Over the past 18 months, we have closely followed litigation and enforcement activity arising from the recent wave of special purpose acquisition company (“SPAC”) transactions. 1Until recently, there had been few, if any, judicial decisions addressing the merits of claims stemming from the recent wave of SPACs. That changed on January 3, 2022, when Vice Chancellor Lori Will of the Delaware Court of Chancery denied, in large measure, the defendants’ motion to dismiss in In re Multiplan Corp. Stockholders Litigation.
Using the entire fairness standard of review instead of the business judgment rule, the court held plaintiffs had adequately alleged that the SPAC sponsor (as controlling stockholder), the SPAC’s directors and the CEO violated their fiduciary duty of loyalty to the SPAC’s stockholders by failing to disclose certain material information regarding the SPAC’s intended target. Although the court focused on a particular disclosure issue, the framework used to arrive at that decision suggests that “inherent conflicts” common to most SPACs may receive further scrutiny in future cases. Going forward, SPACs, their directors and target companies should continue focusing on disclosing of all material information in seeking approvals of a business combination, as well as examining potential conflicts of interest between the SPAC’s sponsor and its public stockholders.
In re Multiplan arose out of a 2020 business combination between Churchill Capital Corporation III (the “SPAC”) and MultiPlan Corp, a healthcare-focused data analytics and technology company. The SPAC had a fairly standard structure, including:
- In its IPO, the SPAC issued units consisting of one Class A share plus a fractional warrant for $10 per unit. The Class A shares represented 80% of the SPAC’s outstanding shares at the IPO.
- The SPAC’s sponsors, however, received “founder” (or Class B) shares, also known as a “promote,” representing 20% of the SPAC’s outstanding shares at the IPO, for a nominal price. The SPAC’s sponsor also purchased 23 million warrants at $1.00 per warrant with an exercise price of $11.50.
- If the SPAC failed to complete a business combination within 24 months, the SPAC would liquidate and the Class A shareholders would receive the $10 per unit plus interest. However, the SPAC’s sponsors would lose their investment entirely.
- If the SPAC did timely identify a business combination, shareholders had both (i) the right to vote to approve the transaction and (ii) the right to redeem their shares at the $10 price plus interest.
In July 2020, the SPAC identified Multi-Plan as its target and approved a plan of merger. The SPAC subsequently solicited proxies from its common shareholders, seeking their approval of the transaction. Few shareholders exercised their right to redemption, and the transaction (or “de-SPAC”) was approved, closing in October 2020.
Following the de-SPAC, the newly combined company performed poorly. In the spring of 2021, several common shareholders filed suit in Delaware state court, alleging that the directors, officers, and other fiduciaries of the SPAC violated their duties to the shareholders, by failing to disclose in the proxy materials that MultiPlan’s largest customer was building an in-house platform to compete with MultiPlan and that this alleged failure to disclose impaired the common shareholders’ ability to exercise their redemption rights.
Further, the plaintiffs argued that the demanding “entire fairness” standard of review should apply, because the SPAC’s directors and officers had a conflict of interest, given that (i) their founder shares, purchased for a nominal price, would increase in value if any deal was consummated, but would be rendered worthless if the SPAC didn’t close an acquisition while, on the other hand, (ii) an acquisition was valuable to the common shareholders only if the newly combined company performed well, because they could otherwise choose to redeem their shares at roughly $10 per share (or get their money back if no acquisition was consummated).
II. Review of the Case
The Court’s analysis first dealt with several threshold issues, applying, in its words, “well-worn fiduciary principles” of Delaware law to the SPAC context. The Court first rejected the defendants’ claim that the shareholder-plaintiffs pled only derivative claims without alleging demand futility. Applying the familiar two-part test developed in Tooley v. Donaldson, Lufkin, & Jerrette2, the court noted (i) the shareholders, suing individually, had suffered the alleged harm, because their redemption rights were impaired and (ii) the shareholders (not the corporation) would receive the benefit of any recovery.
The Court summarized its analysis as follows: “at bottom, the plaintiffs are not suing because [the SPAC] did not combine with MultiPlan on more favorable terms. They are suing because the defendants, purportedly for self-serving purposes, induced Class A stockholders to forgo the opportunity to convert their shares into a guaranteed” approximately $10 per share price. The Court also, in fairly summary fashion, rejected defendants’ arguments that the plaintiffs had brought claims based solely on a contractual right and that the plaintiffs had brought prohibited “holder” claims.
The Court next turned to the standard of review, agreeing with plaintiffs that the heightened “entire fairness” standard, and not the more deferential business judgment rule, applied. The Court found two independent reasons for this conclusion. First, the Court found it “reasonably conceivable” that the SPAC’s sponsor, as the SPAC’s controlling shareholder, had engaged in a “conflicted controller” transaction. The Court noted that the “merger had a value—sufficient to eschew redemption” to common stockholders only “if the shares of the post-merger entity were” worth $10 per share SPAC IPO price or greater. However, for the SPAC’s sponsor, a merger was “valuable well below” the $10 per share SPAC IPO price because its stock would be rendered worthless if a de-SPAC did not occur.
Notably, the Court rejected the defendants’ argument that the “promote” could not trigger entire fairness because “this ‘structural feature’ would appear in any de-SPAC transaction . . . .” (emphasis in original). The court stated that, although “this structure has been utilized by other SPACs, [that] does not cure it of conflicts.”
