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.1 Until 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.
In re Multiplan arose out of Churchill Capital Corporation III’s (CCIII’s) 2020 acquisition of MultiPlan Corp. CCIII had gone public as a SPAC via a February 2020 IPO and had a capital structure akin to many SPACs. Among other things
- Its initial common stockholders received one Class A share (plus a fractional warrant) for $10 per unit. If the CCIII identified a target for an acquisition, a shareholder could either vote to approve the transaction or exercise a right to redeem their shares at the $10 price plus interest. If an acquisition did not close within 24 months of the SPAC IPO, the common stockholder would receive back the full value of their investment
- CCIII’s sponsors, however, received “founder” (or Class B) shares, also known as a “promote,” constituting 20% of the CCCIII’s equity, for a nominal price. If the CCIII completed an acquisition, the founder shares would convert into common shares of the new company. However, if an acquisition was not completed, the SPAC would liquidate, rendering the founder shares worthless.
In July 2020, CCIII identified Multi-Plan as its target and approved a plan of merger. CCIII 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 CCIII 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 CCIII’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 CCIII 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).
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 [CCIII] 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 [CCIII] 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 ordinary business judgment rule, applied. The Court found two independent reasons for this conclusion. First, the Court found that CCIII’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 controlling shareholder, whose stock would be rendered worthless if a de-SPAC did not occur, a merger was “valuable well below” the $10 per share SPAC IPO price.
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 that a majority of CCIII’s board was conflicted, because they were self-interested or because the lack independence from the controlling shareholder, because ,among other things, they had been appointed to multiple other SPAC boards by him and, conceivably, hoped 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 dismiss a breach of fiduciary duty cause of action for failure to state a claim.
While sustaining the claims in large measure,3 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 CCIII’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.
III. Takeaways and What’s Next
- This decision suggests that allegations based on the conflicts of interest between holders of founder shares and common stockholders will make it much easier to trigger 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.
- 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 CCIII directors were “beholden” to the controlling shareholder, because he had appointed them as directors of numerous other SPACs and they presumably hoped to continue to be appointed by him as SPAC directors.
- Moreover, the Court was careful to emphasize that its denial of the motion 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.
1 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
2 845 A.2d 1031 (Del. 2004).
3 The Court dismissed direct claims against one CCIII officer based on the Complaint’s failure to make specific enough allegations about his role.
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