A special purpose acquisition company, or SPAC, is a company without commercial operations formed solely to raise capital through an initial public offering (IPO) or to merge with or acquire an existing company. Sometimes called “blank check companies,” SPACs have been around for decades, but their popularity has skyrocketed in recent years. In 2020, 247 SPACs with $80 billion invested were created, and 2021 saw a record 613 SPAC IPOs. By comparison, 2019 saw only 59 SPACs hit the market. During the 2020-2021 SPAC boom, the business model attracted well-known names including Deutsche Bank, Goldman Sachs, and Credit Suisse as well as many retired or semi-retired senior executives (source 2). However, while SPACs are still happening, their popularity is likely cyclical, as evidenced by the wind-down of many SPACs at the end of 2022 (source 8). Whether a SPAC completes a deal or not, there are still risks to be carefully considered.
WHAT ARE THE RISKS ASSOCIATED WITH A SPAC?
Typically, a SPAC has 18-24 months to complete a deal, or the company faces liquidation, and all invested funds are returned to investors. After an acquisition is completed, a SPAC is usually listed on one of the major stock exchanges.2 Throughout the process investors have to trust that promoters will be successful in acquiring or merging with a suitable target company. However, there is generally a reduced degree of regulatory oversight and a lack of disclosure from the SPAC, which can make it difficult to tell if the potential investment is overhyped.2,7 In addition, SPAC returns may not meet expectations. In fact, as many as 70% of SPACs with a 2021 IPO were trading below their $10 offer price as of September 2021. As of April 2021, the Securities and Exchange Commission (SEC) laid out new accounting regulations causing SPAC filings to plummet in the second quarter, and by early 2022, the popularity of SPACs decreased due to increased regulatory oversight and the less-than-stellar performance of some.2
The process of a SPAC taking a private company public is known as a de-SPAC transaction and deSPACs present first-impression Directors and Officers (D&O) coverage issues that are best addressed by a knowledgeable broker. As popular as blank-check companies have become, they have considerable D&O liability exposure, through all phases of their lifecycle – from initial capital raising to completing or failing to complete an acquisition or acts committed by the acquired operating company after it becomes public.
As many of SPACs come to the end of their 24-month window to complete an acquisition, some are seeking to change their sponsor entity, and thus their board, in an effort to extend the acquisition window via a new proxy vote. This creates new issues for the D&O policy in place as most underwriters view that action as a change of control, which would require the former sponsor board to purchase a tail policy and the newer sponsor board to purchase a new SPAC D&O policy. If the extension amendment is not approved then shares are redeemed via the trust account. If an extension is approved, there is still an opportunity for shareholders to seek a redemption at that time as well as if/ when a business combination is announced during the extension period. This process gives rise to many potentially significant areas of D&O liability, including the sale of the original sponsor shares to the new sponsor entity, the failure of the new sponsor entity to obtain the extension, and the redemption process ending the ability of the new sponsor to complete a business combination. These potential scenarios can give rise to claims against 4 different D&O policies, making it vital that coordination of coverage amongst all the various policies be handled by an experienced and knowledgeable broker.
Market volatility and a buyback tax imposed under the Inflation Reduction Act in 2022 have led to dozens of SPAC liquidations in recent months.5 With the market essentially at a standstill and a new tax looming on the horizon, the creators of SPACS closed approximately 85 SPACs in December alone, losing nearly $750M in the process. Overall, SPAC creators have lost about $1.25B from SPAC wind-downs in the past year. At the end of December 2022, the Treasury Department and Internal Revenue Service surprised many by confirming that SPAC liquidations wouldn’t be taxed under the federal buyback levy. Unfortunately, SPACs that tried to beat the tax ended up locking in their losses. Those that didn’t liquidate now have more time to try to complete a deal pull out a profit if market conditions shift. More than 50 SPACs with roughly $15B in investor funds were seeking investor approval to take additional time to complete a deal in the early 2023 - via votes that also give holders the opportunity to take their money back.8 In total, around 300 SPACs holding more than $70B now face mid-2023 deadlines to finish deals, including some that have previously announced mergers but have yet to officially close them.9
For those companies that did go public in December 2022, a staggering 96% of shareholders elected to redeem their stock on average – setting the pace for a record streak of redemptions. Even when a transaction has been completed, the performance of newly public companies following de-SPACs has been mixed, which can increase the likelihood of shareholder litigation. SPAC litigation is currently the biggest trend in securities lawsuit filings, according to the Securities Class-Action Clearinghouse, illustrating that litigation risks don’t disappear once a transaction has been completed.6
TRITERRAS, INC. LAWSUIT SETTLEMENT
Lawsuits relating to SPACs have begun to accumulate over the last couple of years, and one of the first settlements was recently reached. In 2020, a plaintiff shareholder filed a securities class action against the surviving company following a SPAC’s acquisition of a target company. The complaint named the CEO of the surviving company as well as the former president of the SPAC as defendants.1
Triterras, Inc. is a fintech company focused on trade and trade finance. Triterras operates Kratos, a commodity trading and trade finance platform that connects commodity traders to trade and source capital from lenders directly online. Triterras was originally formed in November 2020 with the merger of Netfin Acquisition Corp., a SPAC, and Triterras Fintech Pte. Ltd. Netfin completed a $253 million IPO in 2019.1
