Even After Multiplan, Pleading Standards Still Have Teeth in SPAC Cases

In 2022, the Delaware Court of Chancery decided In re MultiPlan Corp. S’holders Litig., 268 A.3d 784 (Del. Ch. 2022) (“Multiplan”), a landmark case setting the legal framework for assessing claims that the directors of a Special Purpose Acquisition Company (“SPAC”) breached their fiduciary duties in connection with “de-SPAC” mergers. Given the popularity of de-SPAC mergers, in which the SPAC merges with a private target company and takes it public, the Delaware courts have been faced with a series of cases initiated by public stockholders who did not redeem their shares at the time of the merger but became unhappy when the post-merger public companies underperformed. The focus of those cases is the redemption right: whether stockholders in the SPAC were properly informed when they made the critical decision at the time of the merger to either redeem their shares or remain invested in the newly public company.

Since Multiplan, the Delaware Court of Chancery has applied entire fairness review to these claims. Entire fairness review, which requires defendants to show that both the process and the price were entirely fair, is fact-intensive in nature and often precludes dismissal at the pleadings stage. But not always.

In a recent opinion, White v. Hennessy, the Delaware Court of Chancery for the first time dismissed a complaint alleging breach of fiduciary duty claims similar to those in Multiplan. Vice Chancellor Will clarified that allegations that SPAC insiders were conflicted and the merged company’s stock fell below the $10 redemption price—facts common to nearly every de-SPAC that spawns a Multiplan claim—are not enough to survive a motion to dismiss. Even where entire fairness review applies, the plaintiff must still plead facts showing an impairment of the stockholders’ redemption rights.

The Facts. In late June 2020, a SPAC called Hennessy Capital Acquisition Corp. IV (“Hennessy”) identified Canoo (“Legacy Canoo”), a start-up electric vehicle company, as a potential target. In early December 2020, Hennessy issued a proxy statement recommending that its investors approve the merger with Legacy Canoo. The proxy disclosed that Legacy Canoo’s business model was based on three revenue streams, and discussed the analysis and opportunities supporting the model. The proxy also disclosed the potential conflicts inherent in the structure of the de-SPAC merger, including the issuance of founder shares and the relationships among the founder, directors, and officers of the SPAC. Just 0.03% of Hennessy’s public stockholders opted to redeem their shares before the merger closed, and 99.85% of Hennessy’s stockholders voting approved the merger, after which the post-merger company was renamed to Canoo Inc. (“New Canoo”).

Three months after the merger, in late March 2021, New Canoo’s board received a presentation on business strategy. During the presentation, Executive Chairman Tony Aquila—who had been appointed to that position in October 2020, before the merger—said that the company’s business strategy needed a “reboot,” including because he was skeptical of the engineering services business line that involved the sale of “core IP.” An outside consultant then presented an analysis of the company’s business, and recommended a move away from using a subscription business model for sales to consumers. Three days later, New Canoo held an earnings call during which Aquila announced that the board had decided to “deemphasize” the company’s subscription model and engineering services business lines. New Canoo’s stock dropped more than 21% after the earnings call, recovered for a time, but then began falling again in 2022.

The Litigation. In June 2022, a Hennessy investor brought a putative class action against the Hennessy officers and directors in the Delaware Court of Chancery, alleging that they had breached their fiduciary duties by failing to disclose that Legacy Canoo was changing its business model to deemphasize contract engineering services and the subscription model.

The court dismissed that complaint with prejudice, notwithstanding that the conflicts inherent in the SPAC structure and the relationships between the SPAC sponsor and the directors and officers triggered application of the entire fairness standard. As Vice Chancellor Will noted, “[e]ntire fairness is not . . . a free pass to trial” and Delaware pleading standards are not “relaxed” in a SPAC case. A plaintiff must still allege facts making it “reasonably conceivable” that the conflicted directors and officers deprived stockholders of “a fair chance to exercise their redemption rights.”

Specifically, the court concluded that the plaintiff failed to allege an impairment of his redemption right for two reasons. First, plaintiff’s theory that the decision to change Legacy Canoo’s business model had been made before the merger was contradicted by the board materials on which he relied and other public documents. Although plaintiff relied on the March 2021 board presentation’s use of the past tense to allege that changes to the company’s business model had already been made by that time, the presentation did not say that any decision had been made months earlier before the merger closed. And other materials showed that the decision to change the business model was made after the merger, under the direction and advice of new leadership and the new board.

Second, even if a decision had been made to change the business model before the merger, plaintiff failed to allege any facts showing that this information was known or knowable to the SPAC officers and directors. As Vice Chancellor Will commented, the notion that the SPAC defendants “must have known” about a “target’s nascent internal analysis is strained,” as compared to “the sort of knowable facts that faithless fiduciaries purportedly failed to uncover in prior [SPAC] decisions” like Multiplan. And, of course, the defendants could not have breached a duty to disclose information that was unknown to them.

Since Multiplan established that entire fairness review applies to claims alleging breach of fiduciary duty in de-SPAC mergers, dozens of cases in its mold have been filed. And, to date, the application of entire fairness review has allowed those cases to proceed into costly discovery, even on threadbare allegations of a disclosure violation, emboldening the plaintiffs’ bar to pursue these claims on the assumption that allegations of an inherently-conflicted SPAC structure, some nebulous flaw in the proxy statement, and poor performance post-closing will be sufficient to withstand a motion to dismiss. The Hennessy decision is the first to deviate from that pattern.

Although too soon to tell, the Hennessy decision may signal a shift in the Delaware Court of Chancery’s receptiveness to Multiplan-style allegations. Certainly, Vice Chancellor Will was clear that the application of entire fairness review is not a free pass for plaintiffs to fall short of the ordinary Delaware pleading standards. Even in this context, if stockholders claim their redemption rights were impaired by a disclosure violation, they must plead facts showing that the SPAC directors and officers knew or should have known of material information that they failed to disclose before the merger. The reassertion of these fundamental pleading standards in the Hennessy decision may serve as an important check on the onslaught of SPAC cases.

Sidley represented the defendants in the Court of Chancery. Jim Ducayet, Heather Benzmiller Sultanian, and Thomas Collier led Sidley’s litigation team. Kevin Shannon of Potter Anderson & Corroon was local counsel.

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.