The following conversation between Lisa J. Stark and Priya Cherian Huskins took place in the run-up to the annual meeting of the Virtual Section of the American Bar Association Business Law Section in September 2020.
LISA: Welcome to today’s spotlight series on business law. This is Lisa Stark, Incoming Chair of Business Law Today. I am fortunate to be accompanied by Priya Cherian Huskins. Priya is a board member of Woodruff Sawyer & Company, a 100-year-old commercial insurance broker. She chairs Woodruff Sawyer’s D&O claims group and is an expert on D&O insurance.
Priya recently authored the article “Why More SPACs Could Lead to More Litigation (And How To Prepare For It)” published in Business Law Today, which highlighted the dramatic increase in IPOs this year led by SPACs (Special Purpose Acquisition Companies ) is discussed. In her article, Priya anticipates an increase in SPAC-related litigation and gives some practical tips on how to avoid SPAC-related litigation. Priya, what is a SPAC?
PRIYA: In the simplest sense, the idea is that a group of individuals, the SPAC sponsors, raise money on an IPO and then find a good company to buy. The SPAC is the special vehicle with which the task is carried out. The IPO money is put into a trust, and the sponsors have 18 to 24 months to find a suitable target. Shareholders can then either accept the transaction or redeem their money.
LISA: Perfect. Why are we seeing more SPACs IPOs now?
PRIYA: I don’t really know the answer. But I can see that some of the rules that govern these vehicles have relaxed a little. We are also in a low interest rate environment where investors are demanding returns. I would also observe that success piques interest. Perhaps that explains the explosion in SPAC popularity at the moment. There is no doubt that a wave is coming our way now, but like most waves, it is actually not that sudden. The momentum for SPACs has been building for some time. And I think the final element is that SPACs create a way for businesses and private companies to go public. And that’s very compelling in an environment where market volatility makes a traditional IPO a little riskier for operating companies.
LISA: And we will focus on this element of risk today. What different types of SPAC-related litigation could result from all of this increase in SPAC activity?
PRIYA: SPAC-related litigation can usefully be divided into five categories. These categories track the SPAC life cycle. First of all, SPAC IPO fits. This is actually a theoretical category. To date, no class action lawsuit has been filed against a SPAC IPO registration statement. However, for the sake of completeness we should start here. The second category, the appeal against the merger, is a challenge to the proposed merger. Well, these are actually quite common and in many ways look, smell, and feel just like any other merger complaint we are used to in the public corporation environment. The third category is merger failure lawsuits. And this category arises when a SPAC completes the merger and only later does the true state of the target come to light. And of course, when there is a lawsuit, the true condition is not good. The fourth category is class actions against the operating company. Remember that the purpose of the SPAC transaction was to turn a private company into a publicly traded company. And like any publicly traded company, this company is also subject to a dispute over share abandonment. The last category, the fifth, is bankruptcy. I mention this particularly because if the target company goes bankrupt quickly after the merger is complete, sponsors should expect that they too, or at least the SPAC, could become embroiled in bankruptcy litigation.
LISA: Sounds a bit chaotic.
PRIYA: It could be.
LISA: It could be. So you mentioned sponsors. SPAC acquisitions are often related party transactions with a SPAC sponsor and / or target that often overlap in terms of directors, shareholders and management. Are there litigation-related issues that we should be concerned about given the conflicts associated with these types of IPOs?
PRIYA: Absolutely. SPACs are exciting and nothing about them erases all of the normal fiduciary problems always associated with M&A deals that may have related parties involved. In the few cases of litigation over SPACs, there is much talk about sponsor incentives. Individuals involved in SPAC transactions would be well advised to brush up on the law on independence related to M&A transactions. And remember, it’s not just financial relationships that can be problematic. Social relationships can also cause independence issues.
LISA: Friends, family and golf pals, right?
LISA: Are there any recent SPAC-related lawsuits that our audience should know about?
