Within the D&O marketplace, the SPAC and De-SPAC space has been difficult over the last 18 to 24 months. Pricing for D&O insurance for SPACs and De-SPACs has been extraordinarily high. In addition, the insurers are only willing to provide coverage at all with extraordinarily high self-insured retentions (SIRs). These difficult marketplace conditions have caused many buyers to consider possible insurance alternatives, such as Side-A only insurance programs. The high SIRs also raise practical questions about how the elevated retentions will be funded in the event of the claim. The possible alternative insurance structures and the questions about funding the elevated retentions in turn raise a host of complicated issues about indemnification and advancement, particularly concerning the obligations of the go-forward De-SPAC company to provide indemnification and advancement for post-merger claims against former directors and officers of the SPAC.

 

Anyone who has had to try to think about these complicated indemnification and advancement issues will want to review the recent Delaware Chancery Court decision in action brought by a former SPAC officer and director, Marlene Krauss, to try to enforce her advancement rights against the post-merger De-SPAC company, 180 Life Sciences Corp. In a detailed opinion, Vice Chancellor Will basically held that Krauss was entitled to advancement except with respect to claims brought against Krauss for conduct in her capacities other than as a director or officer of the SPAC. Although D&O insurance is not addressed in the Opinion, the Vice Chancellor’s rulings arguably have important insurance implications, for example, with respect to the availability of Side A coverage and the funding of SIRs. The Vice Chancellor’s March 7, 2022 Opinion can be found here.

 

Background

KBL Merger Corp. IV (KBL) was a special purpose acquisition company (SPAC). Marlene Krauss was the CEO and a director of KBL. On November 6, 2020, KBL entered a business combination with 180 Life Sciences Corp, Katexco Pharmaceuticals Corp., and CannBioRx. The combined enterprise went forward as a public company under the name 180 Life Sciences Corp. Krauss resigned as an officer of KBL in connection with the business combination.

 

In August 2021, Krauss initiated an action in the Delaware Chancery Court against 180 Life Sciences Corp. seeking advancement of her legal fees incurred in connection with three separate legal proceedings: (1) in connection with SEC subpoenas served on Krauss and other entities affiliated with her; (2) in connection with a third-part New York state court proceeding involving Tyche Capital III (the Tyche Action); and (3) in connection with a direct action (the Direct Action) in the Delaware Chancery Court that 180 Life Sciences initiated against Krauss and two of her affiliated entities.

 

With respect to the SEC subpoenas, in April 2021, the SEC served Krauss with four subpoenas. One of the subpoenas was directed to Krauss personally (the Krauss subpoena). The other three subpoenas were directed to entities affiliated with Krauss that were involved in the business combination: KBL IV Sponsor LLC (KBL Sponsor), KBL Healthcare Ventures LP, and KBL Healthcare Management, Inc.

 

The Tyche Action commenced in April 2021 when 180 Life Sciences filed a complaint against Tyche Capital III. In May 2021, Tyche served third-party claims against Krauss and others and served Krauss with a third-party summons.

 

The Direct Action commenced in September 2021 when 180 Life Sciences filed a complaint against Krauss, KBL Sponsor, and KBL HealthCare Management. In the action, 180 Life Sciences asserts claims for breach of fiduciary duty and alleges, among other things, that Krauss intentionally failed to disclose information that rendered certain KBL disclosures materially false and misleading. Krauss and the other defendants answered the complaint and also filed a pleading asserting counterclaims against 180 Life Sciences and third-party claims against 180 Life Science’s directors and officers.

 

In three letters Krauss sent to 180 Life Sciences in 2021, Krauss demanded advancement of her legal fees incurred in connection with the three sets of proceedings described above. In her letters, Krauss also submitted an undertaking to repay amounts advanced to her if it were ultimately later determined that she was not entitled to indemnification from 180 Life Sciences. 180 Life Sciences did not respond to Krauss’s letters.

