SPAC Litigation: A Review of Recent Developments
SPAC Deals: Special purpose acquisition companies ("SPACs") boomed in 2020 as a means of taking early-stage private companies public. Following enhanced scrutiny from the Securities and Exchange Commission and the poor post-merger performance of many SPACs, the SPAC bubble burst in early 2021 as investors and dealmakers turned their attention elsewhere.
Litigation: While interest in SPACs has cooled over the last two years, litigation regarding SPACs has continued to heat up, with shareholders challenging a significant percentage of de-SPAC transactions in Delaware and federal courts. Many high-profile suits have recently survived motions to dismiss (at least in part), and at least one has been resolved through a significant settlement.
Going Forward: SPAC-related disputes have thus far focused on alleged conflicts of interest and the accuracy of disclosures regarding targets' business prospects, and those issues are likely to continue to play a leading role as more motions to dismiss are decided. While only a few decisions have been issued by the Delaware Court of Chancery so far, the standard of review applied in those cases is likely to have a significant impact on outcomes if adopted in other cases.
Delaware Fiduciary Suits
The Delaware Court of Chancery has denied motions to dismiss in three important SPAC cases, one of which has been resolved.
The first decision came in MultiPlan in January 2022. In re MultiPlan Corp. S'holders Litig., 268 A.3d 784 (Del. Ch. 2022). MultiPlan was a healthcare data analytics firm that merged with a SPAC in October 2020. Shortly after the merger—in which the vast majority of the SPAC's stockholders chose to invest in MultiPlan, rather than redeeming their shares—a short-seller research firm published a report claiming that MultiPlan would soon lose its largest client, and the company's stock price plunged. In March 2021, the first stockholder plaintiff filed suit in the Delaware Court of Chancery, bringing claims against the SPAC's directors and officers, its controllers, and its financial advisor. The complaint alleged that the stockholders had been deceived by a misleading proxy statement and sought to reopen the redemption window to allow MultiPlan's public stockholders to redeem their stock at or around the $10 per-share redemption price.
The court denied the defendants' motion to dismiss almost entirely. As threshold issues, the court ruled that the stockholders' claims: (i) were direct, not derivative; (ii) were not governed by contract rather than fiduciary duty; and (iii) were not subject to dismissal on the ground that the SPAC stockholders had chosen to hold on to their stock rather than take further action. The court then held that the plaintiffs had adequately alleged that the SPAC's directors and controlling stockholder were conflicted (triggering the "entire fairness" standard of review) and had breached their fiduciary duties to the stockholders. The court noted that its decision stemmed from the fact that the stockholders had adequately pled that they had been asked to choose whether to invest in MultiPlan, or redeem their stock in the SPAC, based on a materially misleading proxy statement.
In October 2022, the parties agreed to settle the case for $33.75 million, and the court approved the settlement in February 2023. This was a substantial settlement—but a far cry from the redemption value of the shares.
In the second decision, Gig3, the Court of Chancery—per the same judge, Vice Chancellor Will—reached the same result on very similar reasoning. Delman v. GigAcquisitions3, LLC, 288 A.3d 692 (Del. Ch. 2023). Gig3, a SPAC, completed a merger with the electric vehicle company Lightning eMotors in May 2021. Before the SPAC shareholder vote on the merger, the SPAC's stock was trading around the $10 per-share redemption price. But by August 2021, in the wake of poor earnings guidance, it had dropped below $7 per share.
A plaintiff stockholder sued, and defendants advanced the same arguments as in MultiPlan—with the same outcome. Defendants attempted to distinguish MultiPlan on the ground that the stockholders' decision on whether to redeem their SPAC shares was fully informed, but in denying defendants' motion to dismiss, the court held that critical information was lacking from the proxy statement. Plaintiff alleged that, after accounting for expenses, the SPAC had assets of around only $5 per share—making the defendants' statement that Gig3's shares were worth $10 each false or misleading. And, the plaintiff argued, Lightning, which Gig3 was buying, was grossly overvalued—another fact that was not disclosed in the proxy statement.
The decisions in MultiPlan and Gig3 show that obtaining a dismissal of breach of fiduciary duty claims in an action challenging a de-SPAC transaction may be challenging. In both cases, the court held that the entire fairness standard (which courts have described as "Delaware's most onerous standard of review") applied due to "inherent" conflicts of interest between the SPAC's fiduciaries and its public shareholders. Gig3 can also be read to suggest that if a company performs poorly after a de-SPAC transaction, stockholder plaintiffs may be able to allege that the proxy statement was misleading because it did not sufficiently warn them of the potential risks. And, under Gig3, if a SPAC fails to affirmatively disclose that its per-share assets after expenses are substantially less than the shares' redemption price, it may be subject to a disclosure claim.
