As I have noted in prior posts (most recently here),over the last several months plaintiff shareholders have filed numerous SPAC-related securities class action lawsuits. In an interesting variant of SPAC-related litigation, a claimant has filed a post-merger SPAC-related class action lawsuit in the Delaware Court of Chancery against the former directors of a SPAC and against the SPAC’s sponsor, in which the claimant alleges the defendants breached their fiduciary duties to the pre-merger SPAC shareholders. The lawsuit has a number of interesting features, as discussed below. A copy of the plaintiffs’ August 4, 2021 complaint in the action can be found here.
Background
GigCapital 3, Inc. is a special purpose acquisition company (SPAC). Gig3’s sposnor is GigAcquisitions3 LLC. The managing member is Avi Katz. Katz is a serial organizer of SPACs. Katz was Chairman and CEO of Gig3. Gig3 completed its IPO on May 18, 2020. Gig3 completed a merger with Lightning eMotors on May 6, 2021. The go-forward company, referred to in the subsequent complaint as New Lightning, is, as a result of its merger with Gig3, a publicly traded company listed on the NYSE.
The Complaint
On August 4, 2021, a plaintiff shareholder filed a class action lawsuit in the Delaware Chancery Court. The plaintiff purchased shares of Gig3 in August 2020. The complaint purports to be filed on behalf of a class of investors who held Gig3 stock between the merger Record Date and the merger Closing Date. The complaint names as defendants GigAcquisitions3; Katz; and five other former directors of Gig3. New Lightning itself is not named as a defendant. Though Katz and two other former directors of Gig3 are directors of New Lightning, these individuals are not named as defendants in their capacities as directors of New Lightning; they are named as defendants solely in their capacities as former directors of Gig3.
The complaint alleges that Katz, as the owner and controller of the SPAC sponsor GigAcquisitions3, organized the creation of Gig3, and recruited as its directors individuals that “had multiple, long-standing relationships with Katz and his affiliated financial enterprise, GigCapital Global.” The complaint alleges that a combination of financial arrangements had the impact of aligning the directors’ interests with those of Katz and the Sponsor.
Among other things, the complaint alleges that in return for a payment of a nominal sum of $25,000, Katz caused Gig3 to issue 5 million Initial Stockholder Shares equal to 20% of Gig3’s Post-IPO equity. Although the SPAC arrangements required the SPAC to complete a merger in a specified amount of time, with the proviso that if no merger was completed in that time, the shareholders money would be returned to them, the structure of the SPAC, according to the complaint, created strong incentives for Katz and the directors to complete a merger – any merger — rather than return the funds to investors.
The complaint alleges that the redemption rights of certain investors and the dilutive impact of the various financial transactions completed simultaneously with the merger had the effect of substantially diminishing the SPAC’s per share cash value at the time of the merger. The complaint alleges that the cash value was substantially less than the $10 per share merger valuation. The complaint alleges that in order to try to justify the inflated valuation, Gig3 relied on unrealistic production and financial projections for Lightning.
The complaint alleges that once the merger was completed, “New Lightening immediately and substantially downgraded its revenue projections, and revealed details about its business models that made its meteoric projected growth implausible.” New Lightening’s share price declined and has continued to decline.
The complaint alleges that in connection with the proposed merger transactions, the defendants “provided no meaningful oversight, serving instead as a rubberstamp.” There was, in connection with the merger, “no fairness opinion and no special committee.” Instead, the “deeply-conflicted members of the Board breach their duty of loyalty by approving the Merger and its financing, and recommending the transaction to stockholders.” The Board also “failed to consider the fact that the transaction was … a far worse alternative for public stockholders than a liquidation.” Though the merger was “an abysmal deal for Gig3 public stockholders,” it was “a financial windfall for Katz, the Sponsor, inside director Dinu, and the purportedly independent directors.”
The complaint asserts three claims against the defendants: a direct claim for breach of fiduciary duty against the director defendants; a direct claim for breach of fiduciary duty against Katz and the sponsor; and a direct claim for unjust enrichment against the sponsor and the director defendants.