 

The Indemnification and Advancement Provisions

In her complaint in the Chancery Court action in which she sought advancement, Krause relied on provisions in both KBL’s Charter and in KBL’s Bylaws. Specifically, she relied on Section 8.2(a) of KBL’s Charter which specifies that “To the fullest extent permitted by applicable law … the Corporation shall indemnify and hold harmless each person who is or was made a party or is threatened to be made a party to or is otherwise involved in any threatened, pending, or completed action suit or proceeding … by reason of the fact that he or she is or was a director or officer of the Corporation.”

 

She also relied on Section 8.2(a) of the Charter, which provides that “The Corporation shall to the fullest extent applicable by law pay expenses (including attorneys’ fees) incurred by an indemnitee in defending or otherwise participating in any proceeding in advance of its final disposition.”

 

Finally, Krause also relied on Section 8.2 of KBL’s Bylaws, which provides that “An Indemnitee shall also have the right to be paid by the Corporation to the fullest extent not prohibited by applicable law the expenses (including, without limitation, attorneys’ fees) incurred in defending or otherwise participating in any such proceeding in advance of its final disposition.”

 

The Charter provisions on indemnification and advancement remained unchanged in the amended and restated Certificate of Incorporation the company adopted in connection with the business combination.

 

The Advancement Litigation

In the advancement action in the Chancery Court, Krause moved for partial summary judgment on her claims of entitlement to advancement, including an award of fees-on-fees (that is, the fees she incurred in seeking to enforce her claimed rights to advancement). 180 Life Sciences opposed Krause’s motion for partial summary judgment, arguing among other things that only one of the four SEC subpoenas was directed to Krause herself (that is, the Krause subpoena) and that the Krause subpoena was not served “by reason of the fact that” she is a former company officer; that Krause was not named as a third-party defendant in the Tyche action in connection with conduct she undertook in her capacity as a director or officer of KBL; and, while certain of Krause’s expenses in incurred in defending the Direct Action are advanceable, expenses incurred in connection with certain of Krause’s defenses and Krause’s counterclaim are not.

 

The March 7, 2022 Opinion

In a detailed March 7, 2022 opinion, Vice Chancellor Lori Will partially granted Krauss’s motion for partial summary judgment. Vice Chancellor Will ruled that 180 Life Sciences must advance Krauss’s fees and expenses incurred in connection with the Krauss subpoena and her defenses (including affirmative defenses) and one counterclaim in the Direct Action. Vice Chancellor Will denied Krauss’s motion with respect to the Tyche Action.

 

In making these rulings, Vice Chancellor Will first concluded that KBL’s Charter and Bylaws “unambiguously provide for mandatory advancement.” In reaching this conclusion, Vice Chancellor Will considered the “by reason of the fact that” language in KBL’s Charter and Bylaws, which language she said “replicates” language in Section 145 of the Delaware General Corporation Law. This language specifies the connection required between the conduct at issue and the indemnitee’s role as a director or officer of the company. Vice Chancellor Will said that the “by reason of the fact that” standard is satisfied when “a nexus or cause connection exists between the underlying proceeding and the official’s ‘corporate capacity’.”

 

With these general principles in mind, Vice Chancellor Will then considered Krauss’s entitlement to advancement in connection with each of the three proceedings.

 

First, in connection with the SEC subpoenas, Vice Chancellor Will first noted that Krauss had acknowledged that she is not entitled to advancement in connection with the three subpoenas directed to other Krauss-affiliated entities, as those entities are not “indemnitees” as defined in KBL’s Charter and Bylaws. 180 Life Sciences opposed advancement for Krauss’s fees and expenses incurred in responding to the Krauss subpoena because the subpoena does not specify the capacity in which Krauss was served. This argument, Vice Chancellor Will said, did not give rise to a genuine issue of material fact. Even viewing the evidence in light most favorable to 180 Life Sciences, “a causal nexus exists between the SEC’s investigation and Krauss’s former fiduciary duties.” Vice Chancellor Will added, based on her review of the documents the SEC sought in the subpoena, that “it is self-evident that these documents were requested from Krauss by virtue of her former KBL positions and not (as the Company suggests might be the case) because she was a Company stockholder.”

