On Jan. 4, 2023, the Court of Chancery added to Delaware’s developing common law around special purpose acquisition company (SPAC) transactions in Delman v. GigAcquisitions3, LLC, (Del. Ch. Jan. 4, 2023).
Just one year ago, Delaware courts released their first SPAC-related opinion in In re Multiplan Corp. Stockholders Litigation, (Del. Ch. Jan. 3, 2022), which we reported on in detail here. Since then, SPAC transactions have proven to be litigation magnets.
1. What are SPACs, and why are they important?
SPACs are publicly traded companies that raise money through an Initial public offering (IPO) in order to merge with a private company to take the private company public – a so-called “de-SPAC transaction.” SPACs have a management group called sponsors, but no operations. A SPAC’s only assets are IPO proceeds. SPAC sponsors typically receive founder’s shares equivalent to 20% of the SPAC’s post-IPO equity. SPACs must combine with a private company within a narrow window — usually two or three years — or risk liquidating and returning IPO proceeds to investors. If a SPAC liquidates, the sponsor’s founder’s shares are worthless.
Investors do not know the investment opportunity at the time of a SPAC IPO. Instead, SPAC shareholders must rely on the entity’s sponsor, officers, and directors to identify the ultimate merger target. To account for the lack of knowledge, SPAC shareholders have “redemption rights,” which allow them to reclaim their IPO investments before a merger if they choose to forego investing in the combined company.
SPACs surged in 2019, with 59 IPOs raising $13.6 billion. In 2020, 248 SPAC IPOs raised $83.4 billion. In 2021, 648 SPAC IPOs raised $172.3 billion. Observers anticipate most SPACs formed before 2021 must merge or liquidate by the first quarter of 2023.
For readers looking for a quick SPAC tutorial, look no further than Vice Chancellor Will’s opinion in Delman. The opinion’s opening is a five-page TED Talk on SPAC basics.
2. What fiduciary claim defenses have already been tried — and failed?
Delaware law is taking shape on shareholder lawsuits alleging breach of fiduciary duty in de-SPAC transactions. The key takeaways to date:
- Plaintiff’s fiduciary claims are direct and not derivative. At the pleading stage, plaintiffs have succeeded in showing that the sponsor’s allegedly disloyal conduct deprived SPAC shareholders of vital information needed to make a fully informed decision before exercising their “redemption rights.”
- Plaintiff’s fiduciary claims are not “holder claims.” In other words, SPAC shareholders have not been wrongfully induced to hold their stock instead of selling it. Rather, the alleged wrongdoing focuses on the shareholders’ decision to redeem their stock before the de-SPAC transaction.
- Plaintiff’s fiduciary claims are not contract claims. Typically, where a dispute arises from obligations governed by contract, fiduciary claims are foreclosed. But SPAC fiduciary claims are different. Those claims are grounded in the “investment decision” like “purchasing and tendering stock or making an appraisal election,” to which Delaware courts have applied the duty of disclosure.
What’s all that mean? At its core, it means plaintiffs are surviving motions to dismiss. There are no quick defense victories, and plaintiffs get access to discovery, documents, and depositions. SPAC defendants have to defend their actions on the merits. And that means significant defenses costs just to make it to summary judgment.
3. What happened in Delman to trigger this lawsuit?
GigAcquisitions3 (Gig3) was the sponsor. In May 2020, it completed its IPO, raising $200 million by selling 20 million units for $10/unit. Later in 2020, Gig3 identified Lightning eMotors, an electric vehicle manufacturer, as its merger target. Gig3’s proxy statement projected “dramatic growth” between 2020 and 2025. The proxy forecasted Lightning eMotors’ revenues to rise from $9 million to more than $2 billion and profits to grow from zero to $500 million.
In May 2021, Gig3 completed the de-SPAC transaction with Lightning eMotors. At the time the shareholder decided on their redemption rights, shares were trading at $10/share. Weeks after the merger closed, Lightning eMotors’ stock quickly plummeted to $7.82. Lightning eMotors subsequently announced significantly more modest revenue and profit forecasts. In August 2021, shares fell to $6.57/share. By January 2023, Gig3 shares were trading at just $0.41/share.
Short answer: Companies with overly aggressive forecasts that suffer stock drops of more than 95% in a matter of months are prime targets for lawsuits.
4. What new arguments did Gig3 make in support of its motion to dismiss?
Gig3 argued many of the same, failed defenses used by the defendants in Multiplan. The court again rejected Gig3’s arguments that the plaintiff’s claims were derivative, that they constituted “holder claims,” or that they were foreclosed by contract.
Gig3 made two new arguments in support of its motion to dismiss: ratification and exculpation. The court rejected both.
- Ratification/Corwin-cleansing: Gig3 argued that the shareholder vote approving the merger subjects the transaction to business-judgment review under Corwin v. KKR Financials Holdings. The court rejected this argument because the shareholders’ “voting interests were decoupled from their economic interest.” Gig3’s shareholders could both vote in favor of the merger and redeem their shares. The court noted that while 98% of Gig3’s shareholders voted in favor of the merger, 29% also redeemed their shares. As the court summarized: “Public stockholders had no reason to vote against a bad deal because they could redeem. . . . Because this vote was of no real consequence, its effect on the standard of review is equivalently meaningless.”
- Exculpation: Gig3 argued that its charter contained an exculpatory provision eliminating director liability for breaches of the duty of care. The court rejected this argument, finding the plaintiff’s claims against the board were “inextricably intertwined with issues of loyalty.”
5. What could Gig3 have done to better insulate itself from these claims?
Gig3 left itself exposed to claims of fiduciary duty breach on multiple fronts. Some of the steps Gig3 could have taken to better insulate itself include:
- Honest proxy statements: The obvious targets were the overly aggressive forecasts Gig3 published to persuade shareholders not to exercise their redemption rights. SPACs should give honest — perhaps conservative — forecasts of company performance in the proxy materials.
- Disinterested negotiators: The two individuals from the sponsor “who arguably stood to gain the most” directed the merger negotiations. SPACs should consider using lead negotiators who are disinterested and who do not stand to realize significant financial gains as a result of the transaction.
- Disinterested advisors: Two companies, Oppenheimer and Nomura Securities, acted as Gig3’s underwriters for the offering. The underwriters deferred two-thirds ($8 million) of their fees until the merger was approved. The court pointedly noted that the underwriters’ private placement shares and contingent compensation would be worthless if Gig3 failed to merge. SPACs should avoid incentivizing their advisors.
- Fairness opinion: Gig3’s board failed to obtain a fairness opinion. The court noted that Gig3 did not obtain “even an informal presentation on the fairness of the transaction.” SPACs should retain an investment banking firm that is not conflicted to evaluate the merger consideration’s fairness.
- Merger vote: Gig3 allowed shareholders to both redeem their shares and vote in favor of the merger. This caused a “decoupling” of shareholder interests that made the vote to be illusory. SPACs should structure the vote to equate a shareholder’s redemption with a vote against the merger.
The Delaware Court of Chancery’s docket is packed with additional SPAC lawsuits. We will report on further developments as warranted.
Reminder: Taft’s 2022 year-end M&A Litigation webinar
Taft’s M&A Litigation team hosted a CLE on Dec. 14, 2022, to discuss some of 2022’s most significant M&A developments. A recording of the webinar plus the program materials can be accessed here.