This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
A novel Delaware Chancery Court ruling lets public investors in an ex-Citibank Inc. executive’s special purpose acquisition company press charges that the SPAC’s controller, insiders and directors reaped hundreds of millions from an $11 billion merger at the plaintiffs’ expense by concealing the target firm’s newly-decreased value in In Re MultiPlan Corp. Stockholders Litigation, No. 2021-0300, opinion issued (Del. Ch. Jan. 3, 2021).
Vice Chancellor Lori W. Will rejected most of a motion to dismiss consolidated breach of disclosure duty charges against SPAC Churchill Capital Corp III, its founder/controller Michael Klein and his hand-picked directors and officers, finding their merger proxy may have misled public investors into backing Churchill’s acquisition of healthcare cost manager MultiPlan Corp. rather than redeeming their shares.
The decision — the first by the nation’s preeminent business court on a challenge to the unique SPAC type of transaction — is significant because it said Churchill’s founder, sponsor, directors and insiders failed to comply with the ordinary fiduciary duties required of other corporate officials, causing the public investors to lose more than 30 percent of their investment value when the bad news emerged post-merger about Multiplan’s imminent loss of its principal client.
Conflicts provide an opening
Importantly, the vice chancellor also spotlighted the conflicted nature of an SPAC’s structure and operation, in which the directors are often beholden to the founder and have unique rights to very lucrative founder shares that can reap huge returns—if—the SPAC can, within two years, fulfill its mission to acquire a private company and take it public. By contrast, common public investors in Churchill were limited to the choice of backing the deal and taking shares in the acquisition or rejecting it and redeeming their stock for face value plus interest.
Vice Chancellor Will found that this disparity meant that common shareholders who challenged SPAC deals can sue directly for one group — rather than derivatively on behalf of the entire company, which would require them to jump through many procedural hoops. It also means that the defendant directors in this and similar cases will not normally qualify for review of their actions under the protection of the deferential business judgment rule because of their conflicts of interest. Instead, they will be required to show that the deal’s price, negotiation and disclosures met the entire fairness standard, she said.
Deprived of information?
However, those conflicts were not the court’s reason to deny the motion to dismiss. The vice chancellor said plaintiffs sufficiently alleged that they would have redeemed their shares if they knew that Multiplan was losing its primary source of income.
The proxy that Churchill provided to its investors said a due diligence review of Multiplan showed that it was well worth the $11.1 billion offered and any recent decrease in its revenue was due to “idiosyncratic’ factors. But six weeks after the sale, the news about the imminent loss of Multiplan’s main customer caused its stock price to drop by more than 30 percent.
Will said the common shareholders were aware of the structural inequity issue, but: “They did not agree to be deprived of adequate information to make their decision.”
Churchill was founded by Klein in 2020 – the year many such entities were created – and like other SPACs, it had no other business besides the acquisition of a single private company to take public. It bought MultiPlan for $11.1 billion and two common shareholders sued when the bad fiscal news about it was revealed. The suit charged that Klein, Churchill, its directors, insiders and officers breached their fiduciary duties by misleading the common investors and making it difficult to redeem their shares.
In addition to denying the defendants’ motion to dismiss because of their conflicts of interest, Vice Chancellor Will rejected their argument that the disclosure duty count is a fiduciary duty claim that had been “bootstrapped” from a contractual charge. Courts must dismiss such breach of fiduciary duty claims “where the two claims overlap completely,” defendants contend.
Obligated to inform
The plaintiffs are not attempting to “change the contours of their redemption rights beyond those defined by Churchill’s charter,” the vice chancellor ruled. “This case is therefore unlike those where Delaware courts have held that a fiduciary duty claim could not be maintained because it sought to enforce obligations governed by contract. Churchill’s certificate of incorporation does not speak to whether the Board was obligated to disclose all material information about a proposed merger when stockholders were deciding whether to redeem.”
Nor could the charges be called ‘holder claims” because a holder claim is “a cause of action by persons wrongfully induced to hold stock instead of selling it.” And no one was asked to hold stock, Vice Chancellor Will added.
However, as to the charges against Jay Taragin as CEO and CFO of various Klein entities, the plaintiffs “do not make a single allegation about actions that could expose him to liability” or “plead facts sufficient to raise doubt as to whether Taragin fulfilled his fiduciary duties.”
And as to the aiding and abetting charges against The Klein Group LLC, a financial advisor with respect to the merger and a wholly-owned subsidiary of defendant M. Klein & Co. that received $30.5 million for its advisory services, the court dismissed, finding no evidence of knowing participation in the alleged breach of duty.
Will other courts adopt Vice Chancellor Will’s view that the unique structure and operation of SPACs raises unique questions about the independence and disinterest of the defendant directors, controllers and insiders and allows plaintiffs to avoid the maze of derivative actions and more easily get their foot in the door with disclosure or other charges? If they do, there may well be a future need to reformat the SPAC, or similar transactions, in the future.