The rise of SPACs as a common investment vehicle has been accompanied by a rise in concerns regarding SPAC governance. These concerns arise from the peculiar nature of SPACs. When a SPAC is created and goes public, its ultimate acquisition target remains to be identified. Accordingly, public investors in a SPAC effectively put their trust in the SPAC’s managers to identify a value-creating acquisition—often referred to as a “de-SPAC” transaction. There are often reasons, however, to suspect a misalignment of interests between a SPAC’s public investors and its managers when it comes to determining whether to pursue a particular de-SPAC transaction.
The potential misalignment of interests derives from the fact that each SPAC has a limited time—typically, two years—to complete such an acquisition. If the SPAC’s managers fail to complete an acquisition within the requisite time frame, the SPAC must return the funds received in its IPO with interest and dissolve. If the SPAC has been unable to identify a suitable acquisition target, this very well may be the best and most appropriate outcome for the SPAC’s public investors. The SPAC’s managers, however, usually harbor overwhelming incentives to complete a deal before the deadline. This is because the SPAC’s managers or their affiliates typically receive “founders shares” in the SPAC for a nominal fee, usually amounting to around 20 percent of the total equity in the SPAC. The holders of such shares stand to receive significant equity in the new company if a de-SPAC transaction is successfully completed. Such shares are rendered worthless, however, if the SPAC fails to complete a de-SPAC transaction. Accordingly, SPAC managers are often incentivized to find an acquisition target and complete a deal at all costs, even if a truly desirable target cannot be identified. The potential for abuse is rife: Public SPAC investors have little protection in such circumstances. Their primary defense is typically the ability to exercise a “redemption right”—i.e., the right to redeem one’s initial investment, with interest, in cash—immediately prior to the completion of a de-SPAC acquisition. This redemption right serves as a critical backstop and exit right for SPAC investors.
This misalignment of incentives in the SPAC context and the importance of stockholders’ redemption rights have become particularly salient as the rise in SPAC IPOs has generated significant competition between SPACs for deals with desirable private acquisition targets. While there have no doubt been some highly successful de-SPAC acquisitions during the boom of the last two years, there have also been many well-publicized failures in which public SPAC investors saw the value of their shares plummet following the completion of a de-SPAC acquisition.
The Investors’ Suit Alleging Fiduciary Breaches in Connection with a De-SPAC Deal
One such notable failure was the SPAC Churchill Capital Corp. III’s de-SPAC acquisition of the healthcare analytics company MultiPlan Corp. Churchill went public as a SPAC in February 2020, raising more than $1 billion from investors at an IPO price of $10 per share. Churchill completed a de-SPAC acquisition of MultiPlan some eight months later, with the vast majority of Churchill’s investors choosing not to exercise their redemption right in connection with the deal. In the weeks following the deal, however, adverse information emerged concerning MultiPlan’s business: Its single largest and most important customer, responsible for about 35 percent of its revenues, was in the process of creating an in-house platform to replace MultiPlan’s product. When this news was disclosed, the value of the post-acquisition company’s shares plummeted well below Churchill’s $10 IPO price.
In early 2021, two Churchill stockholders who held their shares through the de-SPAC acquisition of MultiPlan brought a class action suit challenging the deal in the Delaware Court of Chancery. The suing stockholders alleged, among other things, that Churchill’s managers—driven by their unique incentives to accomplish any de-SPAC transaction—breached their fiduciary duties owed to public investors by causing the SPAC to complete a value-destroying acquisition. In support of their claims, the suing stockholders emphasized that, in connection with the de-SPAC acquisition, Churchill and its managers had failed to disclose information material to the stockholders’ decision whether to exercise their redemption right—namely, that MultiPlan’s most important customer was known to be in the process of developing an in-house platform.
The defendants moved to dismiss the suit, arguing principally that the stockholder plaintiffs’ claims sought to redress harm incurred by Churchill itself—i.e., harm incurred by overpaying in the acquisition of MultiPlan—rather than harm incurred directly by individual stockholders. Accordingly, the defendants argued the plaintiffs’ claims were stockholder derivative claims subject to the stringent demand requirements of Court of Chancery Rule 23.1, which the plaintiffs had not satisfied. The defendants further argued that, even if the claims had been properly pled as direct claims, they should be dismissed because the claims were governed by contractual rights, rather than fiduciary duties, or otherwise were incognizable “holder” claims.
The Court of Chancery’s Holding Sustaining the Investors’ Claims, Emphasizing Disclosure
Churchill’s structure and misalignment of manager and investor incentives were typical of SPACs generally; and, therefore, many of the parties’ respective arguments could easily be mapped onto other de-SPAC acquisitions that had failed to generate returns for investors. Accordingly, the MultiPlan litigation was viewed as a bellwether, and the Court of Chancery’s ruling on the defendants’ motion to dismiss was widely anticipated as a potential road map for Delaware fiduciary breach litigation in the SPAC context going forward.
