In my review of SPAC-related litigation on this site, I have mostly focused on SPAC-related securities litigation. However, there have been other types of SPAC-related lawsuits filed, including SPAC-related breach of fiduciary duty direct actions filed in Delaware courts (as discussed for example here). On January 3, 2022, Delaware Vice Chancellor Lori W. Will entered an opinion in one of these direct action breach of fiduciary duty cases – the closely-watched MultiPlan action – denying the defendants’ motion to dismiss and holding that though Delaware courts “have not previously had an opportunity to consider the application of our law in the SPAC context,” well-established Delaware legal principles led the court “despite the novel issues presented” to conclude that the plaintiffs have pleaded “viable, non-exculpated claims against the SPAC’s controlling stockholder and directors.”
As discussed below, the court’s ruling is a landmark ruling addressing governance concerns relating to potential conflicts of interest between a SPAC’s sponsors and directors and officers and its public shareholders. A copy of the January 3, 2022 opinion can be found here.
Churchill Capital Corp. III (“Churchill III”) is a Special Purpose Acquisition Corporation (SPAC) that completed an IPO on February 14, 2020. The IPO was sponsored by M. Klein and Company, a financial services firm headed by Michael Klein, who has been, according to the Delaware complaint, a “serial sponsor of SPACs.”
On July 13, 2020, Churchill III announced that it had entered into an agreement to merge with MultiPlan Corp., a data analytics firm that provides services to the U.S. healthcare industry. Its customers include, among others, large national insurance companies. Upon completion of the transaction, the merged company was to be known as MultiPlan. In an October 7, 2020 vote, Churchill III shareholders approved the merger.
On November 11, 2020, short seller Muddy Waters Research published a report entitled “MultiPlan: Private Equity Necrophilia Meets The Great 2020 Money Grab” (here). Among other things, the Muddy Waters report claimed that at the time of the merger, MultiPlan was in the process of losing its largest client, UnitedHealthcare, which, the report claimed, could cost the company about 35% of the company’s revenues and 80% of its levered free cash flow in the next two years. The report further claimed that United Healthcare had launched a competitor, Naviguard, to reduce its business with MultiPlan. MultiPlan’s share price declined on this report.
The Delaware complaint purports to be filed on behalf of a class of stockholders who held Churchill stock between the “Record Date” (September 14, 2020) and the merger “Closing Date” (October 8, 2020). The complaint asserts claims against the former directors and officers of Churchill (including Michael Klein); Klein and his financial vehicles, as well as the related entity that sponsored the SPAC, as the SPAC sponsors; and a related Klein Group, an entity affiliated with Michael Klein, and which performed advisory services in connection with Churchill’s merger with MultiPlan.
The complaint alleges that Klein and the Churchill directors and officers had founder shares and ownership interests that provided massive financial incentives for them to seek and to approve a deal – any deal – and alleges further that even a bad deal for the SPAC’s public investors “would yield massive windfalls to holders of their shares.” The board, the complaint alleges “did not bother retaining their own independent third-party financial advisor,” but instead “retained Michael Klein’s own vehicle, Klein Group, thus transferring a $30.5 million ‘advisory fee’ to M. Klein on top of his founder shares windfall.”
The complaint alleges that before the merger deal was announced, MulitPlan’s largest customer has disclosed its intentions to create an internal operation to provide the services it previously acquired from MultiPlan. The complaint alleges that the disclosures in advance of the merger were deficient owing to the failure to disclose that the customer was setting up a competing operation.
The complaint alleges that the “entire fairness standard applies to this deeply conflicted Merger.” And that in light of the “conflict-laden structure” of the SPAC and the “manner in which Michael Klein and the Board acted with respect to those conflicts and the deal process in general, the Merger cannot meet the test of entire fairness.”
The complaint asserts claims for breach of fiduciary duty against the director defendants and against the officer defendants; a claim for breach of fiduciary duty against Michael Klein and his related entities (the “controller defendants”) for breach of fiduciary duty; and a claim for aiding and abetting breach of fiduciary duty against the Klein Group, the Klein affiliated entity that received the advisory fee in connection with the transaction.
The defendants filed motions to dismiss the complaint.
The January 3, 2022 Opinion
In a detailed 61-page opinion, Vice Chancellor Will largely denied the defendants’ motion to dismiss, although she granted the dismissal motion as to Churchill’s CFO. She also dismissed Multiplan Corporation itself, noting that the complaint did not name the company as a defendant to any count in the complaint.
At the outset, Vice Chancellor Will observed that the parties’ arguments “center around the unique characteristics of a SPAC,” adding the further observation that “Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context.” Applying what she described as “well-worn fiduciary principles,” Vice Chancellor Will reached several conclusions.
First, she concluded that the plaintiffs’ claims were direct, not derivative, meaning that that the plaintiffs were not required to satisfy the demand futility requirements for pleading a derivative claim. In reaching this conclusion, she emphasized that the shareholder plaintiffs, who claimed that their decision whether or not to exercise their redemption rights was impaired by the omission of material information, suffered a harm independent of and not shared with Churchill. She also noted that the plaintiffs sought money damages for the class, and that the class, rather than Churchill would receive the benefit of any recovery. She also rejected the defendants’ argument that the plaintiffs’ claims were contractual, and therefore could not be asserted under a breach of fiduciary duty theory.