Second, the Court found it reasonably conceivable that a majority of the SPAC’s board was conflicted, because they were either (a) self-interested due to their ownership of “promote” shares or (b) lacking independence from the controlling shareholder due to, among other things, their appointment to multiple other SPAC boards by the sponsor, implying their desire to receive more such appointments in the future.
The Court then turned to the merits of the breach of fiduciary allegations under an entire fairness standard, which requires the defendants to demonstrate that the challenged act was entirely fair to the corporation as a matter of both “fair price” and “fair dealing.” As the Court noted, when entire fairness applies, “it is rare” for a court to reject a breach of fiduciary duty cause of action at the motion to dismiss stage.
While sustaining the claims in large measure3, the Court was careful to point out that it was not concluding plaintiffs’ claims were viable “simply because of the nature of the transaction or the resulting conflicts.” Instead, it found the plaintiffs had adequately alleged the defendants “failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights.” In reaching this conclusion, the Court described the SPAC’s disclosures as “unilateral and not counter-balanced by opposing points of view” and specifically cited the failure to disclose that MultiPlan’s largest customer was developing an in-house alternative to MultiPlan that would both eliminate its need for MultiPlan’s services and make it a competitor.
- This decision suggests that allegations based on the “inherent conflicts” between holders of founder shares and public stockholders will be given meaningful consideration when a court evaluates whether to apply the “entire fairness” standard of review in Delaware. As noted above, the Court stated that, although a “promote” “has been utilized by other SPACS, [that] does not cure it of conflicts.” And, once entire fairness applies, it is rare for court to grant a motion to dismiss. Thus—at least where a SPAC is incorporated in Delaware—the private plaintiffs’ bar will likely view the Delaware courts as a more favorable forum than federal courts for bringing claims following this case.
- However, the Court also noted that, while “many of the features” it considered in its opinion were “common to SPACs,” some SPACs “have more bespoke structures intended to address conflicts,” leaving opening the possibility that, in other deals, the parties could implement appropriate (albeit unspecified) measures to address the Court’s concerns about sponsor and director conflicts. In this regard, it also bears noting that the Court appeared particularly concerned that many of the SPAC directors were “beholden” to the SPAC’s sponsor due to numerous other SPAC appointments they received and presumably hoped to continue to receive.
- Moreover, the Court was careful to emphasize that its denial of the motion to dismiss rested on inadequate disclosures, not conflicts. It expressly did “not address the validity of a hypothetical claim where the disclosure is adequate and the allegations rest solely on the premise that the fiduciaries were necessarily interested given the SPAC’s structure.” Instead, it stressed that its “conclusions stem from the fact that a reasonably conceivable impairment of public stockholders’ redemption rights—in the form of materially misleading disclosures—has been pleaded in this case.”
- Further, the alleged omission here was about the near-term strategic plans of the target company’s biggest customer, presumably the type of issue that would have been a key aspect of the SPAC’s diligence of the target, making its omission seemingly fairly significant.
- As we have noted previously, SPACs must perform proper diligence (and targets themselves must know their business) so that the parties can disclose all required material nonpublic information to avoid a claim based on inadequate disclosure.
- We expect future litigation will seek to expand this opinion beyond its clear scope of a “fail[ure], disloyally, to disclose information” as the opinion “does not address the validity of a hypothetical claim where the disclosure is adequate”. Instead, future plaintiffs will likely pressure courts to rebut the business judgment rule in favor of entire fairness review based solely upon “inherent conflicts” in traditional SPAC structures. Existing SPACs and targets should therefore consider whether and how to address such a claim and scrutiny under the entire fairness standard. This may include scrutinizing director independence under Delaware standards as opposed to stock exchange standards, seeking fairness opinions, focusing on board process such as independent special committees with independent financial advisors and independent legal counsel, and other paths well-worn in traditional public mergers.
- We also anticipate courts will address the commonly held understanding that public stockholders of a SPAC, unlike those of traditional Delaware public corporations, receive fundamental and sufficient protections and disclosures due to other structural features of a SPAC—most importantly their redemption feature. On this basis, a court may hold that entire fairness review of a SPAC business combination would be unnecessary so long as these structural stockholder protections and appropriate disclosures are provided to the SPAC’s public stockholders.
- SPAC directors should pay particular attention to this line of cases, as disclosure claims based on a breach of the duty of loyalty might not be exculpated from liability.
- Directors and officers liability insurance for SPACs is already expensive compared to prior years and is difficult to obtain. Cases like this may further raise costs both for SPACs in their initial IPO, as well as for target companies purchasing tail policies for their SPAC partner’s directors.
 See, e.g.,
- SPAC Update: SEC Chair Calls on Staff to Bolster Enforcement Measures | Thought Leadership | Baker Botts;
- SEC Charges Parties to SPAC Combination for Misleading Disclosures and Due Diligence Failures | Thought Leadership | Baker Botts;
- SPAC Update: Congress's Proposal to Eliminate Forward-Looking Statement Safe Harbor for SPACs | Thought Leadership | Baker Botts;
- SPAC Litigation and Enforcement Update: Spring 2021 | Thought Leadership | Baker Botts;
- SPACs to the Future: What Types of Litigation May Arise for SPACs and SPAC Targets? | Thought Leadership | Baker Botts
 845 A.2d 1031 (Del. 2004).
 The Court dismissed direct claims against one SPAC officer based on the Complaint’s failure to make specific enough allegations about his role.
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