With all the SPAC activity and scrutiny over the past few years, it was only a matter of time before Delaware courts had the opportunity to get involved in a SPAC shareholder dispute.
Early last year, in January 2022, Vice Chancellor Lori Will of the Delaware Court of Chancery issued a groundbreaking opinion in Litigation by shareholders of MultiPlan Corp which paved the way for SPAC shareholders to bring direct claims for breach of fiduciary duty against SPAC boards and sponsors.
Among the salient aspects of the decision, MultiPlan clarified that “well-worn fiduciary principles” under Delaware law will apply to Delaware SPAC board decisions (despite the fact that SPACs are not exactly the same as other Delaware corporations). There, the court denied a motion to dismiss applying traditional fiduciary principles, finding that the sponsor (because of its financial interest in the SPAC) and the board of directors (based on distorted personal interests) were in conflict and that the proceeding was defective for lack of independent financial advice or of fair opinion.
The MultiPlan The ruling also turned heavily on what the court found to be misleading disclosures that interfered with the ability of SPAC shareholders to decide whether to approve the merger or redeem their shares. Many practitioners and commentators attributed the decision to “bad facts making for bad law”, and that more attention to process and stronger discovery could help avoid the same result with future contested deals. (See our client alert “Court of Chancery Issues SPAC-Related Decision of First Impression” for more on MultiPlan.)
Flash forward a year, to January 2023, where Vice Chancellor Will had another opportunity to address the SPAC’s breach of fiduciary duty claims. IN Delman v. GigAcquisitions3the court overcame it earlier MultiPlan decision finding that the breach of fiduciary duty claims survived the motion to dismiss. Among the new rulings that make this a “must read” for anyone involved in SPACs or SPAC transactions are the court’s holdings that:
- A SPAC sponsor, even though it controlled less than 25% of the SPAC’s voting power, could be considered a controlling shareholder based solely on the structure of the SPAC;
- A SPAC buyout feature is “a bespoke sponsor’s self-interest check” and “the primary means of protecting shareholders from being forced to invest in a transaction they believe to be ill-conceived” (making disclosure related to the buyout option critical); and
- The Corwin the doctrine does not apply to SPAC mergers because the shareholders’ voting interests are separated from their economic interests as a result of the redemption feature.
GigCapital3, Inc. (Gig3 or company) — now Lightning eMotors, Inc. (New Lightning) — was a SPAC in Delaware. Gig3’s sponsor, GigAcquisitions3 (Sponsor), was issued “founder shares” for $25,000 (representing approximately 20% of Gig3’s post-IPO equity), which were non-redeemable, had no liquidation rights and were also subject to blocking. The company’s sponsor was controlled by accused and alleged “serial SPAC founder” Avi Katz. According to the court, Mr. Katz effectively managed Gig3 through Sponsor, including serving as executive chairman, secretary, president and chief executive officer. He also appointed the initial directors and officers of Gig3, which included his wife and four other directors who were affiliated with him and other Gig3 entities.
Following the IPO, the officer and directors of Gig3 identified Lightning eMotors Inc. (Old Lightning), a manufacturer of electric vehicles, as the target of the merger. Mr. Katz and his wife “dominated” the Company’s negotiations with Old Lightning. According to the court, Nomura and Oppenheimer, Gig3’s IPO bookrunners, were also hired to serve as financial advisors to Gig3, but were not asked to provide an opinion on the fairness of the merger.
The Company issued a press release in connection with the Gig3 stockholder vote on the merger, which also contained disclosures regarding stockholder redemption rights. Approximately 98% of shareholders voted for the merger and 28% for the buyout.
After the shutdown, New Lightning saw its stock price crater, and litigation ensued. The defendants’ motion to dismiss those claims was denied.
Key aspects of the motion to reject the solution
- Sponsor-controller and overall fairness. The court held that the plaintiff had alleged facts supporting two independent bases for review of the merger under complete fairness.
- Sponsor-controller. The court held that the de-SPAC merger with Old Lightning was a conflicting controller transaction. Although the Sponsor held less than 25% of the stock and voting power of Gig3 prior to the merger, the court found that the Sponsor controlled Gig3 because, as is typical of SPAC sponsors, it controlled all aspects of the Company from inception to de-SPAC. merging. Moreover, the court found that the sponsor was in a conflict because the SPAC’s economic structure allowed the sponsor to extract unique value at the expense of public shareholders in two ways: (i) the sponsor’s interest deviated from that of public shareholders in choosing between a “bad deal” and liquidation, and (ii) the Sponsor had an interest in minimizing post-merger redemptions because the merger was conditioned on Gig3 contributing $150 million in cash, of which $50 million had to come from a trust account. “By minimizing the buyout, the Sponsor reduced the risk that the merger would fail and increased the value of the Sponsor’s interest if it closed,” the court stated.
