Seyfarth Synopsis: Special Purpose Acquisition Company (“SPAC”) transactions have dramatically increased since the start of 2020, bringing with them risk of securities litigation.
2020 has been characterized as the “Year of the SPAC,” and there is no doubt that SPAC transactions are on the rise.1 One industry tracker reports that in 2020 there were 248 SPAC initial public offerings (“IPOs”) raising over $83 billion (as compared to 59 SPAC IPOs raising approximately $13.6 billion in 2019).2 This trend is expected to continue in 2021 with 189 SPAC IPO transactions this year at the time of writing.3
We expect this rise in SPAC transactions to be accompanied by the continued filing of securities suits in the coming months and years.4 Much of the litigation will be no different than typical disclosure-related suits that might follow any public company disclosure, but certain unique aspects of the SPAC structure could create additional litigation risks.
SPACs are an increasingly popular vehicle for easily taking a company public. A SPAC has no commercial operations at its formation; it raises money through an IPO with the intention of using the funds to acquire a company with ongoing business operations to be identified after the IPO. The target company then typically merges into the SPAC, in a transaction that is referred to as the “de-SPACing,” resulting in an operating company with publicly traded shares. Because the SPAC is not an operating business at the time of the IPO, the SPAC IPO process involves more limited disclosures than a traditional IPO, with a focus primarily on the experience and expertise of SPAC management rather than detailed financial reports or business history. In addition, because the SPAC typically does not have a specific target company in mind at the time of the IPO, no disclosures regarding the target are necessary.
Once the SPAC IPO is completed, the IPO funds are placed in a trust account until a transaction is completed. The SPAC must identify a target and consummate the transaction within a relatively tight frame, typically two years from the time of the IPO, extendable by shareholder vote. When a target is identified, the proposed transaction is put to a shareholder vote. Shareholders also have the option, after the transaction is approved, to redeem their shares for cash prior to the de-SPACing transaction if they are not satisfied with the selection of the acquisition target or the terms of the deal.
If the transaction is not finalized within the designated time period, the SPAC will be liquidated and the trust funds will be returned to shareholders on a pro rata basis. The SPAC sponsor typically receives a 20% interest in the SPAC, which converts to shares of the public company after the merger. In the event that a transaction is not consummated within the designated timeframe, the sponsor's interest may be forfeited or become valueless. As a result, shareholders and regulators5 have raised concern regarding potential misalignment of the interests of SPAC sponsors and SPAC shareholders as discussed more fully below.
SPAC Securities Litigation Risks
Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse have identified eleven SPAC-related shareholder class action lawsuits filed in 2019 and 2020 and an additional five filed thus far this year.6 At least six non-class action securities lawsuits associated with a SPAC transaction have also been filed since the start of 2020. Because the SPAC process involves a number of public disclosures, each of which carries some securities litigation exposure, we expect to see increased numbers of securities lawsuits filed against SPACs and SPAC-sponsored operating companies as the SPACs that completed IPOs in 2020 and 2021 move into the de-SPACing stage.
Litigation Risks Associated With The IPO
As discussed above, the registration statement in connection with the SPAC IPO is often relatively sparse, as there are no underlying business operations or business history to report. As a result, the risks associated with the SPAC IPO are relatively limited. However, all statements in the registration statement, including the discussion of the management team and its experience, as well as the disclosure of the financial incentives of SPAC sponsors and underwriters, should be carefully reviewed to avoid the strict liability claims for misstatements in connection with an IPO that arise under Section 11 of the Securities Act. Notably, the SEC has cautioned SPACs to “consider carefully disclosure obligations under the federal securities laws as they relate to conflicts of interest, potentially differing economic interests of the SPAC sponsors, directors, officers and affiliates and the interests of other shareholders and other compensation-related matters” in preparing IPO and other public disclosure documents.7
Litigation Risks Related To The De-SPACing Transaction
As discussed above, once a target has been identified and an agreement has been reached between the entities, the proposed transaction is typically presented for shareholder vote. The disclosures to shareholders in connection with the vote on the proposed SPAC acquisition are more detailed and fraught with risk than those associated with the SPAC IPO. The M&A disclosures are required to include detailed reporting on the target's business operations, financial projections and historic operations. As with any proxy statement or tender offer disclosure, any material misstatement or omission in the disclosures to shareholders regarding the proposed de-SPACing transaction could give rise to liability under Section 14 of the Securities Exchange Act of 1934. In fact, plaintiffs' lawyers have been increasingly aggressive in their efforts to challenge deal disclosures, filing suit almost immediately upon the announcement of a proposed deal and arguing that some omitted detail, financial projections or background information on the transaction renders the proxy or registration statements materially misleading.8 SPAC transactions are not escaping these suits9 and we expect to see an increase as the window to consummate deals with respect to the large number of SPAC IPOs that took place in 2020 approaches.
