Regular readers of this blog know that I have been following the developing SPAC-related litigation closely. Readers also know that the cast of defendants in these cases can be extensive, diverse, and in some cases overlapping. For example, the defendants may include former directors and officers of the SPAC; former directors and officers of the acquired company; and current directors and officers of the company formed by the merger. Some of the individuals named may be sued in more than one capacity. These features of the suits will complicate the litigation. These features will also complicate the application of insurance to the defense and settlement of this litigation, as well.
In an April 27, 2021 post on the Freshfields law firm blog entitled “Tower vs. Tower: Implications of SPAC Shareholder Litigation for the D&O Insurance World” (here), Freshfields partner Boris Feldman takes a look at these complications and “what a wave of SPAC shareholder suits may mean for the Directors and Officers Liability Insurance Industry.”
Among other things, Feldman suggests that, as a result of the coming litigation, “we may experience a volume of coverage disputes not seen in the shareholder litigation world since the individual/entity allocation battle of the 1990s.” These emerging disputes may not just between insured and insurer but “also between different towers of insurance implicated by the lawsuits.” In his article, Feldman takes considers what these disputes may look like and suggests that the players should consider “principles and mechanisms” to address these disputes.
Feldman starts his analysis by looking at the potential defendants that may be involved in SPAC-related securities suits. As I noted in the opening paragraph above, there at least three sets of potential defendants, each one of which would look to a separate insurance program (or “Tower” of insurance): the SPAC; the private company (the “Target); and the merged company (the “Newco”); and/or their directors and officers could each be named. As Feldman also notes, there could be additional defendants who are not covered by any of these three insurance programs, such as, for example, the investment banks involved in the deal, outside auditors, or venture capital or private equity funds.
As a result of the transaction, the SPAC’s D&O insurance Tower is put into runoff (that is, provides coverage for claims arising on the future relating to acts that allegedly took place prior to the merger); the pre-merger private company’s pre-merger Tower is also put into run-off; and Newco’s company insurance is put into place for acts allegedly taking place after the merger. Feldman notes that there may be “overlap among the participants in these various towers”; for example, one or more directors or officers of the SPAC may also serve as directors or offers of Newco.
The plaintiffs’ lawyers who will be filing SPAC-related lawsuits are, according to Feldman, “attuned to the insurance implications” and “understand the differences among the various insurance Towers.” We should expect that “complaints may be designed to implicate as much coverage as feasible.”
Feldman suggests that the involvement of the different insurance Towers will introduce complexity to the defense and resolution of the lawsuit.
The “first salvo,” according to Feldman, will involve the defense fees; one likely complicating factor will arise when individuals named as defendants served, for example, both as executives of the SPAC and of Newco. Who, Feldman asks, will cover the defense for these individuals? How, he asks, “does on allocate coverage among the different Towers” for the persons sued in multiple capacities?
These issues will be particularly urgent if at the time of the claim Newco or other entities are insolvent. In that circumstance, the defense funding issue “cannot be kicked down the road.” Efforts to work out funding arrangements may be successful; however, the uncertainty “may trigger a round of declaratory-judgment suits at the very outset of the litigation.” A further layer of complexity is “added by the ability of one Tower to assert subrogation claims against the others.”
The actual course of the litigation will also come into play. These issues may be relatively easier to sort out if the motions to dismiss are successful, as the “exposure will be capped.”
The inter-Tower disputes will be “much more difficult” at the settlement stage. There inevitably will be finger-pointing and responsibility-dodging, complicating settlement efforts. The “which Tower” issue “may preclude settlement until after the relative coverage issues are settled.” For Feldman, “Net net: the presence of multiple Towers may make SPAC cases harder to settle.”
Bankruptcy of Newco or other insured entities would present the most complicated circumstance. The salvage operation that is bankruptcy represents “the gravest risk to all the carriers,” as “in all likelihood, the ‘worst’ law from the standpoint of the carriers, regarding which Tower is responsible for which claims will emerge from the carnage of bankrupt SPACs.”
An added factor that “could transform these scenarios” into “four-dimensional chess” is that a given carrier may have “different policies in effect at “different attachment points on the different Towers in play.” The implications are, Feldman notes, “mind-boggling.”
Having painted this picture, Feldman sidesteps the suggestion of any solution, commenting only that he “doesn’t have one to proffer here.” Instead, he emphasizes that “this is not an imaginary situation,” and that it is “nearly certain that Tower versus Tower tension will emerge in many suits.”
He concludes by suggesting that “it is not too early for the industry to start thinking through principles and mechanisms for resolving these disputes.” The “principles” are “case-neutral doctrines that the carriers generally accept to sort out which Tower bears responsibility for which type of Claims,” and the “mechanisms” will be “procedures or forums for resolving inter-Tower SPAC disagreements” – assuming the mechanism can resolve disputes “without jeopardizing the defense of the case, the insureds’ interests, or timely settlement of the litigation.”
Feldman’s final note is to suggest that “the existence and general embrace of such principals and mechanisms will be an important step in addressing the coming round of SPAC suits.”
Feldman is absolutely correct that the defense and resolution of SPAC-related lawsuits will be complicated by the involvement of multiple insurance carriers. The problem is in fact even more complicated than his characterization of the situation suggests.
