As 2022 came to an end, many SPAC sponsors and executives, concerned about the possible onset on January 1, 2023, of an excise tax on amounts to be returned to investors, moved to liquidate their SPACs. As discussed further below, concerns about the possible applicability of the tax have now been alleviated, but given the general marketplace conditions for SPAC merger transactions, it seems likely that there will be further SPAC liquidations ahead in the new year. The possibility of a SPAC liquidation raises a number of considerations, including also important considerations with respect to D&O insurance.
First of all, with respect to the anticipated 2023 tax consequences, the concern that motivated so many SPAC sponsors and executives to liquidate at year end 2022 was the potential impact of the Inflation Reduction Act, and in particular, the Act’s 1% excise tax on stock repurchases by public companies. The concern was that in a SPAC liquidation 100% of the stock in redeemed and therefore subject to the tax. Under the terms of the Act, the excise tax is imposed on applicable transactions completed after December 31, 2022.
In the waning days of 2022, many SPACs, concerned about the potential applicability of the excise tax, rushed to complete liquidations. According to a January 6, 2023, Wall Street Journal article (here), about 85 SPACs liquidated in December 2022, represented about $750 million in losses to SPAC sponsors. The Journal article notes that concerns about the 1% tax for returned cash led “more SPACs to shut down in December than in the market’s history.”
However, in an exquisite exercise of lousy timing, the Treasury Department and the Internal Revenue Services, according to the Journal article, have now said that SPAC liquidations will not be taxed under the new federal buyback levy.
Even though the concerns about the 1% buyback tax have been eased, the clarification about the tax issues, according to the Journal, “still isn’t likely to shift sentiment in the once-booming” SPAC market. According to the Journal, about 300 SPACs holding more than $70 billion face deadlines by mid-2023 to reach mergers. Some of these SPACs have announced mergers that are yet to close, but, the Journal noted, quoting industry analysts, “many SPACs will likely shut.” Indeed, the poor performance of many de-SPACs post-merger has made it difficult, according to the Journal, for SPAC sponsors and executives “to convince companies to merge with SPACs.”
The possibility for further SPAC liquidations, particularly in the first six months of 2023, raises the questions about what liquidating SPACs should do about their D&O insurance.
An interesting December 19, 2023 post on the Pillsbury law firm’s Policyholder Pulse blog entitled “Closing Up the SPAC Shop: Insurance Consequences and Opportunities for Liquidating SPACs” (here) reviews the insurance issues surrounding SPAC liquidations.
The law firm memo points out the pragmatic consideration that D&O insurance for SPACs is quite expensive, and in a liquidation there is no merger partner to “bankroll the runoff policy premium.” So a liquidating SPAC “may opt to simply let its policy terminate and leave its former directors and officers uncovered after the liquidation,” especially since there are no remaining shareholders to bring breach-of-duty suits or other claims against the officers and directors.
However, there is, as the memo’s authors note, “there is a lot of uncertainty about what risks remain for liquidates SPACs.” Whatever the risks may be, “they are not nonexistent.” Claims, the memo notes, could come from regulators and others about, for example, the conduct of the liquidation. Investigations could follow liquidation, including about the diligence of the SPAC in seeking merger targets and the circumstances of any merger deals that were abandoned. The authors note that “it is also good to remember that directors and officers underestimate the creativity of the securities’ plaintiffs’ bar at their peril.”
Although there may be, as the authors note, post-liquidation risks worth insuring, the possibility of those risks “may not last over several years.” Many SPAC D&O Insurance policies offer runoff insurance options of varying lengths, usually 1, 3, and 6 years. Some, but not all SPAC D&O Insurance policies offer runoff options for both a merger and for a liquidation. Even for SPAC D&O insurance policies that do not include runoff provisions for a liquidation, “that does not mean that such tail coverage is unavailable. Insurance brokers can help find insurers willing to sell a freestanding runoff.” With respect to the possible premium for his standalone coverage, the pricing and duration available for these freestanding policies may be “unclear,” as SPAC liquidation claims and the market for insurance coverage to meet them are “unexplored territory.”
With respect to the run-off coverage itself, it is important to note that post-liquidation, there is no company left to provide indemnification or to face claims directly against it. That “makes Side A coverage the most valuable coverage to have in a post-liquidation tail policy.” Companies can consider “tailoring a runoff policy to provide a Side-A-only runoff coverage.”
However, the authors also note that to the extent that directors and officers are entitled to indemnification for other sources, such as the SPAC sponsor, it could be valuable to maintain Side B coverage as well. The authors suggest that were policies do not include sponsor indemnification in Side B coverage it may be possible to add such coverage when purchasing a tail or wind-down policy. However, with respect to Side B coverage, it is important to note that in the D&O insurance market for SPACs that prevailed from, say, the middle of 2020 to the present, most SPAC D&O policies were written with self-insured retentions of as much as $10 million or more. Given the magnitude of the retentions of the policy to be put in runoff, the purchasers of the runoff coverage should “assess the value of purchasing coverage that would only respond after a significant retention is exhausted.”
Side C coverage, the authors note, is “the least likely to be needed post-liquidation as the likelihood of a securities claim being brought against a liquidated entity is low.” Excluding Side C coverage from the runoff may be possible, but “also may not yield significant premium savings as the risk the insurer is avoiding is low.”
The one thing I would add to the authors’ analysis of these issues is that the market for D&O insurance as we head into 2023 is very different than the one that was applicable in 2020 and 2021 when many of the current searching SPACs completed their IPO. Competition has returned to the marketplace and there are many players – not just the new markets, but even the legacy players – that are eager for opportunities to score premium revenues. It may be that in this marketplace, there could be a viable market for the kind of standalone runoff coverage options that the memo’s authors describe, particularly if the potential market participants perceive the risk of post-liquidation claims to be relatively low.
From my perspective, offering this type of standalone product could represent an attractive commercial opportunity for an entrepreneurial marketplace participant, especially given that the premiums charged for the initial policies at the time of the IPO were so high – the elevated premiums arguably present a good starting point for negotiations for the runoff policy.