litigation has prompted many SPAC teams to consider incorporating their SPACs outside of the United States, with the Cayman Islands being the preferred jurisdiction. The theory is that plaintiffs will be less successful in attempting lawsuits against Cayman-organized SPACs. This solution may create more problems than it may solve. Setting aside complex tax structuring and other difficulties, SPACs organized in the Cayman Islands will have a harder time securing D&O insurance because many US insurance carriers will not be able to offer D&O coverage for non-US entities.