Delaware Chancery Court Issues First SPAC Decision

In a much-anticipated decision, the Delaware Court of Chancery issued its first opinion involving shareholder challenges to de-SPAC transactions. [1] The court largely denied defendants’ motions to dismiss the complaint, which stemmed from the October 2020 $11 billion de-SPAC transaction between prolific SPAC creator Michael Klein’s Churchill Capital Corp. III (Churchill) and its target (MultiPlan), holding that plaintiffs’ direct claims for breach of fiduciary duty against Mr. Klein and Churchill’s board of directors could go forward.  According to the court, plaintiffs adequately pleaded that (i) Churchill’s proxy statement was materially misleading because it failed to disclose that one of MultiPlan’s key customers was developing a competing platform of its own, (ii) this omission implicated the duty of loyalty and candor to which exculpation did not apply, and (iii) given allegedly conflicting interests, the burden was on defendants to show that the transaction was entirely fair for purposes of a motion to dismiss.  

The decision breaks new ground for SPACs and fiduciary duty analysis, raising several questions about the reach of its holdings, the potential scope of liability of directors and officers of SPACs organized under Delaware law, and best practices going forward, all of which will likely give rise to further litigation. 

Key Holdings

• Not Derivative Claims.  The court rejected defendants’ argument that these were overpayment or dilution claims that should be addressed derivatively.  It held instead that the SPAC’s stockholders suffered an independent harm not suffered by the SPAC because they “personally lost the opportunity” to recover the redemption price due to allegedly misleading proxy disclosures. [2]
  
  
• Not Contractual Claims. The court rejected defendants’ argument that plaintiffs’ claims were contractual in nature since the right to redeem was specified in Churchill’s charter, and thus could not give rise to a breach of fiduciary duty claim. According to the court, the charter did not speak to the breadth of required disclosures, but merely required that stockholders be given an opportunity to redeem. The crux of plaintiffs’ claims, the court observed, was that defendants impaired those redemption rights, not that they prevented stockholders from exercising them altogether.
  
  
• Not Holder Claims.  The court also rejected defendants’ argument that plaintiffs’ claims were barred “holder” claims, since their complaint essentially alleged that the shareholders were wrongfully induced to hold their stock instead of selling it.  Not so, said the court, because the decision whether to redeem was an active investment decision, not a passive retention of shares.
  
  
• Entire Fairness.  Applying “well-worn fiduciary principles” to the “novel” SPAC context, the court also held that plaintiffs had pleaded facts rebutting the presumption that the business judgment rule applied based on their allegations that the de-SPAC, including the opportunity to redeem, was a conflicted controller transaction and that a majority of the SPAC’s Board was self-interested or lacked independence from the controller. [3] Crediting those allegations as required on a motion to dismiss, entire fairness therefore applied at the pleadings stage, putting the burden on defendants to show that both the price paid and the process used in the transaction were fair.  
  
  
• Conflicted Controller.  The court held that the well-pleaded allegations of the complaint highlighted a benefit “unique” to Klein because (a) the merger was valuable to him as the SPAC sponsor (which had paid  a very low price for the founder shares) even if the SPAC’s share price fell well below the redemption price post-merger, whereas the common stockholders would realize a value only if those shares were worth at least the redemption price, and (b) because of his founder shares, Klein effectively competed with stockholders for the funds held in trust, which incentivized him to discourage redemptions in the event of a value-decreasing deal.  In so holding, the court rejected each of defendants’ countervailing arguments:
  
  
  • Lockup.  The fact that the sponsor shares were subject to an 18-month lockup and would “unvest” after a year or if the stock price did not hit certain targets undercut the claim that Klein was interested or would receive a windfall from doing “any” deal.  The court found that these features may have lowered the alleged windfall, but that it could not conclude they were sufficient to negate it at the motion to dismiss stage. [4]
    
    
  • Completion Window. Defendants would have pursued other deals if they believed the MultiPlan merger was value decreasing because Churchill had 19 months left in the completion window.  “Time left in the completion window,” said the court, “does not change the potential for misaligned incentives.” [5]
    
    
  • Prior Disclosure. That the founder shares were purchased for a modest sum and would expire worthless in the absence of a business combination was fully disclosed and known to plaintiffs before they invested in Churchill.  Per the court, that was not enough to grant dismissal because the SPAC’s stockholders “agreed to give the Sponsor an opportunity to look for a target,” not “that they did not require all material information.” [6]
    
    
  • Common Structural Features. The promote could not trigger entire fairness because that “structural feature” is common and would appear in “any de-SPAC transaction.”  The court gave this argument short shrift, noting that the widespread use of founder shares “does not cure it of conflicts.” [7]    