 

Second, in connection with the Tyche Action, 180 Life Sciences opposed advancement of Krauss’s fees and expenses incurred in defending against Tyche’s third-party claims against Krause because, the company claimed, Krauss was named as a third-party defendant only because of her conduct as the principal of KBL Sponsor relating to its personal contractual obligation. Vice Chancellor Will concluded, based on her review of the Tyche third-party claims, that Tyche’s actual claims support the Company’s assertion, noting that Krauss was named in the third-party complaint solely in her capacity as KBL Sponsor’s principal. Accordingly, Vice Chancellor Will denied Krauss’s motion for partial summary judgment with respect to advancement of Krauss’s fees and expenses incurred in connection with the Tyche Action.

 

Third, with respect to Krauss’s fees and expenses incurred in connection with the Direct Action, Vice Chancellor Will noted that 180 Life Sciences conceded that Krause is entitled to advancement for portions of the Company’s complaint against her. However, the company disputed that Krauss was entitled to advancement for Krauss’s counterclaims, third-party claims, and certain of her affirmative defenses. Vice Chancellor Will concluded that Krauss was entitled to advancement of her fees and expenses incurred in connection with her affirmative defenses, including even her defenses to allegations of unauthorized transfers after Krauss’s resignation. In reaching this conclusion, Vice Chancellor Will concluded that all of the causes of action associated with Krauss’s affirmative defenses all satisfy the “by reason of the fact” requirement, adding that “it is unclear how Krauss could have signed off on the Company’s financial statements or (allegedly) embezzled funds if she had not been a director or officer.”

 

With respect to Krauss’s counterclaims in the Direct Action, Vice Chancellor Will concluded that fees and expenses incurred in connection with certain of the counterclaims are not advanceable because they were brought not by reason of the fact that Krauss was a company director or officer, but rather in connection with her role as KBL sponsor or in her personal capacity as a stockholder or related to personal contractual obligations. However, Vice Chancellor Will noted that certain of Krauss’s counterclaims were “compulsory” counterclaims, in that they were necessarily part of the same dispute as the claims asserted by the Company in the Direct Action. Vice Chancellor Will concluded that Krauss was entitled to summary judgment as to her advancement rights with respect to her compulsory counterclaims, but not with respect to the remaining counterclaims that were not compulsory.

 

Finally, Vice Chancellor Will concluded that Krauss was entitled to recover “fees on fees” proportionate to her success in establishing her right to advancement, as well as to prejudgment interest.

 

Vice Chancellor Will directed the parties to confer and within ten days to submit an implementing order consistent with her decision. She also directed the parties to submit a joint letter within ten days setting forth their respective positions on a procedure for resolving the outstanding advancement entitlement issues.

 

Discussion

In thinking about Vice Chancellor Will’s opinion in this case, it is important to note as a preliminary matter how critical the actual wording of the indemnification and advancement provisions of KBL’s Charter and Bylaws was to the Vice Chancellor’s rulings. These provisions were written very broadly, which explains in part the outcome of the advancement proceeding. It is also important to note that, as Vice Chancellor Will expressly observed, the indemnification and advancement provisions were not revised in connection with the business combination. I emphasize these points because they underscore the fact that the outcome of this motion ruling may be of only limited guidance in the context of other SPAC-related advancement disputes arising where the indemnification and advancement provisions are not as broad, or where the indemnification or advancement provisions were in fact revised in connection with the business combination.

 

That said, while KBL’s indemnification and advancement provisions are broad, they are not unusual. It is a fairly common practice for indemnification and advancement provisions to be written every bit as broadly as were the provisions in KBL’s Charter and Bylaws. For SPACs whose indemnification and advancement provisions are written with similar breadth, there are a number of important learnings from Vice Chancellor Will’s opinion.

