January 9, 2023

Fiduciary Duties: Del. Chancery Says Entire Fairness Standard Applies to De-SPAC

Picking up where she left off with her decision in the Multiplan case almost exactly one year ago, Vice Chancellor Will last week declined to dismiss breach of fiduciary duty claims against the board and sponsors of a SPAC arising out of a de-SPAC merger, and held that the transaction should be evaluated under the entire fairness standard.

In Delman v. GigAcquisitions3 LLC (Del. Ch.; 1/23), the plaintiff alleged that the SPAC’s and sponsor breached their fiduciary duties by causing the SPAC to enter into a value decreasing acquisition of Lightning eMotors, a manufacturer of electronic vehicles.  In support of his claims, the plaintiff pointed to alleged disclosure shortcomings in the proxy statement by which Gig3 sought to obtain stockholder approval of the deal.  In response, the defendants moved to dismiss.

After rejecting the defendants’ contentions that the plaintiff’s claims – which were premised on his reliance on the challenged disclosures to refrain from exercising his redemption rights – were derivative in nature or represented nonactionable “holder” claims, the Vice Chancellor addressed the substance of the fiduciary duty claims.  This excerpt from Sullivan & Cromwell’s memo on the decision reviews the Vice Chancellor’s approach to those claims:

In denying defendants’ motion to dismiss, the Court held that the SPAC sponsor’s “interests diverged from public stockholders in the choice between a bad deal and a liquidation” by virtue of the sponsor’s founders’ shares which it purchased for nominal consideration and could not redeem for $10.00 per share, unlike the shares held by the SPAC’s public stockholders. If the sponsor failed to complete a transaction and the SPAC was liquidated, the sponsor’s shares would be worthless, while the public stockholders “would receive their investment plus interest from the trust in a liquidation.”

According to the Court, this typical SPAC structure created a “unique benefit” for the sponsor “in the choice between a bad deal and a liquidation” that was not shared by the public stockholders. Although the Gig3 directors, unlike the MultiPlan directors, were compensated for their services in cash, and the Court found the Gig3 directors lacked any self-interest in the de-SPAC transaction, the Court nonetheless held that at least a majority of the directors lacked independence due to their “close ties” to the SPAC sponsor and his “enterprise of entities.”

The Vice Chancellor therefore concluded that the transaction should be evaluated under the entire fairness standard.  Furthermore, she concluded that even if there was no defect in the proxy statement’s disclosure, Corwin would be unavailable to cleanse the transaction. As the Sullivan & Cromwell memo explains, that conclusion again resulted from conflicts inherent in the typical SPAC structure:

According to the Court, the public stockholders’ vote on the de-SPAC transaction does not reflect their “collective economic preferences” because the “public stockholders could simultaneously divest themselves of an interest in” the SPAC’s target by redeeming their shares, while still voting in favor of the transaction.

Further, the Court reasoned that “redeeming stockholders remained incentivized to vote in favor of a deal—regardless of its merits—to preserve the value of the warrants” they received as part of their purchase of the SPAC’s “IPO units.” These IPO units consisted of one share of common stock and three-quarters of a warrant to purchase a share of common stock at an exercise price of $11.50 per share. If the de-SPAC transaction failed and the SPAC liquidated, the warrants would expire worthless.

Vice Chancellor Will’s decision reinforces her earlier decision in Multiplan and strongly suggests that SPAC sponsors & boards are going to find it very hard to avoid entire fairness scrutiny in the event that their actions in connection with a de-SPAC transaction are challenged by disappointed stockholders.

John Jenkins