On January 3, 2022, the Court of Chancery issued an opinion largely sustaining the plaintiffs’ claims. In the decision, Vice Chancellor Will homed in on the plaintiffs’ allegations concerning the defendants’ disclosure failures and, in particular, the plaintiffs’ allegations that “the [Churchill] Board impaired the public stockholders’ informed exercise of their redemption right.” The court found that the complaint properly stated direct claims on behalf of stockholders for interference with their redemption rights, rather than derivative claims on behalf of the company for an overpayment in the overall deal. As Vice Chancellor Will explained, “Churchill had no such redemption right. . . . Therefore, the stockholders suffered a harm independent of and not shared with Churchill.”
The court also rejected the defendants’ other threshold arguments for dismissal. First, the court rejected the defendants’ argument that the plaintiffs were merely seeking to exercise a contractual right, holding that, instead, the plaintiffs sought to enforce “fiduciary duties owed in conjunction with a contractual right.” That is, the plaintiffs did not allege that they had been denied their contractual right to demand redemption but rather that their decision whether to exercise that right was misinformed because of the defendants’ disclosure failures. The court further rejected the argument that the plaintiffs had alleged “holder” claims—i.e., claims by persons wrongfully induced to hold stock rather than buy or sell it, which Delaware law recognizes are inappropriate for class action treatment. The court explained that the plaintiffs’ decision whether to exercise their redemption right was an “active and affirmative choice around which the SPAC structure revolved”; accordingly, the defendants could not “escape liability for fiduciary duty breaches in connection with that choice by characterizing it as a passive holder decision.”
Finally, having rejected all of the defendants’ threshold arguments for dismissal, the court confirmed that the misaligned incentives created by Churchill’s SPAC structure were sufficient to invoke Delaware’s plaintiff-friendly entire fairness standard, putting the burden on the defendants to demonstrate the fairness of both the challenged transaction’s price and the process that led to it. Ultimately, with this framework established, the court sustained the plaintiffs’ claims against all but one of Churchill’s fiduciaries.
Delaware SPAC Cases after MultiPlan
The most notable aspect of the Court of Chancery’s decision sustaining the MultiPlan suit is its focus on the plaintiffs’ allegations of insufficient disclosure and the resulting impairment of the plaintiffs’ ability to exercise their redemption right. Indeed, Vice Chancellor Will specifically emphasized that the allegations concerning insufficient disclosure were critical to her decision on the motion to dismiss, cautioning that her opinion did not “address the validity of a hypothetical claim where the disclosure is adequate and the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure.” Indeed, she explained that “[i]f public stockholders, in possession of all material information about the target, had chosen to invest rather than redeem, one can imagine a different outcome.”
The Court of Chancery’s emphasis on the defendants’ disclosure failures and its suggestion that complete disclosure might have led to a different outcome are consistent with broad trends in Delaware law following the Delaware Supreme Court’s landmark decision in Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015). The Corwin decision held that, in most scenarios, even otherwise suspect transactions will be insulated from stockholder challenge and judicial review if they are approved by a fully informed stockholder vote. Where, however, disclosure is inadequate, Corwin is inapplicable and stockholder challenges may proceed.
The court’s opinion in MultiPlan appears to contemplate a similar regime for cases centered on the impairment of stockholder redemption rights in the SPAC context. The decision makes clear that, where disclosure is inadequate and claims are otherwise well pled, challenges to de-SPAC transactions will be permitted to go forward. On the other hand, though the court did not expressly hold as much, the decision suggests that full disclosure may be sufficient to insulate claims pertaining to stockholder redemption rights from judicial review, notwithstanding the structural conflicts inherent in SPACs.
Accordingly, SPAC investors seeking to bring claims modeled on those asserted in MultiPlan should come armed with arguments that their SPAC’s managers breached their duty of disclosure in a manner rendering the investors’ redemption decisions materially uninformed or misinformed. Where obvious disclosure deficiencies are not apparent based on the public record, such investors will want to consider following a path that has become well worn in other Delaware litigation following Corwin: pursuit of a books-and-records investigation pursuant to section 220 of the Delaware General Corporation Law. The Delaware courts have interpreted section 220 as entitling stockholders to extensive document productions concerning significant corporate transactions. In several merger suits following Corwin, stockholder plaintiffs have been able to use this right under section 220 pre-suit to identify deficiencies in public disclosures, ultimately enabling those plaintiffs to overcome motions to dismiss and proceed to full discovery in cases challenging Delaware merger activity. We anticipate that SPAC investors seeking to challenge an impairment of their redemption rights will now seek to do the same.
Other salient questions relating to SPAC litigation in Delaware remain open following MultiPlan. Among other things, it remains unclear how the structural conflicts inherent in SPACs will influence the Delaware courts’ analysis of future SPAC cases in which, rather than challenging the impairment of redemption rights, investors do seek to plead derivative claims for overpayment in the de-SPAC transaction. For now, however, we anticipate that most SPAC-related stockholder suits will seek to follow the MultiPlan model and that the battle lines between plaintiffs and defendants will center, as much Delaware litigation now does, on issues of disclosure.
