06 January 2022

New School SPAC Subject to Old School Rules: Court of Chancery Rejects SPAC Sponsor’s Motion to Dismiss

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We previously wrote about the MultiPlan Corp. SPAC litigation relating to the de-SPAC merger of Churchill Capital Corp. III (“Churchill”) and its target, MultiPlan Corp.  On January 3, the Delaware Court of Chancery issued its long-anticipated decision on the defendants’ motion to dismiss—the first dispositive motion to be briefed and decided in the Delaware courts in the wave of recent SPAC litigation.  Below we highlight some key takeaways.

Background

In relevant part, the MultiPlan complaint alleged that Michael Klein, Churchill’s controlling shareholder, received “founder” shares constituting 20% of the SPAC equity, which he purchased for a nominal price.  Klein’s founder shares would convert into common shares upon completion of a de-SPAC transaction but, if no transaction materialized, the SPAC would liquidate, leaving the founder shares without value.  The complaint also alleged that members of Churchill’s Board of Directors, including Klein’s brother and a close business associate, were handpicked by Klein and received economic interests in the founder shares without diluting Klein’s control of Churchill.  Churchill also hired The Klein Group LLC (where Klein is the managing member/majority partner) as a financial advisor in connection with the merger; the Klein Group was paid $30.5 million for its services.  Finally, the complaint alleged that the Board failed to perform adequate diligence in proposing MultiPlan as the de-SPAC target company and that the proxy contained material misstatements and omissions (i.e., allegedly concealing the imminent departure of MultiPlan’s largest client, which accounted for 35% of its revenues in 2019).  Premised on these key facts, the complaint asserted various claims for breach of fiduciary duty.  In MultiPlan’s motion to dismiss, the defendants argued that the business judgment rule applied to their actions concerning the de-SPAC transaction and, therefore, shielded those actions from judicial review.

The Court’s Decision and Takeaways

As an initial matter, Vice Chancellor Will confirmed that “well-worn fiduciary principles” would be applied to plaintiffs’ claims, even though they pertained to the “novel” and nontraditional nature of a de-SPAC transaction.  The Court signaled that despite their unique structure, on certain matters SPAC parties will need to engage with traditional corporate law standards applicable to Delaware fiduciaries.

In largely rejecting defendants’ dismissal arguments, the Court applied the generous “reasonably conceivable” standard that governs a motion to dismiss and agreed that the entire fairness standard applied because (1) the de-SPAC transaction, including the opportunity for stockholders to redeem, was both a conflicted controller transaction and one in which stockholders were deprived of material information, and (2) a majority of the Board was conflicted because they were either self-interested due to their interest in the founder shares or lacked independence in some way from Klein.  As regular readers know, the entire fairness standard is Delaware’s “most onerous standard of review,” and shifts the burden to defendant fiduciaries “to demonstrate that the challenged act or transaction was entirely fair to the corporation and its stockholders.”  In doing so, defendants must prove that both the price of the transaction and the course of dealing (including structure, negotiations, disclosures, and timing) were fair.  The entire fairness inquiry is fact intensive—almost without exception resulting in the lawsuit surviving past the motion to dismiss phase.

As to the “conflicted controller transaction” aspect, the Court reiterated that the sponsor’s status as a controlling stockholder was insufficient, by itself, to trigger entire fairness.  A controller also must either “stand on both sides” of the deal or “compete with the common stockholders for consideration.”  Here, the Court held that the facts alleged suggested the sponsor/controller was obtaining a “unique benefit” to the detriment of the minority, in particular because the sponsor’s founder shares in this case offered an upside even in the event of a transaction that led to a decline in stock price—incentives that differed from those of other common stockholders.

The Court also held that a majority of the Board approving the transaction was interested due to their economic interest in the same class of founder shares.  A Board majority was also found to lack independence from Klein due to significant business and familial connections, including (1) familial relationships (the sponsor’s brother was a director), (2) professional relationships (another director was a managing director at a Klein-controlled company), and (3) service as a director on multiple Klein-sponsored SPAC boards, and receiving founders shares with each.

It should be noted that the Court acknowledged that some SPAC entities “have more bespoke structures intended to address conflicts,” implicitly rejecting plaintiffs’ contention that the very structure of SPAC transactions are “conflict-laden.”  The Court also highlighted that, in addition to plaintiffs’ varied conflict allegations, the MultiPlan plaintiffs pled viable disclosure claims, alleging that stockholders lacked material information necessary to fully evaluate their redemption right.  Specifically, plaintiffs alleged that a customer responsible for 35% of MultiPlan’s revenue was designing a product to compete with MultiPlan, obviating its need to be a MultiPlan customer and increasing future competition.

This disclosure-related finding played a critical role in MultiPlan because of a unique SPAC feature: the opportunity to redeem.  Unlike a traditional merger, where a stockholder is presented with a “deal or no deal” choice via a right to vote, a SPAC stockholder receives both a right to vote as well as a separate choice to (i) maintain his or her investment and own shares in the de-SPAC entity or (ii) redeem the shares for the initial investment value (usually, $10/share), plus interest earned (here, $10.04/share).  Some, including the defendants here, have argued that this feature—through which a stockholder affirmatively chooses to invest in the de-SPAC company or get his or her money back, separate from voting for or against the transaction—can limit liability for alleged breaches of fiduciary duties.  That argument failed in MultiPlan in large part due to the disclosure allegations—i.e., the Court found that the company’s stockholders assessing their redemption rights were not fully informed.  As the Court put it:

Critically, I note that the plaintiffs’ claims are viable not simply because of the nature of the transaction or resulting conflicts.  They are reasonably conceivable because the Complaint alleges that the director defendants failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights.  This conclusion 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.  The core, direct harm presented in this case concerns the impairment of stockholder redemption rights.  If public stockholders, in possession of all material information about the target, had chosen to invest rather than redeem, one can imagine a different outcome.

The extreme nature of the conflicts alleged in MultiPlan, where members of the Board as well as the financial advisor were closely linked to Klein, along with the allegations of substantial disclosure failures, likely means that this decision is not a bellwether of future SPAC cases.  It remains to be seen how a SPAC that has made adequate disclosures and/or implemented alternative “bespoke structures” to mitigate sponsor and/or director conflicts would fare when faced with litigation, and whether a SPAC stockholder’s redemption right will ultimately prove to be a substantial liability shield.