Delaware Court of Chancery Applies Entire Fairness Review in Novel SPAC Lawsuit
A year ago, as the SPAC wave continued to build, we wrote that lawsuits challenging de-SPAC transactions would likely pose a question that had thus far received little attention from courts or commentators: is a de-SPAC transaction subject to entire fairness scrutiny under Delaware law? On January 3, 2022, the Delaware Court of Chancery reached this question for the first time in In re MultiPlan Corp. Stockholder Litigation, albeit under specific facts.1
The Court denied a SPAC sponsor and directors’ motion to dismiss claims that they breached their fiduciary duties by entering an unfavorable conflicted transaction and impairing through misleading disclosures stockholders’ decision whether to redeem their shares in advance of the transaction. In so ruling, the Court applied entire fairness review on the basis that (i) defendants’ founder shares provided a “unique benefit” to entering the transaction not shared by other stockholders, and (ii) the stockholders’ redemption rights did not provide sufficient protection to avoid entire fairness review due to misleading disclosures that prevented stockholders from making an informed redemption decision. The opinion underscores the importance of adequate disclosures and the careful consideration by the SPAC of potential conflicts. However, it does not change our prior assessment that a lawsuit challenging a standard de-SPAC transaction based on supposed conflicts posed by founder shares should be subject to dismissal, assuming adequate disclosure.
In re MultiPlan involves Churchill Capital Corp. (“Churchill”), a SPAC that went public in February 2020 and then acquired MultiPlan Corp. in October 2020. Like most SPACs, its sponsor, led by Michael Klein, received founder shares constituting 20% of the SPAC’s equity that were purchased for a nominal price. Also consistent with the general SPAC structure, each Class A stockholder in Churchill had the right to redeem their Class A shares for roughly the same $10 per share that they initially paid for the units (comprised of a share and a fraction of a warrant) in the initial public offering, rather than retain those shares in the post-transaction entity. Churchill’s charter required the redemption right be made available to stockholders in connection with the vote on the transaction. Few stockholders redeemed, and the transaction was overwhelmingly approved.
A month after the transaction closed, MutiPlan’s stock fell 40% upon reports that its largest customer, UnitedHealthcare, was launching a rival platform and would effectively terminate its business with MultiPlan by the end of 2022. The MultiPlan plaintiffs then filed a class action alleging that the SPAC’s sponsor and directors breached their fiduciary duties by approving the acquisition of MultiPlan and issuing a misleading proxy that failed to disclose the imminent problem of UnitedHealthcare’s new data platform, depriving stockholders of their right to a fully informed decision on whether to redeem their shares. The harm alleged was the difference between the value of the stockholders’ redemption right and the value of their post-transaction shares once the misleading disclosures were uncovered. The plaintiffs also argued that these claims should be evaluated under the entire fairness standard, because the defendants’ founder shares posed a material conflict in entering the transaction: specifically, whereas other stockholders would simply receive ~$10 per share if the SPAC failed to acquire a target within the allotted two years, the founder shares (worth roughly $305 million if a deal closed) would become worthless, thus incentivizing the sponsor and directors to acquire a target even on unfavorable terms.
The Court began by rejecting defendants’ argument that plaintiffs were asserting an “overpayment” claim that could only be brought derivatively on behalf of Churchill – which would have created substantial procedural obstacles for plaintiffs.2 The Court reasoned that the redemption right was held personally by stockholders, and alleged interference with that right could therefore be asserted directly by a class of stockholders.3
The Court then determined that the entire fairness standard applied to these direct claims “because of the nature of the transaction [and] resulting conflicts” and because of adequate allegations “that the director defendants failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights.”4 With respect to the nature of the transaction and resulting conflicts, the Court held that entire fairness applies when a controlling stockholder “competes with common stockholders” for consideration, through receiving “a ‘unique benefit’ by extracting something uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders” to the detriment of other stockholders.5 The Court concluded that Klein was a controlling stockholder whose founder shares provided a “unique benefit.”6 Even though the founder shares converted into the same consideration received by other stockholders, the Court found a “misalignment of interests”: whereas other stockholders would benefit from a transaction only if it exceeded the redemption value, the founder shares would be “worthless if Churchill did not complete a deal,” incentivizing the sponsor to complete a transaction even if at a lower value than the redemption amount.7 The Court also found adequate allegations that a majority of the Churchill board was not independent with respect to the transaction. It noted that each of the directors (other than Michael Klein’s brother, Mark) received over $3 million in founder shares, which the Court could not conclude was immaterial as a matter of law, and was found to pose the same type of conflict as it did for the sponsor. Further, a majority of the directors lacked independence from Klein due to personal and/or professional ties, including that several directors had served on the boards of at least five other SPACs sponsored by Klein.
