Is everything securities fraud, as Bloomberg’s Matt Levine frequently maintains? (See this PubCo post.) Or perhaps, in the SPAC environment, will all claims of fraudulent misrepresentation and omission now become claims of breach of fiduciary duty under Delaware law—and reviewed under the entire fairness standard? Is that a possible takeaway from the Delaware Chancery Court’s refusal last week to dismiss the complaint in In Re Multiplan Corp. Stockholders Litigation? In that case, the plaintiffs, purchasers of securities in a SPAC IPO, claimed that the defendant SPAC sponsor and SPAC board members disloyally impaired the plaintiffs’ rights to redeem their SPAC shares prior to consummation of the de-SPAC transaction by breaching their fiduciary duty to disclose to the plaintiffs material information about the de-SPAC target company. According to the Court, the “Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context. In this decision, well-worn fiduciary principles are applied to the plaintiffs’ claims despite the novel issues presented. Doing so leads to several conclusions.” In particular, one of those conclusions was that, due to inherent conflicts between the SPAC’s fiduciaries and the public stockholders, the entire fairness standard of review applied, establishing a very high bar for dismissal of the complaint.
Background
As described in the opinion, the SPAC was formed in 2019 as a typical blank-check company through a sponsor entity, which was controlled by a serial SPAC sponsor, Michael Klein. The SPAC went public in 2020 in a $1.1 billion IPO, selling units (at $10 per unit) consisting of one share of SPAC class A common stock and a quarter of a warrant with an exercise price of $11.50. The IPO funds were held in a trust account. In addition to the class A, 20% of the SPAC’s capital structure consisted of Class B shares, which were purchased by the SPAC sponsor for $25,000 and would convert into Class A shares upon completion of the de-SPAC merger. The SPAC sponsor was also compensated through an option to purchase warrants in the SPAC.
Consistent with market practice, the sponsor had two years to identify a merger target and compete a de-SPAC transaction; if a de-SPAC merger were not completed on a timely basis, then the SPAC would return the IPO proceeds plus interest from the trust account to its stockholders and cease operations; importantly, in that circumstance, both the Class B shares and the warrants would expire worthless. If a merger target were identified and disclosed, each Class A stockholder could exercise a “redemption right” for the $10 IPO price plus interest just prior to the stockholder vote, regardless of whether the stockholder voted in favor or against the merger. Any funds remaining in the trust after the redemptions could be used to finance the operations of MultiPlan as a public company going forward. Upon completion of the de-SPAC merger, the sponsor’s Class B shares would convert into Class A shares of the newly public combined operating entity.
Klein appointed the SPAC’s directors and officers, all of whom “allegedly had prior connections to Klein.” Generally, the directors were compensated with interests in the sponsor, which meant that they indirectly held class B shares and warrants.
In Spring 2020, the SPAC commenced negotiations with MultiPlan, a provider of “healthcare industry-focused data analytics and cost management solutions,” as its intended merger target. The board approved the merger agreement in July, and the proxy statement related to the vote on the merger was issued in September. The affirmative vote of a majority of the SPAC’s stockholders represented at the special meeting was required to approve the merger. The implied enterprise value of MultiPlan as a public company following the merger was estimated at $11 billion. On the record date, the implied value of the Class B shares (once converted to Class A common) held by the sponsor was about $305 million, with Klein’s interests valued at about $230 million, and the other directors at least $3 million each.
The proxy statement indicated as reasons for the merger the “attractive valuation” and growth opportunities of the target, MultiPlan. The proxy statement also said that the board had conducted “extensive due diligence” and had communicated with several large customers of MultiPlan. While the proxy statement disclosed that MultiPlan was dependent on its single largest customer for 35% of its revenues, it did not identify the customer or, critically, disclose that the customer intended to create an in-house data analytics platform that would compete with MultiPlan and cause the customer to move its key accounts in-house, a plan that the customer had disclosed back in June, well before issuance of the proxy statement in September. There was no third-party valuation or fairness opinion. The SPAC stock closed at $11.09 on the record date, and fewer than 10% of the SPAC’s public stockholders exercised their redemption rights. In October, the SPAC stockholders approved the de-SPAC merger. In November, a research firm published a report about MultiPlan that included a discussion of Multiplan’s major customer and its intent to create a competitive platform. The following day, MultiPlan’s stock price fell to a low of $6.27.
The plaintiffs filed their complaints, subsequently consolidated, in March and April of 2021. The plaintiffs made direct claims against some of the SPAC directors, officers and its controlling stockholder alleging, among other things, breach of fiduciary duty on the basis that the defendants “put their own interests above [the SPAC] Class A stockholders’ interests [by issuing] a false and misleading proxy that impaired Class A stockholders’ informed exercise of their redemption and voting rights.”