The full impact of these decisions remains to be seen, but they have already significantly influenced motion practice in the Court of Chancery. Shortly after deciding Gig3, the court (again per Vice Chancellor Will) heard a motion to dismiss a very similar case involving a SPAC created by the same founder—and denied the motion for similar reasons. Laidlaw v. GigAcquisitions2, LLC, No. 2021-0821-LWW, 2023 WL 2292488 (Del. Ch. Mar. 1, 2023). And the defendants in another high-profile SPAC case, In re Lordstown Motors Stockholder Litigation, No. 2021-1066—also before Vice Chancellor Will—withdrew their motion to dismiss the claims against them.
Section 10(b) Claims
Unlike the Delaware lawsuits, SPAC-related cases in federal court usually involve claims under Section 10(b) or 14(a) of the Exchange Act, although state law claims may also be asserted. The timing of the alleged misstatements and the roles of the individual defendants are important issues that may influence whether such claims survive at the pleading stage.
The Eastern District of New York's recent decision in Virgin Galactic is instructive. Virgin Galactic, a spaceflight company controlled by Richard Branson, announced that it would merge with a SPAC in July 2019, and the transaction closed in October 2019. The company's post-merger stock price imitated its product: It rocketed in February 2021 to nearly $55 per share before descending back to $16. Plaintiff stockholders filed suit, alleging that Branson, other officers of the target, and the CEO of the SPAC made false and misleading statements concerning the safety and reliability of the company's flights both before and after the de-SPAC transaction closed. Plaintiffs amended their complaint after the company's stock price yo-yoed again, and the court ruled on defendants' motion to dismiss in November 2022. The court granted most of the defendants' motion, including dismissing all of the plaintiffs' claims against the SPAC's CEO. Kusnier v. Virgin Galactic Holdings, Inc., 2022 WL 16745512 (E.D.N.Y. Nov. 7, 2022). The court's ruling suggests that federal claims against the SPAC's officers and directors (rather than the target's) may be more difficult for shareholders to pursue, particularly where the alleged misstatements relate to the target's operations or future prospects. The court whittled down the dozens of alleged misstatements and ruled that only 10 of them could be considered misleading in context. The court then dismissed six more of the alleged misstatements on the grounds that the plaintiffs had not adequately pled loss causation or scienter, allowing just four of the 35 challenged statements to survive the defendants' motion.
Lucid Motors, a case decided by a federal district court in San Francisco in January 2023, also involved allegedly misleading statements made before the de-SPAC transaction closed—but here, they were made by the target's CEO before the merger was announced. News of a potential merger between Lucid Motors and the SPAC (which had the same sponsor as the SPAC in MultiPlan) leaked in January 2021, and the merger was formally announced the following month. During that one-month interval, Lucid's CEO made allegedly misleading statements about how many cars Lucid expected to produce in 2021 and about the operational status of the company's Arizona factory. After the close of trading on the day the merger was announced, Lucid published an investor presentation that contradicted the CEO's previous statements, and the SPAC's stock price plunged (although the merger still closed as expected in July 2021).
Investors who purchased shares in the SPAC during the one-month interval before the merger announcement sued Lucid and its CEO for fraud under Section 10(b). The defendants moved to dismiss on the ground that the alleged misstatements had been made about Lucid, not about the SPAC—the company in which the stockholders had invested. The court ruled that the plaintiffs had standing even though the alleged misstatements concerned a different company from the one in which they had invested. In re CCIV/Lucid Motors Secs. Litig., 2023 WL 325251 (N.D. Cal. Jan. 11, 2023). In doing so, the federal district court declined to follow the approach recently taken by the Second Circuit in Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd., 54 F.4th 82 (2d Cir. 2022), in which the court held that to have standing, a plaintiff must "have bought or sold the security about which a misstatement was made." But despite ruling that the plaintiffs had standing, the court in Lucid Motors ruled that the misstatements were immaterial as a matter of law: The plaintiffs had failed to allege that the merger between Lucid and the SPAC was likely at the time the supposed misstatements were made. The case was therefore dismissed.
