Knowledge

In recent years the BVI and Cayman Islands (“Cayman”) have seen a sharp rise in the number of Special Purpose Acquisition Companies (“SPAC” or “SPACs”) being incorporated. A SPAC is an entity which is formed and listed on a major exchange with no specific business purpose except to raise capital for a future purpose.

This purpose is often undefined or ambiguous at best and, for this reason, they are known euphemistically as ‘blank cheque companies’. Often, the broad purpose of the SPAC is to identify and make acquisitions of other, as yet unidentified, target companies and it is usual for the SPAC to have a fixed amount of time to do this. This gives the SPAC a limited lifespan.

In the event that a transaction is not completed during the allotted timespan, the SPAC is required to be dissolved and any funds received from investors returned to them.

Given the nature of the SPAC and the ‘unknown’ nature of the transaction(s) involved, it is highly likely that the increasing demand for SPACs in the BVI and Cayman may lead to significant disputes between those investing in a SPAC and those employed to make investment decisions on its behalf.

The purpose of this article is to laser in on where those disputes may arise and the areas that those who structure, manage or invest in SPACs should pay close attention to in order to avoid future pitfalls. 

Background

The genesis of the SPAC is not a new one and SPACs in one form or another have been around since at least the 1980s, with most onshore SPACs traditionally incorporated in the US state of Delaware. The major exchanges in London and New York now allow the listing of SPACs formed outside of the US and SPACs may be incorporated in most of the leading offshore jurisdictions.

The offshore boom in the formation of SPACs can be seen partly as a result of the perfect storm of a global pandemic, an excess of liquidity in the global markets and an election year in the US, alongside the inherent risks that a traditional IPO involves in terms of pricing and valuation risk.

Pioneering offshore innovation

In many ways, the BVI has been even more successful than Cayman in positioning itself as a global leader in SPAC innovation. It was the BVI that was the destination of choice for the first ever NASDAQ listed Chinese finance business back in 2016 as well as for the first India focused SPAC and, in 2018, it was a BVI SPAC, the National Energy Services Reunited Corp, that completed a unique simultaneous double business combination when it acquired two Middle Eastern oil businesses with a combined value of over US$1.1 billion.

The BVI has led innovation in terms of the structuring of these vehicles, including introducing novel features such as ‘rights’, ‘fractional warrants’ and the ability to extend the SPAC’s lifespan. But wait…

Future disputes

It is in this last innovation that the seed of future disputes may lie.

It’s easy to see why the ability to extend the life of the SPAC may be advantageous where the company is in the midst of negotiations or about to enter into a transaction and has a target squarely in its sights. It is, however, equally obvious that, from an investor’s standpoint, investing capital ‘blindly’, for a defined period of time, into a company which can generate no ROI until it completes a transaction and owns no other assets, that company choosing to roll over its ‘allotted time’ could generate the potential for serious disputes.

Any decision to extend the lifespan of the SPAC, and thereby delay the return of capital to the investor, not only exacerbates the failure to generate a return, but also magnifies the opportunity cost of investing in the SPAC in the first place.

Investors, sponsors and directors

In addition to the risk of a SPAC attempting to keep itself alive beyond the originally anticipated investment period, investors face the more obvious risk that this is a true ‘blank cheque investment’. They rely entirely on the judgment of those involved in forming the SPAC (the sponsors) and the management team during the life of the SPAC.

Directors of SPACs owe all of the same duties as directors of ordinary companies and, from an investor’s standpoint, it is important to understand that they will almost certainly also benefit from the usual director’s indemnity clauses which offer them protection unless their actions were carried out dishonestly, in bad faith or were illegal. Many directors may also enjoy generous remunerative arrangements linked to the ultimate success of the SPAC.

In this context it is, therefore, easy to see how conflicts may arise between the duties owed to the SPAC and the director’s own self-interest which may lead to disputes with the investors, especially in circumstances where the directors want more time to find an acquisition target.

The opposite may also be true, i.e. that the directors ‘rush into’ a bad deal because they only have limited time to find an acquisition target, instead of waiting for a better deal or carrying out thorough due diligence. It is also clear that the time limitation of SPACs offer target companies a clear pinch point when leveraging negotiations and it is understandable that it might be desirable to allow the SPAC to extend its lifespan. To counter some of these risks, some SPACs are forming ‘special committees’ designed to offer increased objectivity but, again, this relies heavily on who appoints such committees and, again, disputes may arise.

Recent litigation

Following the boom in incorporating SPACs in the BVI and Cayman, it is highly likely that disputes may arise, given the high risk nature of the investment, the uncertainty as to outcome and the potential conflict for those managing the SPAC between their fiduciary duties and their own economic interest in its success.

Litigators in both Cayman and the BVI have been alerted to the likely development of SPAC litigation in their jurisdiction by recent law suits in New York and Delaware concerning alleged violations of the federal securities laws and claims against directors of SPACs for misrepresentation and breach of fiduciary duty. It is, therefore, almost certain that the wave of SPAC incorporations in Cayman and the BVI over the past few years will lead to similar litigation on behalf of disgruntled investors in those jurisdictions. It is a matter of when and not if such litigation will materialise. 

Authored by: Kai McGriele (Cayman Islands), and Owen Prew (BVI) - Bedell Cristin

This article first appeared in the ThoughtLeaders4 Disputes magazine issue 2, September 2021.