The defendants then moved to dismiss the complaint on the basis of failure to plead demand futility and failure to state a claim upon which relief can be granted. The Court emphasized that the pleading standards for that type of motion were “minimal,” and that the operative test was “one of ‘reasonable conceivability,’” which asks “whether there is a ‘possibility’ of recovery.” Accordingly, “the plaintiffs’ well-pleaded factual allegations are credited in full” and “the plaintiffs are receiving the benefit of all reasonable inferences.” Essentially, in this context, the plaintiffs needed to plead only a “reasonably conceivable impairment of public stockholders’ redemption rights… in the form of materially misleading disclosures.”
Analysis
The Court first observed that there was no dispute that the defendants owed fiduciary duties of care and loyalty to the SPAC stockholders. The duty of loyalty, the Court said, requires that the interests of the company and its stockholders take precedence over any interest of a director, officer or controlling shareholder. In addition, the “duty of disclosure is an ‘application of the fiduciary duties of care and loyalty’ implicated when fiduciaries communicate with stockholders,” and when there is “reason to believe that the board lacked good faith in approving a disclosure, the violation implicates the duty of loyalty.”
According to the Court, viewing the complaint in the light most favorable to the plaintiffs, “the crux of the plaintiffs’ claims is that the defendants’ actions—principally in the form of misstatements and omissions—impaired [the SPAC] public stockholders’… redemption rights to the defendants’ benefit. In a value-decreasing merger, non-redemptions would be valuable to those holding founder shares. Because the public stockholders were allegedly not fully informed of all material information about MultiPlan, they exchanged their right to $10.04 per share—held in a trust for their benefit—for an interest in Public MultiPlan.”
As an initial matter, the Court rejected defendants’ contention that the complaint should be dismissed because the plaintiffs’ claims were actually derivative claims (that the SPAC overpaid for MultiPlan) and that the plaintiffs failed to allege demand futility. Not so, the Court said; the case was about impairment of plaintiffs’ informed exercise of their redemption right as a result of defendants’ allegedly providing “purposefully and materially misleading disclosures,” not overpayment. The Court was also unpersuaded by defendants’ argument that the plaintiffs’ claims were governed by contract (the certificate of incorporation); rather, the Court viewed the plaintiffs’ claims as concerning “fiduciary duties owed in conjunction with a contractual right.” The Court was likewise unsympathetic to defendants’ argument that the plaintiffs had made “holder” claims predicated on stockholder inaction and deemed inappropriate for class actions. Instead, the Court viewed the case as involving an investment decision, “an active and affirmative choice around which the SPAC structure revolved.”
For our purposes here, however, the most significant issues related to the Court’s conclusions regarding the breach of fiduciary duty claims and the applicable standard of review.
Standard of review.
The plaintiffs claimed that, because of conflicts of interest, the business judgment presumption had been rebutted, with the result that “Delaware’s ‘most onerous standard of review,’” the entire fairness standard, should apply. First, the plaintiffs contended that the de-SPAC merger, including the opportunity to redeem, was a “conflicted controller” transaction. Second, they argued that a majority of the SPAC’s board was “conflicted either because the directors were self-interested or because they lack independence from Klein,” who controlled the sponsor entity and was the SPAC’s controlling stockholder. The Court concluded that the plaintiffs “pleaded facts supporting a reasonable inference that entire fairness applies on both bases.”
Conflicting controller. According to the Court, one way that conflicted controller transactions implicate the entire fairness standard is in circumstances “where the controller competes with the common stockholders for consideration.” Under Delaware law, a controller competes with common stockholders where the controller “receives “a ‘unique benefit’ by extracting ‘something uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders’ to the detriment of the minority.” In this instance, the plaintiffs’ claims “center around a misalignment of interests during a prior step in the de-SPAC transaction process.” The Court concluded that the well-pleaded allegations in the complaint “highlight a benefit unique to Klein at the point when Class A stockholders held redemption rights backed by a trust that Class B stockholders could not access, and Klein (who controlled the Sponsor) had an economic interest in 70% of the Class B shares.” If the SPAC did not complete a deal, the SPAC stockholders would receive $10.04 per share, but the Class B and warrants would be worthless; if the deal were completed, the sponsor stood to realize a “1,219,900% gain on the Sponsor’s $25,000 investment.”
Based on the allegations in the complaint, the Court reasoned that
“the merger had a value—sufficient to eschew redemption—to common stockholders if shares of the post-merger entity were worth $10.04. For Klein, given the (non-)value of his stock and warrants if no business combination resulted, the merger was valuable well below $10.04. This is a special benefit to Klein. It can also be reasonably inferred that Klein gained a unique benefit from the redemption offer itself—it brought him one step closer to consummating a transaction that allegedly benefitted him to the detriment of Class A stockholders. Further, in a value-decreasing deal where the post-merger entity is expected to be worth less than $10.04 per share, issuing a share at $10.04—the effective result of a stockholder choosing not to redeem a [SPAC] share—is value enhancing to the existing stockholders. It is also patently harmful to the ones giving up $10.04 for something less valuable. Because of his founder shares, Klein effectively competed with the public stockholders for the funds held in trust and would be incentivized to discourage redemptions if the deal was expected to be value decreasing, as the plaintiffs allege.“
The defendants contended, among other things, that the public stockholders were aware of the “mismatched incentives,” which were disclosed when the plaintiffs invested in the SPAC, and, therefore, should be equitably estopped from challenging the disclosed incentives. However, the Court observed, the “structure of the SPAC—and Klein’s incentives—were disclosed in the prospectus but the transaction at issue was not.” Here, the Court said, “those stockholders were allegedly robbed of their right to make a fully informed decision about whether to redeem their shares”; they did not agree, when they invested in the SPAC, “that they did not require all material information when the time came to make that choice.” That argument might been more persuasive, the Court observed, “if it had been made about the Proxy and the plaintiffs had opted not to redeem despite adequate disclosures—but that is not the universe alleged in the Complaint.”