Rhodium Resources Pte. Ltd is a commodity trading business headquartered in Singapore and controlled by the same individual who is also the Chief Executive Officer of Triterras. The complaint alleged that Rhodium was responsible for launching the Kratos platform and that users were referred by Rhodium with an agreement that incentivized Rhodium to continue to refer commodity trading customers to Kratos, in exchange for fixed payments to Rhodium when a referred customer met the total transaction volume requirements for a specific period.1 In mid-December 2020, Triterras announced via an SEC filing that Rhodium had advised Triterras that on December 1, 2020, Rhodium had received a statutory demand for payment from a creditor and had to respond within 21 days or the creditor could file a bankruptcy application against Rhodium. Rhodium sought a moratorium while planning a debt restructure. According to the lawsuit complaint, Triterras’s share price fell 31% when the news broke.1
The complaint sought the recovery of damages based on the allegation that the defendants did not disclose the extent to which Triterras’s revenue growth was dependent on the company’s referral relationship with Rhodium, that Rhodium faced significant financial liabilities, and that Rodium was likely to refer fewer users to the Kratos platform. As a result, it was alleged that the defendants’ positive statements about Triterras’s business, operations, and prospects were materially misleading and/or lacked a reasonable foundation.3
POTENTIAL FUTURE IMPACTS
This particular lawsuit was interesting to many because it was filed against a company that was acquired by a SPAC and underscores the risk that litigation can arise following a de-SPAC transaction. It’s also worth noting that the named defendants include not only the CEO of the post-transaction company but also the president of the SPAC prior to the de-SPAC transaction, which highlights the fact that individual directors and officers of the SPAC have litigation risk that extends past the completion of deSPAC transaction.1 Individuals involved in organizing SPACs and taking them public often believe they are engaged in a very low-risk activity, and that the SPAC IPO is itself a relatively lower-risk endeavor because the SPAC has no pre-IPO activities or employees, and after the IPO, the SPAC exists only as a pool of investment funds. However, as this lawsuit illustrates, the increased litigation risk continues after the SPAC has completed the de-SPAC transaction.1
The Triterras lawsuit is far from the first post-deSPAC transaction lawsuit that names former directors or officers of the SPAC as defendants, and it points toward possible implications for future securities litigation as de-SPAC transactions continue to unfold. As some of those transactions falter, acquired companies will stumble or encounter obstacles after the de-SPAC transaction is complete, and in some instances, litigation will follow involving former directors or officers of the SPAC as defendants.1 With the immense popularity of SPACs in 2020 and 2021, it is possible that most of the best deals have already been done. The risk is that SPACs may turn toward seeking out less promising options, which increases the possibility of post-transaction litigation.1
While SPACs can be profitable for sponsors and useful for target companies looking for a less expensive way to go public, it’s not always possible to complete a deal, and many SPACs are now winding down. In addition, when transactions falter, there are litigation issues that must be considered. There’s a risk that as the deadline for unwinding nears, SPACs will pull companies into the public eye before they’re truly ready.3 Investors would be wise to step back and carefully review financial records, and the company’s track record as well as how SPACs have treated shareholders in the past to better predict what may happen in the future.7 CRC Group is home to a deep bench of professional brokers with the knowledge and experience needed to help assess potential D&O exposures and coverage needs. Contact your local CRC Group producer today to discuss your clients’ evolving D&O risks should they become the target of a SPAC.
- Garrett Koehn serves as the Co-President of Brokerage for CRC Group. His expertise focuses on professional lines, including Directors and Officers, Private Equity, Cyber, and Intellectual Property.
- Jason White is the Managing Director & National Practice Leader for CRC Group’s Executive Professional Practice Group.
- SPAC-Acquired Company Hit with Post-Acquisition Securities Suit, The D&O Diary, December 22, 2020. https://www.dandodiary.com/2020/12/articles/securities-litigation/spac-acquired-company-hit-with-post-acquisition-securities-suit/
- Special Purpose Acquisition Company (SPAC) Explained: Examples and Risks, Investopedia, June 30, 2022. https://www.investopedia.com/ terms/s/spac.asp
- SPACs Look Like a Bubble Within a Bubble, Investopedia, February 9, 2021. https://www.investopedia.com/spacs-look-like-a-bubble-within-a-bubble-5105202
- US SPACs Data Hub, White & Case, 2022. https://www.whitecase.com/publications/insight/us-spacs-data-hub
- “SPAC liquidations top $12 billion this year as sponsors grapple with tough market, new buyback tax,” CBNC, October 19, 2022; https://www.cnbc.com/2022/10/19/spac-liquidations-top-12-billion-this-year-as-sponsors-grapple-with-tough-market-new-buyback-tax.html
- “Current Trends in Securities Class Action Filings,” Securities Class Action Clearinghouse; https://securities.stanford.edu/current-trends.html
- A Short Seller Offers His Unfiltered Perspective on the End of the SPAC Boom, Fortune, November 7, 2022. https://fortune.com/2022/11/07/ short-seller-perspective-spac-boom/?tpcc=nltermsheet
- Great SPAC Crash of 2022 Deepens as Investors Cash Out in Droves, Bloomberg, December 14, 2022. https://www.bloomberg.com/news/ articles/2022-12-14/great-spac-crash-of-2022-deepens-as-investors-cash-out-in-droves
- Good News on Taxes Came Too Late for Many SPACs, The Wall Street Journal, January 5, 2023. https://www.wsj.com/articles/good-news-on-taxes-came-too-late-for-many-spacs-11672867533