A Strategic Approach to Restructuring: What Sponsors Should Know

By John Umbach and Andrew Fiscella, Marsh’s SPAC leaders

Additional contribution from Michael Gil and Paul Figliozzi, Marsh’s Turnaround & Restructuring Practice leaders

For more information on SPAC risk and Marsh’s SPAC risk specialists, visit Marsh.com

Tougher SPAC market requires increased diligence

The special purpose acquisition company (SPAC) market has cooled significantly from the highs of 2021. In a difficult economic environment where capital is tight, many companies are finding it difficult to raise the capital needed to continue operating efficiently, and that includes companies that went through the SPAC process.  When companies are in distress, it can lead to potential takeovers, restructuring, or even bankruptcy.

Several early stage growth companies that were brought public by a SPAC in 2020 and 2021 are believed to be facing financial difficulties in the current macroeconomic environment.

Any resulting investor losses could increase the risk of litigation for these companies and their directors and officers.

As De-SPAC’d companies navigate escalating challenges, many of these companies that went public through a SPAC are facing financial difficulties and risk running out of cash. While many currently have operating capital, they should consider making decisions to see them through a potential cash crunch. This includes reviewing and potentially updating their directors and officers liability (D&O) insurance coverage since it provides critical personal asset protection to executives.

Rethink your D&O program

In 2021, as the SPAC market got hot, it conversely coincided with a difficult D&O insurance market in the US. Faced with significantly higher rates and more restrictive terms and conditions, companies going through the SPAC process at that time often faced challenges securing coverage that provided optimal protection to their directors and officers.­

However, the D&O market in the US has improved.  New carrier entrants, as well as increased capacity from existing markets, have led to increased competition, generally resulting in lower rates and improved terms and conditions, including for SPACs and companies that merged with SPACs over the last few years. .

An important consideration is to make sure that companies have dedicated Side-A difference in conditions limits, which provide coverage only for the defense of individual directors and officers and not the company itself.  This coverage is critical in a bankruptcy scenario or in the event of other non-indemnifiable costs related to litigation. While senior leaders may be tempted to wait until the future of the company is clearer before expanding their D&O policy or purchasing new limits, it is important to start the process before the company has filed for bankruptcy and Work with your broker or insurance advisor to consider all potential scenarios and make sure that your D&O program will provide adequate coverage in all situations.

It is also important to look beyond pricing and select the right insurer. Your broker can help you to review carriers’ financial ratings, history in the D&O market, executive leadership, and claims-paying history to ensure you are partnering with insurers that have proven track records.

Plan ahead of potential restructuring requirements

As inflation surged and the Federal Reserve raised interest rates in an attempt to tame inflation, growth companies saw a corresponding decrease in valuations and growth companies fell out of favor. As these companies face challenges to raise cash, there is increased potential that they will need to restructure under the protection of bankruptcy.

Additionally, it is not uncommon for cash-strapped companies to consider divesting their most valuable assets to raise capital. As a result, the divestitures may trigger the D&O policy’s change in control clause. Should that occur, the company’s D&O policy may automatically enter an extended reporting period — also known as a run-off or tail period — during which coverage for directors and officers could be discontinued, potentially leaving them exposed until a new program is in place.

Further, when companies file for bankruptcy following a divestiture, there is increased risk of litigation. Investors may allege that some creditors were given preferential treatment when they were paid from funds raised through the divestiture. Allegations of conflicts of interest or that the divested entity was not adequately valued are also common.

Considering the increased risk of litigation, it is critical for management teams to have a clear understanding of their D&O policy going forward, with special focus on how it would respond to an insolvency. Particular attention should be paid to the priority of payments provision, which tend to be included in standard D&O policies and stipulate which losses will be paid first. Because directors’ and officers’ personal assets may be at risk, it is important that the policy wording provides them with adequate protection.

A bankruptcy filing can further complicate matters. Once a company has filed for bankruptcy, purchases — including insurance premiums — will typically need to be approved by a court. It is prudent for companies going through financial difficulties to pre-purchase tail coverage prior to filing. This allows for management to control the terms of the run-off, including any coverage modifications to the existing insurance program. They will also be able to secure the necessary coverage for insured individuals’ personal assets in the event of a non-indemnifiable loss and ensure payment can be made without requiring bankruptcy court approval. Tail coverage typically incepts at either the time of re-emergence (in a Chapter 11) or following a liquidation and wind down period (in a Chapter 7) and provides six years of personal asset coverage for past wrongful acts.

Depending on how a D&O policy is worded, directors and officers may need to request a stay to be lifted by a court in order for the insurer to pay any legal expenses that are typically covered. This could prolong the time during which executives are out of pocket for legal costs.

For all of these reasons, it’s a good idea for all organizations, and especially those that are having financial difficulties, to work with an experienced insurance advisor or broker to identify any problematic language and seek to address it early on.