Discussion
This new lawsuit is interesting, but it is not unique, nor is it the first SPAC-related lawsuit of this type to be filed. As I noted in a prior post (here), in March 2021, a plaintiff shareholder filed a Delaware Chancery Court class action lawsuit against Churchill Capital Corp. III, a SPAC, in connection with Churchill III’s October 2020 merger with MultiPlan Corporation. The plaintiff in the Churchill III lawsuit, like the plaintiff in the recent Gig3 lawsuit, alleged that the SPAC board members had breached their fiduciary duties in connection with the proposed merger transaction. Both cases emphasized the financial incentives that the SPAC’s sponsor and backer had to complete a deal, even one that was poor from the perspective of the SPAC’s shareholders.
The Gig3 lawsuit, like the prior Churchill III lawsuit, takes a different litigation approach than the various other SPAC-related securities class action lawsuits that have been filed in recent months. Rather than asserting claims for alleged violations of the federal securities laws, these Delaware state court lawsuits seek damages under the common law for breach of fiduciary duty and for other common law violations. Also, as I noted in connection with the Churchill III lawsuit, the emotional center of this new lawsuit is the conflicting interests and motivations of the SPAC sponsor and founder and his “hand-picked” board by contrast to the interests of the public shareholders.
It is also interesting and important that these Delaware state court lawsuits are about the SPAC itself and the SPAC-related individuals pre-merger conduct. By contrast to the federal securities class action litigation, which often focuses on the merger target and the merger target’s post-merger conduct and performance, this lawsuit’s primary focus is the pre-merger time period; indeed, the purported class consists only of SPAC shareholders who held shares up to the time of the merger vote. Neither the post-merger company nor any post-merger company executives are named as defendants. For D&O insurance purposes, the D&O insurance program that this lawsuit will trigger is the former SPAC’s runoff D&O insurance program.
Yet another interesting feature of this lawsuit is the extent to which the complaint invites the Delaware Chancery Court to treat the lawsuit as a judicial referendum on the excesses of the SPAC frenzy and as an opportunity to lay down some markers on the legal duties of SPAC executives generally. Thus, in the its prelude, the complaint sets the tone by declaring that Gig3’s history “is part of a disturbing trend of SPAC transactions in which financial conflicts of interest of sponsors and insiders override good corporate governance and the interests of stockholders.” The complaint also states in the same section that the Gig3 transaction “failed to observe the most basic principle of Delaware corporate governance – namely that a corporation’s governance structure should be designed to protect and promote the interests of public stockholders, not the financial interests of its insiders and controllers.”
Finally, the complaint urges the Court to “take the opportunity” to “affirm that the boards and controllers of SPACs incorporated in Delaware owe the same fiduciary duties to their stockholders as do boards and controllers of any Delaware corporation, and thus put an end to the money-grabbing SPAC bonanza that has been burgeoning in recent years at the expense of the investing public.”
A further note about this lawsuit for D&O insurance practitioners is that the Gig3 SPAC’s sponsor is one of the lawsuit’s primary targets. The SPAC sponsor typically would not be an insured person under most unamended D&O insurance programs for SPACs. Under most circumstances, a SPAC sponsor named as a defendant in a SPAC-related lawsuit would have to look to its own insurance program for defense cost protection and indemnity. Which raises a separate question about the adequacy of the sponsor’s D&O insurance program and availability of insurance protection to respond to a claim of this type.
One final thought about this lawsuit is that the SPAC involved completed its IPO in May 2020. By virtue of the timing of its IPO, it qualifies as a member of the SPAC IPO frenzy class of 2020 (albeit in the frenzy’s earliest stages). For litigation trend observers, the SPAC-related litigation phenomenon is only now getting around to the SPACs that were part of the SPAC IPO wave in late 2020 and early 2021. To which I say, strap on your helmets, litigation activity levels are about to get very heavy out there.