January 23, 2022

Volume XII, Number 23

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Delaware Chancery Court Signals Heightened Scrutiny of SPAC Boards and Sponsors

The Delaware Chancery Court has issued a decision with major implications for sponsors and directors of Delaware incorporated special purpose acquisition companies (SPACs).  In re MultiPlan Corp. Stockholders Litigation1 is a suit arising from the purchase of healthcare-data company MultiPlan, Inc. by Michael Klein’s $1.1 billion Delaware SPAC, Churchill Capital Corp. III.  Shortly after the closing, the combined entity’s share price plummeted when the market learned that MultiPlan’s largest customer was building its own in-house data platform.  Stockholders sued the SPAC’s sponsor and board.2

Vice Chancellor Will largely denied motions to dismiss and held that the transaction will be subject to the rigorous “entire fairness” review.

I.         Facts

Churchill’s structure followed a typical blueprint for SPACs:

  • Class A shares representing 80% of the SPAC’s outstanding stock were sold for $10 per share in a $1.1 billion IPO.

  • The sponsor paid $25,000 for “Class B founder shares” representing the other 20% of the stock—the so-called “promote.” All of the SPAC’s directors, in turn, were awarded in the sponsor.

  • Public stockholders could opt out of any business combination by exercising pre-closing redemption rights.

  • If no deal were closed during a 24-month “completion window,” Churchill would refund all IPO proceeds plus interest to investors, and the promote would become worthless.

Five months after the IPO, Churchill announced its agreement to acquire MultiPlan.  The proxy touted the target’s “attractive valuation” and growth prospects; it did not identify the target’s largest customer or disclose that the customer had publicly announced a plan to launch a competing data platform.  The stockholders overwhelmingly voted to approve the merger, which closed on October 8, 2020, and redemptions were low.  Immediately following the merger, Mr. Klein’s interests in the combined entity were worth roughly $230 million and all but one of the remaining directors each held interests worth at least $3 million.

After news of the customer’s business plan broke, the company’s share price fell more than 40%, from $11.09 per share to a low of $6.27.  At that point the promote was still worth $108 million.  Stockholders sued Mr. Klein and Churchill’s other officers and directors, alleging breaches of fiduciary duty.

II.        The Motion-to-Dismiss Decision
 

A.       Claims Held Derivative, Not Direct

The Chancery Court held as a threshold matter that the stockholders’ claims are direct, not derivative—meaning the plaintiffs are suing on behalf of themselves and other stockholders, not asserting the company’s rights.  The thrust of the complaint is that the defendants “impaired the public stockholders’ informed exercise of their redemption rights”—a harm that could not have “run to the corporation.”3  That opens the door to class actions, which are more lucrative for the plaintiffs’ bar than derivative cases.

B.       Entire Fairness Test Held to Govern

The court held that the defendants’ conduct must be judged under the “entire fairness test,” Delaware’s “most onerous standard of review.”4  That test is typically applied when the board is not entitled to the protections of the Business Judgment Rule.  The board is not entitled to Business Judgment Rule protections if it hasn’t complied with any of four fiduciary duties:

  • Care

  • Loyalty

  • Good faith

  • Candor

Under the entire fairness test, the defendant must prove “fair dealing” and a “fair price” for stockholders.  That framework applies, the court concluded, for two reasons:

1.          The case involves a “conflicted controller transaction.”  Mr. Klein, through his control of the sponsor, was Churchill’s controlling stockholder.  The conflict arose because he stood to profit from any deal—and would lose everything without a deal—whereas public stockholders would have preferred liquidation over a bad deal.  On top of that, Churchill was advised on the deal by Klein’s investment bank, which was paid $30.5 million—a fact that “bolsters” the conclusion that this was a conflicted controller transaction.5

2.          A majority of the directors were self-interested due to their ownership of founders’ shares and/or conflicted because they were beholden to Mr. Klein due to other business ties.

Against the entire fairness backdrop, the court held that the plaintiffs pleaded viable claims against the director defendants and the controlling stockholder:  “for purposes of the motions to dismiss, the alleged disclosure violations sufficiently give rise to a lack of overall fairness.”6

The court’s ruling on the standard of review substantially increases litigation risk. Churchill is not unusual for SPACs in either its structure or in the way it compensates its independent directors.  The issues noted by Vice Chancellor Will will apply identically to virtually all other Delaware SPACs.

III.      Takeaways

The Chancery Court’s decision in MultiPlan counsels caution. In connection with their business combination transactions, Delaware SPACs should consider the following:

1.          The board’s process.

2.          Should a financial advisor issue a fairness opinion?

3.          Can the issue of interested independent directors be addressed?

1   Cons. C.A. No. 2021-0300-LWW, 2022 Del. Ch. LEXIS 1 (Jan. 3, 2022).

2   Id. at *4.

3   Id. at *24.

4   Id. at *36.

5   Id. at *43.

6   Id. at *52.  A claim for aiding and abetting breach of fiduciary duty against the SPAC’s financial advisor, The Klein Group, also survived, given allegations that it knew the undisclosed facts about the target.  A claim against Churchill’s CFO for breach of fiduciary duty, on the other hand, was dismissed for lack of supporting allegations.

© Copyright 2022 Cadwalader, Wickersham & Taft LLPNational Law Review, Volume XII, Number 13
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About this Author

Stephen Fraidin, Cadwalader, Corporate lawyer
Partner

Stephen Fraidin represents major corporations and investment funds, special committees and boards of directors in connection with acquisitions, mergers, proxy contests, corporate governance engagements and other matters. He is widely recognized as one of the country’s leading M&A lawyers.

Listed among the ten “Most Highly Regarded Individuals” worldwide in The International Who’s Who of Mergers & Acquisitions Lawyers in 2013 and selected by Law360 as an “M&A MVP of the Year” in 2013, Stephen is recognized annually by Chambers USA...

212 504-6600
Gregory Patti Securities Lawyer Cadwalader Law Firm
Partner

Greg Patti represents clients in a wide variety of mergers and acquisitions, securities and corporate governance matters. Greg represents foreign and domestic entities in complex business transactions and counsels clients on negotiated acquisitions, divestitures and private equity transactions.

In addition to his transactional practice, Greg counsels clients on a broad range of business-related matters including securities law, directors’ duties and responsibilities and disclosure matters. Greg has represented public and private acquirors, targets and portfolio companies. He has...

212 504 6780
Jonathan Watkins, Charlotte, North Carolina, Cadwalader, partner, antitrust litigation, class action, white collar, global, merger, acquisition, New York
Partner

Jonathan Watkins represents public and private businesses and financial institutions in complex litigation and white-collar investigations. His practice covers securities, derivative, and other shareholder actions, M&A-related litigation, suits alleging breaches of fiduciary duties by corporate directors, disputes involving complex financial benchmarks and instruments, litigation arising out of commercial contracts and transactions, antitrust and other competition-related litigation, and government and internal investigations. Jonathan has represented clients at...

704-348-5129
Aaron Lang Litigation Attorney Cadwalader
Special Counsel

Aaron Lang is a special counsel in Cadwalader’s Global Litigation Group. He concentrates his practice on litigation and investigations for banks, investment firms and corporate clients. He has experience with securities, M&A, corporate governance, AML and other complex commercial matters.

Prior to joining Cadwalader, Aaron was counsel at Moore & Van Allen in Charlotte, and an associate in the Financial Institutions Disputes Group in the New York office of Freshfields Bruckhaus Deringer.  Aaron also has worked at HSBC and RBC on...

704 348 5145
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