- Conflict panel. Most of the board members were not disinterested or independent, the court concluded. Mr. Katz, through his ownership and control of the Sponsor, was found to have a material conflict based on the 155,900% return on the initial investment of $25,000, and his wife (also a director) shared those interests. The court also concluded that it was reasonably conceivable that the remaining directors, who held “multiple positions within Katz’s GigCapital Global business entities,” were not independent of Mr. Katz.
- Right of redemption. The court attached great importance to the right of redemption, reasoning that “[t]The right of redemption is the primary means of protecting shareholders from being forced to invest in a transaction they believe is ill-conceived. It is a customized check of the sponsor’s self-interest, which is inherent in the SPAC’s governance structure. It follows that SPAC fiduciaries must ensure that this right is effective, including disclosing ‘full and fair all material information’ reasonably available about the merger and the target to inform the buyout decision.” Here, the plaintiff argued that the defendants acted disloyally, impeding the shareholders’ ability to exercise that important right of redemption.
- The Corwin doctrine. The court refused a Corwin defense, not only because there were well-cited disclosure deficiencies, but also “because Gig3’s shareholder voting structure is contrary to the principles that encourage Corwin.” According to the court, “[u]like a typical merger or acquisition,” “a shareholder vote on a de-SPAC merger could not reflect the collective economic preferences of its investors” because the shareholders’ voting interests were separate from their economic interests. However, in a note, the court noted that if the SPAC’s voting structure changes and the voting and economic interests are “re-merged” (so that shareholders cannot redeem if they did not vote against the de-SPAC merger), Corwin could be available.
- Additional fairness concerns. The court also addressed issues related to discovery and process.
- Disclosure issues. The court explained that “compliance with the duty of disclosure is included in the fair dealing aspect” of the entire fairness analysis. The court found that the proxy had two major disclosure deficiencies: the proxy (i) misstated the cash per share that Gig3 would invest in the combined company; and (ii) omitted the true value that Gig3 and its non-redeeming stockholders would receive in exchange as part of the merger.
- Disadvantages of the process. Among other points, the court noted the alleged (i) lack of fair dealing due to Mr. Katz and his wife managing the merger negotiations, (ii) lopsided motivations for Nomura and Oppenheimer, who had large stakes in private placements that would have worthless and $8 million in contingent consideration that would not be paid if the deal did not close; and (iii) the board’s failure to obtain a fairness opinion or even an informal financial presentation on the fairness of the transaction. The court also held that unfair pricing could be inferred from the allegation that Gig3 shareholders were left with New Lightning shares worth far less than the $10 per share purchase price. The court held that at the pleading stage, all of this constituted an overall fairness claim that allowed the case to move forward to trial.
To take away
It is important to remember that, as MultiPlan, Gig3 was a decision at the pleading stage in which the court is obliged to accept the allegations of the plaintiff as true. Moreover, the Delaware Supreme Court has not yet had an opportunity to rule on the issues addressed by either MultiPlan or Gig3. It is said, Gig3The legal analysis clearly illustrates the court’s skepticism about the current SPAC structure that prompted some of its new rulings.
- The court held that a SPAC sponsor without a 50% ownership interest is still considered a controlling shareholder because it controlled all aspects of the SPAC from creation to de-SPAC merger, as is typical of a SPAC transaction. This suggests that a Delaware de-SPAC transaction could potentially be subject to a full fairness review for this reason alone.
- The court also noted in the note that, similar to in Corwin “separation” analysis, MFW it was also “ineligible” for SPAC purposes. Therefore, the fundamental Delaware doctrines that normally apply to allow transactions to review business judgment may not be available in SPAC transactions that use a typical SPAC structure. (See our article “Corwin, MFW and Beyond: Developing Trends in Delaware Disclosure Law” for more on these two cases.)
- Many aspects of thinking in Gig3 they appear to have been driven by the fact that the board was not independent of the SPAC sponsor. Gig3 therefore emphasizes the need for SPACs to have independent directors, and for such directors to thoroughly evaluate each potential SPAC target, with advice from non-conflicted advisors.
- As with MultiPlan, Gig3 points out that appropriate proxy disclosures remain paramount.