 

First, Vice Chancellor Will concluded that KBL’s Charter and Bylaws “unambiguously provide for mandatory advancement.” And not only did Krauss have the right to mandatory advancement, but that right is enforceable against KBL’s successor-in-interest, 180 Life Sciences. While the enforcement of an advancement right against a successor-in-interest arguably is uncontroversial, it is still worth emphasizing that Vice Chancellor Will held that the advancement rights of a former SPAC officer and director are enforceable against the post-merger go-forward De-SPAC company. While that is the way I think everyone has assumed things would work, it is one thing to think that is the way things will work and it is another thing to actually see it play out in practice.

 

Second, although some of Vice Chancellor Will concluded that Krauss was not entitled to summary judgment with respect to certain of the amounts for which she sought advancement, the critical factor in reaching this conclusion was that the conduct at issue in connection with which Krauss was seeking advancement was not undertaken “by reason of the fact that” she was a director or officer of the SPAC. These other amounts related to conduct she undertook in her capacity as a principal of the SPAC sponsor or in her personal capacity. The fact that the Vice Chancellor concluded that Krauss was not entitled to advancement for claims relating to conduct in other than her capacity as an “indemnitee” does not take away from the fact that Krauss was entitled to advancement from 180 Life Sciences in connection with claims relating to conduct that was undertaken in her capacity as a director or officer of the SPAC.

 

Vice Chancellor Will’s opinion was only concerned with Krauss’s advancement rights. Her opinion does not consider or discuss any D&O insurance issues. However, notwithstanding the fact that D&O insurance considerations do not appear anywhere in her opinion, I still think Vice Chancellor Will’s opinion arguably has important D&O insurance implications.

 

For starters, it is a fundamental part of Vice Chancellor Will’s opinion that the former SPAC officer and director has advancement and indemnification rights that not only survived the merger transaction but that were enforceable against the post-merger go-forward De-SPAC company. The availability and enforceability of these rights against the post-merger company have important implications for the availability of Side A insurance under the SPAC’s runoff D&O insurance policy. If the former SPAC officer or director has indemnification and advancement rights that are enforceable against the post-merger company, the SPAC’s runoff D&O insurer will likely take the position that the Side A coverage under the SPAC’s runoff D&O insurance policy is not triggered. This consideration obviously has important considerations for SPACs, seeking to save insurance expense, that put a Side A-only insurance policy in place, rather than a full traditional insurance ABC D&O insurance policy.

 

(To be sure, the availability of indemnification and advancement for the former SPAC officer will depend significantly on the actual wording of the SPAC’s indemnification and advancement provisions and whether the provisions were modified in connection with the business combination. My comments here are most applicable with respect to company’s whose indemnification and advancement provisions are equally broad as those in KBL’s Charter and Bylaws.)

 

There is another important insurance implication from the conclusion that a former SPAC officer or director may enforce their indemnification and advancement rights against the post-merger company. That has to do with the massive retentions that in place under most SPAC D&O Insurance programs. If a post-merger claim does not trigger a Side A claim (for reasons discussed above), then post-merger claims against a former SPAC director and officer will trigger Side B, putting the Side B retention in play. The practical implication is that the Side B retention will have to be satisfied before the insurance coverage itself is triggered. If, as was the case for Krauss here, the former SPAC director or officer has enforceable indemnification and advancement rights against the post-merger company, then the post-merger company will be responsible for funding the retention amount. While there may be those who say, in response to this observation, well, of course that is the way it is going to work, I will say this: it is one thing to noodle all that through in the abstract, it is another thing to actually walk through the way it is all going to work in practice.

 

I have one further observation based on Krauss’s advancement dispute and this has to do with how complicated all of this got because she was alleged to have been acting in multiple capacities, some of them having to do with her capacity as a SPAC director and officer, some of them having to do with her role as a principal of the SPAC sponsor, and some of them having to do with her personal capacity. I suspect that in connection with many litigated SPAC-related disputes, the multiple capacity issue is going to be a significantly complicating concern. These complications not only create complex issues with respect to indemnification and advancement, they also create complex issues for insurance as well – particularly as multiple different insurance programs are put into play. These are not going to be easy issues to solve.