Illustrating the impact of the Second Circuit's Menora Mivtachim decision, at the end of March 2023, the Southern District of New York dismissed a challenge to a de-SPAC transaction involving CarLotz, a secondhand car retailer. In re CarLotz, Inc. Secs. Litig., 2023 WL 2744064 (S.D.N.Y. Mar. 31, 2023). CarLotz entered into a merger agreement with a SPAC in October 2020 and completed the merger in January 2021. By July 2021, the company's stock price had halved, and a plaintiff stockholder sued the company, its CEO, its CFO, and its general counsel for violations of Section 10(b). The plaintiffs alleged that the defendants had made false and misleading statements about the company and that the truth had only come to light after the de-SPAC transaction. The court dismissed the complaint: All of the statements complained about had been made by privately held, pre-merger CarLotz, and the plaintiff had been a stockholder of the SPAC, not CarLotz before the merger. (The court also dismissed the plaintiffs' claims under Sections 11 and 12(a) of the Securities Act of 1933 for a similar reason. In those claims, the plaintiffs alleged that one of them had purchased shares pursuant to a misleading registration statement—but that the plaintiff had bought his shares pursuant to the SPAC's registration statement, and he failed to allege any false statements in that registration statement, as opposed to the merger proxy statement.)
Section 14(a) Claims
In addition to claims under Section 10(b), shareholders challenging de-SPAC transactions in federal court often also assert claims under Section 14(a) of the Exchange Act for false or misleading statements in the SPAC's proxy statement. Courts split on whether the plaintiff needs to allege and prove scienter or mere negligence to prevail on a Section 14(a) claim; the difference between these standards may, at the pleading stage, be dispositive. Courts also split on whether to treat the Section 14(a) claim as direct or derivative.
In Romeo Power, the stockholders of a SPAC alleged that the registration statement, proxy statement, and prospectus issued in connection with the SPAC's proposed merger with a battery manufacturer contained more than a dozen misleading statements about the target's business. The court, relying on the Supreme Court's decision in J.I. Case Co. v. Borak, 377 U.S. 426 (1964), ruled that the plaintiffs' Section 14(a) claim was derivative rather than direct. The court reasoned that the harm had been caused to the entire company (the SPAC), which overpaid for the target, rather than to individual shareholders. And because plaintiffs had not made a demand on the SPAC's board of directors to commence the suit or pled that demand on the board was futile, the claim was dismissed. In re Romeo Power, Inc. Secs. Litig., 2022 WL 1806303 (S.D.N.Y. June 2, 2022).
The result in Romeo contrasts with the more nuanced analysis of the court in Faraday, an opinion issued several months later. Faraday, an electric car manufacturer, went public by merging with a SPAC in July 2021. A few months thereafter, a short-seller alleged that Faraday was unlikely ever to sell a single vehicle and that the majority of its preorders were fictitious. Stockholders sued under Section 14(a), alleging that two statements in the SPAC's proxy statement were false and misleading. These statements were that Faraday had 14,000 preorders and that it expected to begin production within 12 months of the merger. Defendants argued, as in Romeo Power, that the claim that stockholders had lost money by voting for the merger was a derivative claim because it "affecte[d] all stockholders equally." The court disagreed. Applying Delaware law, the court held that the deprivation of the right to an informed vote gives rise to a direct, not derivative, claim. Zhou v. Faraday Future Intelligent Elec. Inc., 2022 WL 13800633 (C.D. Cal. Oct. 20, 2022). The court nevertheless dismissed the plaintiffs' Section 14(a) claims on other grounds, including because the statement about existing preorders, which had appeared in a press release, was not incorporated by reference into the proxy statement.
Four Key Takeaways
- The Delaware courts' application of the entire fairness standard in MultiPlan, Gig3, and Gig2 suggests that defendants face an uphill battle in moving to dismiss SPAC-related breach of fiduciary duty claims in Delaware, at least depending on the facts asserted. And given the incentives available to sponsors in most SPAC transactions, and the poor performance of many post-de-SPAC companies and the accompanying loss of stockholder value, SPAC mergers may present greater risks of hindsight-driven litigation than other mergers.
- SPAC transactions also create a high risk of lawsuits alleging violations of the federal securities laws, as many such lawsuits challenge statements made by or about the target company both before and after the de-SPAC transaction closed. SPAC management may not have sufficient information to verify the accuracy of pre-closing statements about the target's business, so the risk they present must be carefully managed in any de-SPAC-related disclosures.
- SPAC participants must make the disclosures as accurate as possible. Not only do such disclosures have to comply with the securities laws, but accurate disclosures may materially reduce settlement value in the event that a lawsuit is filed and a motion to dismiss is denied.
- The statutes governing jurisdiction and venue in federal securities suits confer some discretion on plaintiffs on where to sue. Given the lack of uniformity in the application of the securities laws as it relates to SPACs in particular, defendants may find some jurisdictions more amenable to investors' claims than others.