Managing SPAC Risk from Start to Finish
Andrew Pendergast, from Marsh, is back again to help further explain a SPAC team’s insurance needs. This time, he’ll walk us through what teams should be considering from pre-bid diligence all the way through post-combination closing. Read on for his comprehensive overview of SPAC insurance programs.
If you’d like to read Andrew’s previous article, you can find that HERE.
Managing SPAC Risk from Start to Finish
By Andrew Pendergast, SPAC Practice Leader, Marsh
The most common question any insurance broker is asked is “so what do I need to do now?” Most often for SPACs this question comes up after the deal team has signed a letter of intent and is preparing to propose the combination to its shareholders. In this article we will discuss what SPAC directors and officers should be doing from an insurance perspective to protect their personal assets and investment before, during and after closing.
Convert Your SPAC Directors & Officers Insurance Policy to Run-Off
At the time of the IPO, and throughout the due diligence phase, a SPAC’s insurance needs are satisfied by a directors and officers liability (D&O) policy that incepts on the date of its initial public offering. This policy will cover the costs of defense and settlement incurred by the individual D&Os and the entity itself as the result of a suit — generally a securities class action — brought against them during the due diligence period.
If everything goes according to plan and a target is identified, an 8-k will be filed presenting the deal to shareholders and the SPAC directors will move onto the next project upon closing. Unfortunately this is not where SPAC directors and officers liability ends. The 8-k is essentially a second prospectus that public shareholders can point to as the basis for bringing a securities suit post-close alleging that what the SPAC and its D&Os represented was materially misrepresented.
An effective way to limit post-acquisition risk for the SPAC D&Os, and preserve insurance limits dedicated to protecting their personal assets, is to run-off the SPAC’s D&O policy while simultaneously incepting a new, entirely separate D&O policy for the go-forward public company. A runoff provision — which is added to the SPAC D&O policy as an endorsement — states that the insurer will be responsible for any claims made against the former SPAC directors and officers from the closing date of the transaction through the end of an extended reporting period, typically six years.
All SPAC IPO and 8-k proxy related liability are covered under the runoff D&O policy and the limits can’t be used to protect the go-forward entity or board. This protects the personal assets of SPAC directors while ensuring that the new company starts with a clean slate. Containing SPAC risks in the runoff policy can also help to reduce costs for the new D&O policy.
Consider Representations and Warranties Insurance Prior to Signing
In a merger or acquisition, the seller is generally required to indemnify the buyer for breaches of any representations and warranties that are made in the purchase and sale agreement. Depending on the parties involved and the nature of the representations and warranties, the seller may be required to escrow a material percentage of the indemnification requirement. This requires the seller to maintain substantial illiquid capital following an exit.
From the buyer’s perspective, an uninsured indemnity agreement provides limited comfort, as there is no guarantee that a buyer will be able to collect losses if a breach occurs. But purchasing representations and warranties (“reps and warranties”) insurance can protect buyers and sellers without tying up too much capital in an escrow account.
A reps and warranties insurance policy can reduce or replace the indemnification and escrow requirements created by the seller’s representation and warranties section of a purchase and sale agreement. The policy will pay excess of a retention, which is often the basket aggregate outlined in the purchase and sale agreement. For the seller, this allows them to immediately realize the proceeds of the deal rather than waiting two to three years for the indemnity period to end. For the buyer, this offers peace of mind knowing there is an insurance solution in the event of a breach.
Conduct Due Diligence on Your Entire Insurance Program
An insurance due diligence exercise should also be performed prior to completing an acquisition. This will highlight any issues related to the target company’s insurable risks, identify any gaps in its current insurance portfolio and recommend any additional protections that may needed to properly insure your investment. As mentioned previously, the SPAC will only have procured D&O insurance however the post-close entity will need to consider:
- Employment practices liability
- Fiduciary liability
- Crime/fidelity insurance
- Cyber insurance
- Casualty coverage, including workers’ compensation
- Property insurance
- Professional liability/errors and omissions coverage
- Products liability
- Employee benefits.
More often than not, clients wait until closing before contacting their risk advisor, leaving the advisor scrambling to evaluate a target’s insurance portfolio and ensure that run-off coverage is properly negotiated. Be proactive and engage a risk advisor early and often in the process to assist in explaining your reps and warranties insurance options, manage the due diligence process and ensure that your run-off coverage is properly negotiated.
For more on SPAC risk and Marsh’s SPAC risk specialists, visit Marsh’s SPAC specialist page or contact Andrew Pendergast. Marsh is the world’s leading insurance broker and risk adviser. With over 35,000 colleagues operating in more than 130 countries, Marsh serves commercial and individual clients with data driven risk solutions and advisory services. Marsh is a business of Marsh & McLennan Companies (NYSE: MMC), the leading global professional services firm in the areas of risk, strategy and people.