The first way that this will be even more complex is the fact that complications are going to be baked into the situation even before the claim arises, at the time that the various policies are put in place.
To cite but one example of the way the insurance is put in place could really complicate the situation, consider one specific type of potential liability. Many of these cases involve projections of the target company that are used in proxy statements or other pre-merger documents. In the event of post-merger litigation, these pre-merger projections – made at the time the target is still a private company – may be the subject of many of the litigation claims. The private company’s pre-merger insurance policy, which likely was put into run off at the time of the merger, will in many instances have a securities law exclusion. This means that at the time the private company run-off and the go-forward newco public company policy are put in place, the possibility of this liability for pre-merger wrongful acts will have to be taken into account and addressed in the way the policies operate. How (and how well) pre-merger private company conduct is taken into account in the placement of the insurance could significantly affect the Tower vs. Tower interplay in the event of a claim.
The second further complication is that the roster of potential defendants is much more extensive than the list Feldman provides. To cite but one example, in many of the cases filed recently, the list of defendants includes, in addition to the potential defendants Feldman identifies, the defendants named in the lawsuit could also include the SPAC sponsor and directors and officers of the SPAC, or the private equity firms that owned the private company target prior to the merger. (For an example of a recent SPAC-relate case in which these types of defendants were named, refer here). To make things even more complicated, the directors and officers of the SPAC could also be named as defendants as directors and officers of the Sponsor. In other words, the prospects for multiple towers to become involved could actually be even greater than Feldman suggest – there could be more than just three towers of insurance involved.
A third complication is that many of these policies (particularly the policies for the SPACs and the post-merger de-SPAC companies) are being written with massive self-insured retentions, in most cases into the millions of dollars. The presence of these massive retentions virtually guarantees that there will be fights about which retention applies. The presence of these massive retentions could mean that in many cases, the resolution of the defense expense and settlement issues Feldman identifies could not only entail fights among the Towers of Insurance, but further fights between the indemnifying entities and the insurers. Indeed, in my view, these fights over amounts within the retention and whether a retention even applies could be the worst part of all, as they will set in from the very beginning of the claim and at the time that the defense against the lawsuit should be being developed.
A fourth complication has to do with what Feldman called “four-dimensional chess” – that is, the presence of the same carrier on multiple different implicated insurance policies. This concern represents one aspect of what the insurance industry calls “aggregation risk.” There is, however, a larger aspect of this concern, which has to do with the involvement of the various insurers not just within a single claim, but across multiple claims – the compounding of losses in connection with a single phenomenon that produces multiple claims (which is what most insurance professionals usually are referring to when they talk about “aggregation risk”). The involvement of repeat players in many claims will motivate insurers to avoid taking positions that could be played against them in other claims. In other words, the chess game arguably has even more than four dimensions. It is quantum mechanics chess.
This may sound like a discouraging account. But the situation is not hopeless. As I recently noted, in at least one pretty complicated situation (discussed here), the parties managed to reach at least a partial settlement of a SPAC-related securities suit, despite the involvement of many of the complicating factors that Feldman identified and that I identified. To be sure, one of the ways the parties were able to reach a settlement was to leave for another day the complicated issues having to do, for example, with the question of insurance coverage involving, in this particular case, the target company and the post-merger company.
On the other hand, as most insurance claims professionals know, it can be hard enough working out these kinds of issue within a single tower of insurance. The involvement of multiple towers of insurance will risk turning the usual dispute into a tower of babble. The problem with postulating the need for neutral principles to resolve these kinds of disputes as the interests of the carriers involved will vary from claim to claim; what is in a carrier’s interest in one claim may be exactly the opposite in another claim. (This is, I might suggest, characteristic of quantum mechanics chess.)
Even more complicating at this moment is that the claims have only just begun. The bulk of the SPAC-related claims are in the future, many of them only to arise at the point that the over 430 SPACs now out in the financial marketplace looking for merger partners have finally concluded their business combinations. It could not only be months it could be years before the full litigation potential materializes. While it may well be, as Feldman suggests, that it would be better to formulate principles and mechanisms at the outset, it may also be that it may be too much of a challenge to try to come up with neutral rules and processes without knowing a lot more about what the litigation we are going to have to deal with will actually look like. (Indeed, as the recent Churchill IV/Lucid Motors lawsuit strongly suggests, the litigation might wind up looking a lot different than the insurance industry currently expects.)
All of that said, I am all in favor of trying to come up with a way to try to avoid the worst of the kinds of disputes that Feldman suggests could await us. If others are interested, I for one would welcome an initiative, for example, the develop an industry forum to take up these disputes, as well as a set of procedural rules to guide the industry process. Certainly, a forum of some type could avoid the wasteful expenditure on attorneys’ fees that would be involved to litigate coverage issues in traditional litigation. The who-pays-for-the-forum issue could be addressed by having the forum panel include in its mandate a requirement to conclude as part of its decision-making process a ruling on who should pay.
How as an industry we might be able to make something like this happen is a challenging question, but this blog happens to be a neutral forum where this kind of idea could be explored, so if there are others out there that would like to try to use this site as a way and as a place to try to get something started, I am all for it. If you are interested, please use the comment feature of this blog to present your views or if you would like to make a longer statement, please reach out to present the possibility of a guest post.