The Court also rejected defendants’ contention that the sponsor’s founder shares could not “trigger entire fairness because this ‘structural feature’ would appear in ‘any de-SPAC transaction.’” But prior use of the structure by other SPACs would not, the Court maintained, “cure it of conflicts.” In the end, the Court held that the “potential conflict between Klein and public stockholders resulting from their different incentives in a bad deal versus no deal is sufficient to pass the ‘reasonably conceivable’ threshold.”
Absence of independent board majority. The entire fairness standard can also apply when there is no independent board majority acting in good faith. The plaintiffs alleged that all of the board members were “self-interested in the Merger, not independent from Klein, or both.” The plaintiffs asserted that the directors were interested in the merger by virtue of their economic interest in the sponsor entity. The complaint alleged that, as with Klein, the “director defendants would benefit from virtually any merger—even one that was value diminishing for Class A stockholders—because a merger would convert their otherwise valueless interests in Class B shares into shares of Public MultiPlan.” The Court did not buy the defendants’ contention that the “founder shares aligned the directors’ interests with public stockholders with respect to maximizing [the SPAC]’s long-term value.” Rather, the Court found that their interests still diverged.
The plaintiffs also contended that the board majority was conflicted because the directors were not independent from Klein, who had appointed all the directors and retained the power of removal. The directors were also compensated through interests in the sponsor, controlled by Klein. The plaintiffs also alleged that Klein had appointed some of the directors to serve on the boards of his other SPACs, with potential for financial upsides in those other instances. The Court held that the “existence of these interests and relationships is enough to defeat a motion to dismiss.”
Breach of fiduciary duty claims
With regard to claims against the directors, the plaintiffs alleged that the directors breached their fiduciary duty of loyalty (which comprehended a duty of disclosure) by “prioritizing their own personal, financial, and/or reputational interests and approving the Merger, which was unfair to public Class A stockholders” and “issuing the false and misleading Proxy,” which hurt those public stockholders who did “not exercis[e] their redemption rights.” Under the entire fairness standard, the Court reminded us, the defendants have the burden “to demonstrate that the challenged act or transaction was entirely fair to the corporation and its stockholders.” The test requires an examination of both fair price and fair dealing, viewed as a whole. And, under Delaware law, the “entire fairness standard incorporates a requirement of compliance with the duty of disclosure into the fair dealing aspect of the test.” However, the entire fairness inquiry, the Court said, is fact-intensive and, therefore, fiduciary duty claims evaluated under the entire fairness standard will usually survive a motion to dismiss. And that was true here. In this case, the Court concluded that the complaint contained “well-pleaded allegations that false and misleading disclosures impaired Class A stockholders’ exercise of their option to redeem,” most notably the failure to disclose the name of MultiPlan’s largest customer and its plan to develop its own platform. And because there were no opposing viewpoints presented (much like a tender offer), “an even more exacting duty to disclose {was placed] upon fiduciaries in possession of the information.” Looking at the disclosure violations alleged in the complaint, the Court held that they were sufficient to give rise to a lack of overall fairness.
The complaint also stated claims against Klein as the controlling stockholder, alleging a breach of fiduciary duty “‘by agreeing to and entering into the Merger without ensuring that it was entirely fair’ to the public stockholders who were harmed by not exercising their redemption rights.” The Court determined that the claim against Klein was based on many of the same reasons given by the plaintiffs in their claim against the directors. However, the Court said, the “role (if any) of Klein as a controlling stockholder in the alleged impairment of stockholders’ redemption rights cannot be resolved at the pleading stage.”
While the decision might seem to portend a flood of SPAC cases in Delaware, the Court’s efforts to narrowly frame the decision could cabin its impact. In its discussion, the Court took pains to distinguish this case from an ordinary case involving a SPAC with a standard structural conflict of interest where the disclosure was adequate: in this case,
“the plaintiffs’ claims are viable not simply because of the nature of the transaction or resulting conflicts. They are reasonably conceivable because the Complaint alleges that the director defendants failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights. This conclusion 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. The core, direct harm presented in this case concerns the impairment of stockholder redemption rights. If public stockholders, in possession of all material information about the target, had chosen to invest rather than redeem, one can imagine a different outcome.”
Nevertheless, time will tell whether the potential availability of the entire fairness standard in Delaware—with its near-preclusive impact on motions to dismiss—will bring more SPAC cases alleging material misrepresentation or omission to the Delaware courts.
