The recent Court of Chancery decision in Delman v. GigAcquisitions3 offers some interesting insights into the circumstances in which “entire fairness” review applies, and where “Corwin cleansing” can be used to achieve a lesser review standard.
The Delman plaintiff is an investor in a SPAC. For the uninitiated, a SPAC is an investment vehicle that exists solely to merge with a private company and take it public. A SPAC generally will have no more than two years to find a merger partner, after which it must return its capital to investors.
Delaware courts – both the Delman court and the court in a prior case called In re Multiplan – have expressed concern that the SPAC structure may create inherent conflicts of interest, given their view that the sponsors of the SPAC may be incentivized to agree to a merger – to monetize their own investment – even if the merger might not result in a positive return for public stockholders. To protect against this perceived conflict, SPAC investors are provided with a right to redeem their shares for full value plus interest once a merger partner is identified, and, given the timing of when the record date is set and when the redemption decision is made, may have a right to vote on the proposed merger regardless of whether they have chosen to redeem their shares.
In this case, the SPAC merged with an electrical vehicle company, which then missed revenue targets. The stock price declined and litigation predictably followed. On a motion to dismiss, the Court faced a number of thorny questions – for instance, whether the claim was derivative or direct, and whether it was an improper “holder claim.” But the primary question, or at least the most interesting question in this author’s view, was the applicable standard of review.
When a Court applies the “entire fairness” standard, it is very difficult for a defendant to prevail on a motion to dismiss. The Court’s inquiry is simply too fact-intensive. The entire fairness standard generally will be triggered when a (i) controlling stockholder engages in a (ii) conflicted transaction.
Here, the Court determined that entire fairness applied. Delaware courts normally are hesitant to put a “controlling stockholder” label on an entity with less than a 50% controlling interest. Nonetheless, even though the SPAC sponsor held less than a quarter of the SPAC’s voting power, the Court found that it was “reasonably conceivable” that the sponsor was a controller given that this particular sponsor “control[led] all aspects of the entity from its creation until the de-SPAC transaction.” The Court also found the requisite “conflict” because “the Sponsor’s interests diverged from public stockholders in the choice between a bad deal and liquidation,” and the “Sponsor had interest in minimizing redemptions after the merger agreement was signed.”
The Court then determined that this conflicted transaction could not be “cleansed,” under the decision in Corwin v. KKR Financial Holdings LLC., by showing that stockholders approved the merger in an informed and uncoerced manner. The Court held that the proxy was misleading – and therefore the vote was not “informed” – but also that the very nature of the SPAC structure was “inconsistent with the principles animating Corwin.” The Court took the view that, unlike typical merger votes, a SPAC stockholder vote “does not reflect its investors’ collective economic preferences” because investors can simultaneously divest themselves of an interest in the merged company, while at the same time voting in favor of the deal. In other words, according to the Delman court, “[p]ublic stockholders had no reason to vote against a bad deal because they could redeem,” and in fact were incentivized to vote in favor to preserve the value of certain warrants. The result, in the Court’s view, was that the “vote was of no real consequence,” and “its effect on the standard of review [was] equivalently meaningless.”
Certainly this won’t be the last word with respect to the feasibility of early motion practice in SPAC litigation, but the particular facts in this case resulted in a good ruling for plaintiff SPAC investors. The result was an entire fairness review and all that comes with it.
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.