Contractarian Principles Carry the Day in De-SPAC Merger Dispute

As previously covered in this blog, the recent increase in litigation arising out of de-SPAC mergers has left some open questions as to how courts will apply traditional legal principles to the unique SPAC structure. The Delaware Court of Chancery, for example, stated in Lordstown Motors that SPAC litigation “raises emerging issues of Delaware law,” while at the same time cautioning in MultiPlan that “well-worn fiduciary principles” generally apply to claims for breach of fiduciary duty in a de-SPAC merger. There understandably is some uncertainty in this space — particularly given the recent stipulation of settlement filed in the MultiPlan litigation, which some commentators had hoped would provide further insights. Thankfully, the Delaware Court of Chancery has recently provided some potentially helpful guidance in the ongoing P3 Health Group Holdings litigation. There, Vice Chancellor Laster addressed claims for breach of a limited liability company agreement related to a de-SPAC merger. In granting in part and denying in part defendants’ motion to dismiss, the Vice Chancellor provided some clarity on how to assess the nature of the pre- and post-de-SPAC merger entities, and in doing so adhered closely to standard principles of Delaware contract law.

In the P3 litigation, stockholder plaintiff Hudson Vegas Investment SPV, LLC (“Hudson”) brought a series of claims against P3 Health Group Holdings (“P3” or the “Company”), P3’s controlling investor Chicago Pacific Founders Fund, L.P. (“Chicago Pacific”), and the parent entity of a SPAC, Foresight Acquisition Corp. (“Foresight”). Prior to the de-SPAC merger, P3 was a private LLC that had originally sought to go public through a combination with MyCare, a portfolio company of Chicago Pacific. The hang-up for this deal was P3’s LLC agreement, which required Hudson’s consent for any transaction with an affiliate of Chicago Pacific, which Hudson was not willing to provide. Undeterred, defendants crafted a workaround as follows: they would merge P3 with a subsidiary of Foresight, eliminate Hudson’s protective rights, and later have the new entity combine with MyCare.

Hudson brought a bevy of claims under several theories, including for breach of fiduciary duty, tortious interference, fraud, and breach of contract. (The court’s recent opinion, and therefore this post, only addresses Hudson’s breach of contract claims.)  At the outset, the Court of Chancery dismissed all of Hudson’s breach of contract claims against Foresight and Chicago Pacific. Foresight was not a party to P3’s LLC agreement, and its subsidiary (not Foresight) would assume the Company’s obligations as the surviving entity following the de-SPAC merger. Chicago Pacific was a party to the LLC agreement, but only as a member, and the court held it did not owe any of the obligations that Hudson sought to enforce.

That left Hudson’s breach of contract claims against the Company, brought under a variety of theories, some of which were dismissed and others sustained. Among other things, Hudson alleged that, following the de-SPAC merger, (i) it lost its right under the Company’s prior LLC agreement to appoint two members of the board, and (ii) the Company’s board shrank by two seats. The Chancery Court found these theories failed to state a claim because Delaware’s LLC Act allows parties to convert member interests through a merger and, once the de-SPAC merger became effective, the LLC agreement that contained Hudson’s right to designate board members “no longer existed.”  Further, Hudson had no explicit right under that agreement to designate board members in a post-merger entity. Regarding board size, the court explained that Hudson’s claims were misguided as they “focus[ed] on the wrong board,” i.e., the pre-merger board.

This analysis is particularly interesting, as the Court of Chancery noted that it previously had declined to grant a preliminary injunction against the de-SPAC merger, finding Hudson had not shown at that time a likelihood of success “on any claim that could not be addressed after closing.”  This seemingly put Hudson in a lose-lose situation regarding its ability to enforce its rights under the prior LLC Agreement.

The court, however, did find that Hudson had adequately pleaded many other breach of contract claims, largely based on a provision in the prior LLC agreement that required Hudson’s consent before the Company could engage in a transaction — or a “series of transactions” — with a Chicago Pacific affiliate. The “series of transactions” language was key for the court because it provided a contractual hook for the court to apply Hudson’s consent right in the now-extinguished LLC agreement to post-merger conduct, provided that the initial step began prior to the merger. Based on this consent provision, the court found that Hudson had adequately pleaded breach of contract claims under several theories, including for (i) the placement of three Chicago Pacific principals on the new company board, (ii) an anticipated future combination of the Company and MyCare (a Chicago Pacific affiliate), and (iii) a series of blocker transactions used in the merger that allowed Chicago Pacific to obtain favorable tax treatment.

It remains to be seen how the claims in P3 will unfold, but for now the Vice-Chancellor’s opinion highlights novel issues that de-SPAC mergers can present, particularly with assessing the obligations a company has to its shareholders both before and after a de-SPAC merger. As should be expected in Delaware, ordinary principles of contract interpretation govern review of an LLC agreement and, at least insofar as contractual claims are concerned, parties should not expect to be able to enforce rights post-merger that were not explicitly laid out in the prior LLC agreement. This last point bears emphasis, given the hesitancy of courts to enjoin pre-merger conduct, which may limit a party’s ability to enforce its rights.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.