Where the SPAC merger involves the issuance of new shares to seller, the company and its officers and directors as well as the sponsors of the SPAC and the deal underwriters could face the risk of strict liability claims under Section 11 of the Securities Act. In fact, there have been at least three such lawsuits filed following SPAC mergers since 2019.10 These suits have been filed against the post-merger companies, their officers and directors, the SPACs and their sponsors and, in one instance, the company's underwriter.11
Securities Class Actions Against SPAC Funded Operating Companies
Litigation is also likely where the post-merger company experiences performance issues following the de-SPACing. Where the company does not perform well post de-SPACing, plaintiffs will attempt to use a SPAC-sponsor's purported monetary incentive to finalize an acquisition within the designated time frame to suggest that a SPAC merger was born of urgency instead of prudence and that due diligence was inadequate.12 The complaints then allege that due diligence related disclosures were misleading and that the defendants misrepresented the financials of the target company to convince shareholders to approve the transaction. There have been several such lawsuits in the past year,13 asserting claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 14(a), 10(b) and 20(a) of the Exchange Act of 1934 against the post SPAC operating company, their officers and directors, SPAC sponsors, and, in connection with the Section 11 suit, the deal underwriter. A number of these complaints rely on short seller reports14 and involve government investigations.15 These lawsuits contain more substantive allegations than the Section 14 suits discussed above, and are less likely to be resolved quickly.
Breach of Fiduciary Duty Claims
In addition to the claims under federal securities laws, SPAC transactions also may give rise to suits against SPAC directors and sponsors alleging breaches of duties of care, loyalty and good faith as a result of purported conflicts of interests associated with SPAC sponsors' financial incentives to pursue a deal.16 In order to support these claims, plaintiffs generally focus on factors such as a failure to appoint a special committee to evaluate a proposed transaction or a lack of third party valuation or fairness opinion. Where plaintiffs adequately establish a conflict of interest, the board's decision is evaluated under the more rigorous entire fairness standard as opposed to the more deferential business judgment rule. Because the entire fairness analysis involves a judicial determination of whether a transaction is entirely fair to stockholders, which can be a fact intensive inquiry, it is difficult to resolve such cases at the motion to dismiss stage. As a result, companies and their boards should consider certain protective measures such as engaging an independent financial advisor and appointing an independent special committee to evaluate the fairness of proposed transactions.
SPAC IPOs are on the rise and the litigation related to the SPAC life-cycle is sure to follow. In order to minimize securities litigation risks associated with SPAC transactions, companies are advised to follow typical best practices with respect to disclosures. Disclosures should be reviewed carefully for accuracy and completeness and projections should be identified as forward-looking and accompanied by meaningful cautionary statements.
Companies should include federal forum selection provisions in bylaws prior to an IPO to reduce the risk of simultaneous state court litigation of Section 11 suits in light of the Supreme Court's 2018 Cyan decision.17 In addition, it is critical that the offering documents for the initial IPO clearly disclose the material risks involved, including compensation paid to sponsors.
In connection with proposed de-SPACing M&A transactions, companies and their boards should consider the engagement of an independent financial advisor that is paid a flat fee, rather than one whose payment is contingent on the outcome of the deal, and the appointment of an independent special committee to evaluate the potential de-SPACing transaction. Such measures could help insulate against claims of conflict of interest with respect to the transactio
4 According to SPACInsider, of the 248 SPAC IPOs, only 70 have announced a proposed merger and 19 have completed a merger transaction as of this date. Id. As more SPACs enter the merger stage, we expect the number of SPAC-related securities law suits to increase.
5 See Bain, Benjamin, Hot Blank-Check Companies Get SEC Scrutiny on Pay Structures, Bloomberg News (Sept. 24, 2020) (discussing comments made by then-SEC chair Jay Clayton).
8 Many of these suits have been voluntarily dismissed within months of their filing as discussed in detail in our previous article: Over 50 M&A Deals Have Been Challenged This Year by a Single Group of Lawyers Seyfarth Shaw LLP (Jun 12, 2020).