In concluding that entire fairness applied, the Court rejected a number of arguments by defendants that were anticipated in a SPAC entire-fairness challenge. First, and most importantly, defendants argued that their economic incentives and founder shares could not be a basis for applying entire fairness because they were all disclosed to stockholders before they invested in the SPAC and were a “structural feature” that would have applied to any transaction.8 But the Court responded that stockholders “did not, however, agree that they did not require all material information when the time came to make that [redemption] choice.”9 That response highlights an important limitation to the Court’s ruling: it is premised on the finding of a materially misleading proxy. The Court explained that the argument that stockholders knowingly signed up for this economic incentive structure “might be persuasive if it had been made about the Proxy and the plaintiffs had opted not to redeem despite adequate disclosures.”10 Thus, the opinion “does 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.”11 Second, the Court reasoned that a “lock-up” period and “unvestment” for a substantial portion of the founder shares did not remove the conflict posed by founder shares.12 Third, the Court rejected the argument that defendants had no incentive to enter an unfavorable transaction because 19 months remained in the two-year window to complete a transaction, meaning they could have just pursued another transaction.
While the MultiPlan opinion is an important development, those dealing with SPACs should recognize its circumscribed scope and consider how best to guard against litigation risk in this rapidly evolving landscape.
- As noted above, the Court took pains to explain it was not concluding that all SPACs with typical economic and governance structures would be subject to claims surviving dismissal under entire fairness review. Rather, the Court’s decision hinged on adequate allegations that defendants disloyally withheld material information from the SPAC’s proxy statement. Without expressly citing the Corwin line of cases, the Court suggested that proper disclosures by a SPAC could defeat a claim regarding redemption rights, just as under Corwin an informed shareholder vote on a traditional merger can “cleanse” certain conflicts and defeat most lawsuits.13 As we argued in our prior article, the redemption right provides an important structural protection for stockholders that can serve as a powerful argument against entire fairness review. But the Court concluded that depends on an informed redemption decision. Thus, the MultiPlan opinion heightens the importance of the already critical issue of ensuring accurate and sufficient disclosures by the SPAC.
- While much of the Court’s analysis would seemingly apply to any SPAC with the typical structure, the outcome may have been driven partly by allegations of some extreme facts not present for most SPACs. For example, Churchill hired a financial advisor that was a wholly owned subsidiary of the sponsor and received $30 million for its services. And the SPAC’s board was made up of the sponsor’s controller, Klein’s brother, his employee, and multiple other directors who had served on at least five other Churchill SPAC boards, standing to make millions of dollars in the process. These additional facts could provide daylight for later courts to distinguish MultiPlan from other SPAC cases. It should also cause SPACs and their sponsors to consider the incentive structures provided to their directors, including the amount of founder shares received and the number of times they are asked to serve on related SPAC boards. Arguing that the SPAC structure does not inherently pose a material conflict may prove easier when additional alleged conflicts cannot be piled onto them.
1 C.A. No. 2021-0300-LWW, 2022 WL 24060 (Del. Ch. Jan 3, 2022) (Will, V.C.)
2 In re MultiPlan, 2022 WL 24060, at *9.
3 The Court also rejected defendants’ arguments that: (1) plaintiffs’ claims regarding redemption were governed by contract (specifically, Churchill’s charter) and could not be brought as fiduciary duty claims; and (2) plaintiff was asserting “holder” claims – i.e., claims based on a decision to hold stock, rather than sell it. Id. at *13-16. The Court held that this was not a “holder” claim because “the stockholders could only redeem if they voted (either for or against) the merger.” Id. at *15.
4 Id. at *22.
5 Id. at *17 (quoting IRA Tr. FBO Bobbie Ahmed v. Crane, 2017 WL 7053964, at *6 (Del. Ch. Dec. 11, 2017, revised Jan. 26, 2018)).
6 Id. at *18.
7 Id. at *17.
8 Id. at *19.
12 Id. at *18.
13 Corwin v. KKR Financial Holdings LLC. 125 A.3d 304 (Del. 2015).
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.