• Conflicted SPAC Directors.  Plaintiffs also adequately alleged that the SPAC’s directors were likewise conflicted because they allegedly would also benefit from virtually any merger—even one that was value diminishing.  Each director also allegedly had a personal or employment relationship with or received lucrative business opportunities from Klein, including service on the boards of certain of his other SPACs. [8]  
  
  
• Breach of Fiduciary Duty.  Applying these standards, the court held that the complaint adequately stated a non-exculpated claim for breach of fiduciary duty against Mr. Klein and the Churchill board sufficient to withstand a motion to dismiss because, while the Proxy disclosed that MultiPlan was dependent on a single customer for 35% of its revenues, it allegedly failed to disclose that that customer planned to develop an in-house platform that would compete with MultiPlan, a plan that had allegedly already been publicly disclosed before the shareholder vote. [9]

Takeaways and Open Questions

• The reach of the opinion is unclear.  The court eschewed the notion that its holdings would apply to all de-SPAC transactions, given their common features, and expressly stated that its decision “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.”[10]  But it also signaled that “some entities have more bespoke structures intended to address conflicts,”[11] suggesting that disclosure alone may be insufficient to insulate SPACs and their directors from potential liability.
  
  
• The precedential effect of the court’s entire fairness holding remains to be seen.  Because many of the relevant features of the Churchill SPAC’s structure are common to other SPACs, the court’s holding rested on characteristics and incentives that are frequently present in de-SPAC transactions.  It therefore raises the possibility that entire fairness could be applied with greater frequency to de-SPAC transactions at the motion to dismiss stage and, perhaps, beyond.  Alternatively, the decision also contains several caveats indicating that its holdings are intended to be read narrowly due to the particular disclosure allegations presented, though it leaves open how more robust disclosures could have altered its conflicts analysis.
  
  
• With respect to the conflicts allegations, potential strategic considerations for future de-SPACs include shifting the composition of compensation and incentives for board members and other stakeholders to predominantly cash or non-sponsor shares as opposed to founder shares or interests in the sponsor vehicle, as well as closer monitoring of director independence (i.e., not using overlapping directors if a sponsor has multiple SPACs).  Existing SPACs may also consider bringing in new directors and forming independent committees under Kahn v. M&F Worldwide Corp. [12] to review proposed de-SPACs.
  
  
• The case reiterates the importance of good, robust disclosure.  The decision raises questions about what disclosures are required in the de-SPAC context and what facts trigger a disclosure obligation, including whether it is effectively requiring disclosures beyond those that are “plainly material,” the threshold set forth in In re Trulia, Inc. S’holder Litig. [13] Until further clarity is provided, best practices continue to be the inclusion of robust disclosures and the performance of thorough diligence, especially with regard to material risks to the target’s business that could result in a post de-SPAC downturn, including any potential losses of major sources of revenue, key clients or partners, or substantial contracts.
  
  
• For SPACs organized in Delaware, the decision may incentivize the plaintiffs’ bar to bring more claims in Delaware Chancery Court, as opposed to securities law claims in federal court, given the lower pleading standard of reasonable conceivability under Delaware law and the significant difficulty of securing dismissal on the pleadings where entire fairness is adequately pleaded in the complaint as the governing standard of review.
  
  
• Because the court appeared to go out of its way to explain that its denial of defendants’ motions to dismiss rested primarily on the alleged disclosure violations rather than the structural features of the de-SPAC transaction alone, it may be that discovery into the latter should be limited or reserved until after targeted discovery on the disclosure issues can be conducted.  That could be important inasmuch as many de-SPAC challenges have heavily relied on short seller reports to support their disclosure claims.
  
  
• The holding that plaintiffs’ claims are direct relieves plaintiffs of the obligation of making a pre-suit demand or adequately pleading demand futility, which is a demanding standard to satisfy.  Given the potentially dispositive nature of this issue, we expect this to be a focal point in subsequent litigation.

  
  

  
  

___________________________

[1] In re MultiPlan Corp. S’holders Litig., C.A. No. 2021-0300-LWW (Jan. 3, 2022).

[2] Slip Op. at 29. 

[3] Slip Op. at 3. 

[4] Slip Op. at 44.

[5] Slip Op. at 45.

[6] Slip Op. at 46. 

[7] Slip Op. at 46. 

[8] Slip Op. at 48-53. 

[9] Slip Op. at 53-56.

[10] Slip Op. at 55. 

[11] Slip Op. at 3. 

[12] 88 A.3d 635 (Del. 2014).

[13] 129 A.3d 884 (Del. Ch. 2016).