PRIYA: I’m very interested in the fact that there have been some pretty messy bits of SPAC-related litigation. Again, the M&A context is the most interesting. The classic case is the case of the Heckmann Corporation. This is sometimes referred to as the China Water Fall. This is a slightly older case, but very instructive. Since it has all of the elements I’m talking about, where there is a target, there is a proxy, the deal gets closed, and once the deal is closed it looks like it won’t be a great deal. And also keep in mind that SPAC sponsors are seeing a huge upward trend if they can close the deal successfully. And what looks like an economic gain can later be re-characterized in litigation as an inappropriate incentive.
LISA: It is this incentive that creates the conflict that is suing public shareholders. Finally, I think this is perhaps the most helpful part of the conversation. How can SPACs, their sponsors, and target companies reduce the risks associated with litigation and ultimately reduce litigation?
PRIYA: Sure. First off, I actually want to mention that we are more likely to think of civil and plaintiff disputes when we think of SPACs and these types of transactions. But just as a quick reminder, the SEC might also be interested in what’s going on. I didn’t see a lot of handshakes and the kind of warnings we saw for other innovations, think of the SEC’s first coin offerings. But they didn’t fail to notice what was going on. Might be useful in considering the June 2019 enforcement action against Benjamin Gordon. He was the CEO of Cambridge Capital Acquisition Corp. He agreed to an omission, a personal fine of $ 100,000, and a 12-month suspension from working on anything truly SEC related. And the SEC also follows the principles of the SPAC Transaction Capability Computer goal. So a lot has gone wrong in this business, possibly a downright scam. If you read the SEC’s press releases and related documents, it can be seen that the SEC has focused on disclosing the proxy statement that Cambridge Acquisition Corp. has carried out a thorough due diligence. They focus on it because somehow they don’t believe it’s true. So that’s a starting point, as much as we’re all very interested in plaintiff-style litigation, there’s nothing more frightening than when the government comes after you. Anyone connected to a SPAC may want to remind yourself that this is a regulated situation and the SEC and ultimately the DOJ are in charge.
Now let me talk about what, because I started with the SEC, is the friendlier part of litigation. So when we think about how SPAC sponsors can protect themselves from litigation, here are a few tips. First and foremost, and we’ve talked a little about it already, treat the M&A process with the same level of care that you would if you were on the board of a public company to close the deal. It won’t be okay to be fooled as you ask investors to read the proxy materials and vote for the deal. The careful effort and the documentation of the careful use are exactly the same as in any other situation. Another tip is to look for a destination in good time. It’s noteworthy how many of the SPACs involved in litigation were at the end of their timeline and basically able to heroically toss an acquisition target across the finish line. Given the positive impact sponsors have in closing a deal, this is a recipe for extreme skepticism by the court when the business struggles.
Finally, buy good D&O insurance from a broker who actually understands the entire SPAC life cycle and the risks involved. There are a lot of insurance policies that are taken out by insurance brokers who are very young, know very little about the current D&O litigation environment, and knock up expensive D&O insurance policies without really knowing what the policies are supposed to cover . Remember, your broker doesn’t just take orders for insurance limits. The guidelines are negotiated, they are tailor-made and very individual. When you have a claim, you hope that the person who placed the policy can actually stand up for you with the carriers. Not all brokerage houses are set up this way. You should therefore inquire about your broker’s experience, not just about taking out SPAC IPO insurance, but also about paying claims for IPO companies, possibly M&A transactions, and paying claims in warranty policies and damage payments. And of course you will work with publicly traded companies as you will have them on hand after the SPAC transaction. I have to tell you that some of the best deals my insurance broker has ever worked on are deals that our clients have refrained from based on what we uncovered in the careful insurance process of all things. Working with an insurance broker who can take a holistic integrated approach to the full SPAC lifecycle is much, much better than relying on a junior broker to take you to another silo for the next phase of the SPAC lifecycle must pass. or if there is a claim against the insurance.
In summary, be diligent, be on time and do not forget to pay attention to D&O insurance early on.
LISA: Thank you, Priya. It was a fascinating conversation. Again, Priya’s article is titled “Why More SPACs Could Lead to More Litigation (and How to Prepare).” Thank you for joining our Business Law Today Spotlight series. And Priya, thank you very much.
PRIYA: Thank you very much.