Chancery Applies Traditional Fiduciary Principles to a SPAC in First Test of the Popular Vehicle for Private Companies to Access Public Markets under Delaware Corporate Law
A Special Purpose Acquisition Company or SPAC is a popular investment vehicle to take private companies public. A SPAC, commonly referred to as a blank check company, is a company whose stock is traded on a public market, but has no operations. Typically, the SPAC raises capital through an IPO with the singular goal of entering into a business combination with a private operating company (referred to as a de-SPAC merger), taking the private company public and giving the new public company its stock listing. A SPAC is often formed and controlled by a sponsor, whose primary job is to identify a target private operating company for the de-SPAC merger. A common feature of a SPAC is that the sponsor receives founder shares in the SPAC for a nominal capital contribution, which shares convert to substantial common shares in the new public company if a business combination with a private company is consummated within the market-standard, two-year period from the IPO. However, if no such transaction is completed within two years, the IPO proceeds are returned with interest to the public stockholders, and the SPAC winds up and liquidates, which renders worthless the sponsor’s founder shares. While these features and structure are common in SPACs, and the attendant mismatched financial incentives between the sponsor and the public stockholders in a de-SPAC merger are known to SPAC investors, this does not remedy the conflicts of interest inherent in the SPAC structure. Moreover, that a de-SPAC merger may legally comply with the DGCL does not shield the merger from application of well-established equitable fiduciary principles of Delaware corporate law.
In re MultiPlan Corp. Stockholders Litigation, No. 2021-0300-LWW, --- A.3d ---- (Del. Ch. Jan. 3, 2022), the Court of Chancery applied entire fairness review and held that the plaintiff stockholders had stated legally-sufficient “non-exculpated claims against the controlling stockholder and directors” of Churchill Capital Corp. III, a SPAC, in connection with its de-SPAC merger with a private operating company. In denying defendants’ motion to dismiss, the Court found that the plaintiffs had adequately pled that the “director defendants failed, disloyally, to disclose information necessary for plaintiffs to knowledgeably exercise their redemption rights”, in lieu of maintaining their shares in the new public company, in the proxy statement, and that the role of the controlling stockholder Sponsor, which caused the SPAC to enter into the merger, “in the alleged impairment of the stockholders’ redemption rights [could] not be resolved at the pleadings stage.”
By way of background, to raise capital for a de-SPAC merger with a private operating company, the SPAC conducted an IPO sponsored by a management group led by former Citigroup executive Michael Klein, who had a long track record of sponsoring SPACs. Klein through his control of the SPAC’s Sponsor was a controlling stockholder of the SPAC with exclusive power to appoint and remove its directors. The Sponsor selected the private operating company, MultiPlan, Inc., as its merger target. The SPAC issued a proxy to solicit stockholder votes to approve the proposed de-SPAC merger and informed stockholders of their redemption rights. Few stockholders exercised their redemption rights and the merger was approved. After the merger closed, however, the share price of the common shares in the new public company declined several dollars below the $10 plus interest that the stockholders would have received had they instead exercised their right to redeem their shares in the SPAC before the merger closed. The plaintiff stockholders claim that the SPAC’s proxy failed to disclose that MultiPlan's largest customer UnitedHealth was creating an in-house data analytics platform that would result in the transfer of key accounts from MultiPlan to UnitedHealth (and a potential loss of approximately 35% of revenues to MultiPlan) by the end of 2022.
In concluding that the controlling stockholder and the directors received a unique benefit in the de-SPAC merger not shared with the public stockholders, the Court relied in part on the conflicts inherent in the structure and features of the SPAC. As is common in a SPAC’s structure, the SPAC Sponsor received "founder shares" in return for a nominal capital contribution, which shares amounted to 20% of the SPAC’s equity as compensation for identifying a business combination within two years. If a business combination with a private company was consummated within the two-year period, these founder shares converted to substantial common shares in the new public company. But if a business combination was not completed within two years, the SPAC would wind up and liquidate, rendering worthless the Sponsor’s founder shares. In contrast, the public stockholders of the SPAC would receive the full value of their shares in the SPAC plus interest if a business combination was not completed within the two-year period. Hence, as opposed to no deal, which would return the full value of their investment to the public stockholders, even a bad deal that resulted in losses to the public stockholders from their initial investment in the IPO, would nevertheless result in “pure upside” to the Sponsor in the converted value of its founder shares to common shares in the new public company.
Because the directors also held founder shares, the board’s interests were aligned with the Sponsor, as they similarly benefited financially with the Sponsor if a merger was completed. The Court also found that the directors were conflicted due to their receipt of compensation in stock of the Sponsor, which compensation would disappear if they were removed from the board by the Sponsor. Further, the directors were allegedly beholden to the Sponsor because of their potential opportunity to benefit financially from their participation in other SPAC transactions with the Sponsor.
To safeguard the value of their investment in the SPAC from a bad deal, a key feature of the SPAC was the right of public stockholders in the SPAC to choose between either redeeming their shares in the SPAC, or maintaining their shares in the new public company after a target private operating company was identified by the Sponsor. The plaintiff stockholders allege that the SPAC’s controlling stockholder and directors were motivated by financial incentives not shared by the public stockholders to disloyally withhold material information in the proxy that impaired the stockholders’ ability to make an informed decision to exercise their redemption rights before the merger closed.
While the Court relied in part on conflicts of interest between the Sponsor, directors, and the public stockholders, the Court pointed out that the “mismatched incentives relevant here were known to public stockholders who chose to invest in the SPAC.” Accordingly, the Court emphasized that the conflicts of interest inherent in the structure of the SPAC and the features of a de-SPAC merger alone were not the key to its decision to uphold the plaintiffs’ claims, but rather that the stockholders were “robbed of their right to make a fully informed decision about whether to redeem their shares,” and that the board itself was not independent and instead, beholden financially to the Sponsor. Indeed, the Court aptly noted the possibility of a different outcome “where the disclosure is adequate and the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure.”
In sum, to potentially avoid a MultiPlan challenge to a SPAC transaction, practioners should first ensure that the proxy makes full and complete disclosure of all material information in the de-SPAC merger. Second, to avoid board conflicts, a SPAC’s directors would be better served to receive compensation for their service, such as, for example, common shares in the SPAC, which aligns the board’s interests with the interests of the public stockholders in maximizing the value of the common shares in a de-SPAC merger. Finally, the SPAC’s directors should be independent and not beholden with financial ties to the Sponsor.Share