9 These include the following class action suits alleging violations of Section 14 of the Securities Exchange Act all filed upon the announcement of the proposed transaction: Ryan v. GigCapital3, Inc. et al, 5:21-cv-00969 (N.D. Cal.); Hutchings, et al. v. Churchill Capital Corp III, et al., 20-CV-06318 (S.D.N.Y.); Wolf, et al. v. Boxwood Merger Corp., et al., 19-CV-02184 (D. Del.); Rosenblatt, et al. v. Chardan Healthcare Acquisition Corp., et al., 19-CV-01801 (D. Del.); Wheby, Jr., et al. v. Greenland Acquisition Corporation, et al., 19-CV-01758 (D.Del. ); Rosenblatt, et al. v. Black Ridge Acquisition Corp., et al., 19-CV-01117 (D.Del.); In re Alta Mesa Resources, Inc. Securities Litigation 19-CV-00957, (S.D. Tex.). The following complaints were filed by individual plaintiffs upon the announcement of the proposed transaction, alleging violations of Section 14 of the Securities Exchange Act: Schuman v. Hennessy Capital Acquisition Corp. IV et al. 20-cv-10175 (S.D.N.Y.); Ward v. Switchback Energy Acquisition Corporation et al. 20-cv-10557 (S.D.N.Y.); Wallace v. Stable Road Acquisition Corp. et al. 19-cv-10193 (S.D.N.Y.); Meissner v. RMG Acquisition Corp., et al. (SDNY 20-cv-9872); Martinez v. Tortoise Acquisition Corp. et al. 20-cv-7595 (S.D.N.Y.). Eight of these suits have been voluntarily dismissed to date: Churchill, Boxwood, Chardan, Greenland, Black Ridge, Hennessy, RMG, and Tortoise.
10 Kaul v. Clover Health Investments, Corp., et al., 3:21-CV-00101 (M.D. Tenn.); In re Akazoo S.A. Sec. Litig., 20-cv-1900 (E.D.N.Y.); Welch v. Meaux et al., 2:19-CV-1260 (W.D. La.).
12 This alleged misalignment of interest is commonly alleged by plaintiffs in securities litigations arising out of private equity deals.
13 These include suits related to SPAC transactions involving MultiPlan (Srock v. MultiPlan Corp. f/k/a Churchill Capital Corp. III et al., 1:21-cv-01640 (S.D.N.Y.); Clover Health Investments Corp., (Kaul v. Clover Health Investments, Corp., et al., 3:21-CV-00101 (M.D. Tenn.)); Immunovant, Inc. (Pitman v. Immunovant, Inc. et al., 1:21-cv-00918 (E.D.N.Y.)); QuantumScape, Corp., (Malriat, et al. v. QuantumScape Corp., et al., 21-CV-00058 (N.D.Cal.)); Triterras, Inc., (Ferraiori, et al. v. Triterras, Inc., et al., 20-CV-10795 (S.D.N.Y.)); Nikola, Corp., (Borteanu, et al. v. Nikola Corp., et al., 20-CV-01797 (D. Ariz.)); Akazoo, Ltd. (In re Akazoo S.A. Sec. Litig., 20-cv-1900 (E.D.N.Y.)); Waitr Inc. (Welch v. Meaux et al., 2:19-CV-1260 (W.D. La.)), and Alta Mesa Resources (In re Alta Mesa Resources, Inc. Sec. Litig., 19-cv-00957 (S.D.Tex.)).
14 See Srock v. MultiPlan Corp. f/k/a Churchill Capital Corp. III et al., 1:21-cv-01640 (S.D.N.Y.); Kaul v. Clover Health Investments, Corp., et al., 3:21-CV-00101 (M.D. Tenn.); Borteanu, et al. v. Nikola Corp., et al., 20-CV-01797 (D. Ariz.); and In re Akazoo S.A. Sec. Litig., 20-cv-1900 (E.D.N.Y.).
15 See Kaul v. Clover Health Investments, Corp., et al., 3:21-CV-00101 (M.D. Tenn.); Borteanu, et al. v. Nikola Corp., et al., 20-CV-01797 (D. Ariz.); In re Alta Mesa Resources, Inc. Sec. Litig., 19-cv-00957 (S.D.Tex.).
16 See Chaplin v. Social Capital Hedosophia Holdings Corp. III, et al, Index No. 655802/2020 (N.Y. Sup. Ct.); Hutchings, et al. v. Churchill Capital Corp III, et al., 20-CV-06318 (S.D.N.Y.).
17 Cyan, Inc. v. Beaver Cty. Employees Ret. Fund, 138 S. Ct. 1061 (2018). For a further discussion see Dropbox Becomes Third California Superior Court Decision To Enforce Delaware Corporations' Federal Forum Provision For Securities Act Lawsuits Seyfarth Shaw LLP, (Dec. 8, 2020).
Originally Published by Seyfarth Shaw, March 2021
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