Insurers are seen as unlikely to pay out on D&O liability cover for Xiamen-headquartered Nasdaq-listed Luckin Coffee which was found to have fabricated sales figures by as much as CNY2.2bn ($310m) or 40% of its projected 2019 sales.
An internal investigation of the Chinese coffee chain found that the COO Jian Liu and other employees had cooked the company's books from the second to the fourth quarter of 2019. To make the sales figures look credible, those behind the fraud also inflated costs and expenses.
The company raised $778m from a share sale and a convertible bond offering in early January, according to people with knowledge of the matter. The company also raised $645m in its US IPO.
California-based Muddy Waters Research sounded the alarm in January when it published a report that accused the Chinese coffee company of fraud. Its findings were made after mobilising 92 full-time and 1,418 part-time employees who recorded over 11,000 hours of Luckin Coffee store traffic.
D&O liability insurance
Luckin Coffee had purchased D&O liability insurance before its IPO on Nasdaq last year. The insured sum is $25m, reported Xinhua News Agency. The coverage is provided by a consortium of more than 10 insurance companies in China including Ping An Property and Casualty, according to local media reports.
The insurance cover is said to comprise four tiers. The bottom tier, with an insured sum of $10m, involves eight domestic insurers. They are Ping An P&C (with an underwriting share of 30%); China Pacific P&C (17.5%); PICC P&C (15%); China United P&C (15%); Guoren P&C Insurance (10%); China Continent P&C (5%); Jintai P&C (5%) and Qianhai P&C (2.5%).
If the bottom tier's insured sum is exceeded, then recourse would be made to the second, third and top tiers, where necessary, up to an aggregate of $25m.
It is understood that several of the insurers, such as China Pacific, have reinsured the business.
Meanwhile, investigations are underway. If the directors and officers of Luckin Coffee are found guilty of fraud or other criminal conduct, insurers would refuse to make payouts on any insurance claim lodged by Luckin Coffee, industry players say.
Ping An told Shanghai Securities News that it has already received a claim application from the coffee company. This is because a securities class action lawsuit was filed against the company in February.
US law firm, Robbins Geller Rudman & Dowd, one of the world’s leading law firms representing investors in securities class action litigation, states on its website that on 13 February 2020, a securities class action lawsuit was filed charging Luckin Coffee and certain of its officers with violations of the Securities Exchange Act. The lawsuit was commenced in New York on behalf of purchasers of Luckin Coffee securities between 13 November 2019 and 31 January 2020 (the Class Period).
The Luckin Coffee securities class action complaint alleges that throughout the Class Period, defendants made materially false and misleading statements and/or failed to disclose adverse information regarding Luckin Coffee’s business and financial condition. Specifically, defendants failed to disclose that certain of Luckin Coffee’s financial performance metrics, including per-store per-day sales, net selling price per item, advertising expenses, and revenue contribution from “other products,” were inflated, and that Luckin Coffee’s financial results thus overstated Luckin Coffee’s financial health and were consequently unreliable. As a result, Luckin Coffee securities traded at artificially inflated prices during the Class Period.
And while the price was artificially inflated, management is alleged to have cashed out 49% of their own Luckin Coffee shareholdings through stock pledges (i.e., using the inflated stock as collateral for personal loans).