Second, she concluded that the “entire fairness standard of review applies due to inherent conflicts between the SPAC’s fiduciaries and public stockholders in the context of a value-decreasing transaction.” Her conclusion that the “entire fairness” standard applies, rather than the business judgment rule, is significant because the “entire fairness” standard is Delaware’s “most onerous standard of review.” Indeed, in analyzing the plaintiffs’ claims, Vice Chancellor Will noted that “it is rare that a court will dismiss a fiduciary duty claim … when entire fairness is the governing standard of review.”
In concluding that the entire fairness standard applied, Vice Chancellor Will concluded that because the controlling shareholder (Klein) stood to receive a “unique benefit” from the transaction, he “effectively competed” with the public shareholders and was incentivized to discourage redemptions. Though his incentives were disclosed, the particulars of the transaction were not.
In support of her conclusion that the entire fairness standard applied, Vice Chancellor Will also concluded that the board was conflicted because of the financial benefits the board stood to obtain of the transaction was completed. In essence, because they were compensated in founders’ shares, their interests aligned with those of the Sponsor. Vice Chancellor Will also concluded that the plaintiffs had sufficiently alleged that the board was not independent of the Sponsor, owing to their long-standing financial relationships with the Sponsor and their prospects for participating in other future, potentially lucrative SPAC transactions with Klein.
Third, applying “entire standard” review to the plaintiffs’ allegations concerning the transactions, she held that the plaintiffs have “pleaded viable, non-exculpated claims against the SPAC’s controlling stockholder and directors.” In reaching this conclusion, she observed that the complaint sufficiently alleges that the “director defendants failed, disloyally, to disclose information necessary for plaintiffs to knowledgeably exercise their redemption rights.”
In reaching these conclusions, Vice Chancellor Will acknowledged that “many of the features [of the transaction] that I consider in this opinion are common to SPACs,” and that “the mismatched incentives relevant here were known to public stockholders who chose to invest in the SPAC.” She emphasized that what was critical in this circumstance is that, according the plaintiffs’ allegations, the “stockholders were allegedly robbed of their right to make a fully informed decision about whether to redeem their shareholder.” Thus, it was not the supposed conflicts alone that led to the dismissal denial; it was the allegedly conflict-caused withholding of information in advance of the transaction.
In a paper published late last fall (and discussed here), Stanford Law Professor Michael Klausner and NYU Law Professor Michael Ohlrogge, discussing the issues raised in the motion to dismiss in the MultiPlan litigation in Delaware, said that this case had the potential to be “groundbreaking,” and indeed, the decision as written by Vice Chancellor Will arguably is indeed groundbreaking.
For starters, it applies Delaware fiduciary duty standards in the context of SPAC entities, presenting considerations that the Delaware’s courts had not previously addressed. More importantly, Vice Chancellor Will concluded, based on the specific allegations presented, that the “entire fairness” standard applied to her review of the plaintiffs’ allegations, a conclusion that, as Vice Chancellor Will noted, has important implications for the outcome of the motion to dismiss. Simply put, dismissal motions considered under the entire fairness standard are much less likely to be granted, a consideration that has important implications for plaintiffs in deciding which litigation vehicle to use in pursuing claims against a SPAC.
At a certain level, the outcome of Vice Chancellor Will’s dismissal motion analysis might be interpreted to suggest that the plaintiffs’ lawyers might now have incentives to pursue the type of direct-action breach of fiduciary duty claims alleged here – perhaps even instead of filing a securities class action lawsuit, or in addition to a securities claim that another set of plaintiffs’ attorneys might have filed.
However, Vice Chancellor Will was very conscious of this possibility, and she went out of her way in her opinion to emphasize that even though supposed conflicts of interest between the Sponsor and a SPAC’s public shareholders are a common feature of SPAC structures, that was not why she concluded that the entire fairness standard applied here. Indeed, she emphasized that the “mismatched incentives relevant here were known to public stockholders who chose to invest in the SPAC.” It was not the conflicts of interest alone that created the concern, but rather that the stockholders were “robbed of their right to make a fully informed decision,” and that the board was financial conflicted and lacked independence.
She expressly noted that the plaintiffs’ claims are viable “not simply because of the nature of the transaction or resulting conflicts,” but rather because the plaintiffs had sufficiently alleged that the defendants had acted “disloyally” in failing to disclose the necessary information for plaintiffs to exercise their redemption rights.
Vice Chancellor Will emphasized that her conclusions do not address “the validity of a hypothetical claim where the disclosure is adequate and the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure.”
What made these claims viable was not the mere conflict inherent in the SPAC structure but rather the omission of information that impaired the stockholders’ redemption rights. Thus, it is not going to be every SPAC-related breach of fiduciary duty claim that will survive dismissal based on the standards Vice Chancellor Will applied; only those cases with sufficient allegations will survive. These considerations must be taken into account in assessing the extent to which plaintiffs’ lawyers may launch a race to pursue these kinds of direct action breach of fiduciary duty claims in Delaware.
That said, there are undeniably a series of important conclusions in Vice Chancellor Will’s opinion that could be important for plaintiffs’ lawyers filing these kinds of claims or considering whether to decide these kinds of claims. Her conclusion that this lawsuit is a direct and not a derivative action is important because it obviated the need for the plaintiffs to have plead demand futility. Her conclusion that the plaintiffs’ claims are not contract claims avoided that the defendants’ contention that the plaintiffs could not assert fiduciary duty claims for were merely alleged contract breaches. Her conclusion that the plaintiffs’ claims were not mere “holder” claims – that is, that supposed omissions caused them to hold their securities – because the plaintiffs alleged that they had been misled in connection with an investment decision (that is, whether to redeem or to invest in the ongoing enterprise) is also significant. All of these issues will be important in connection with other SPAC-related direct actions in which the plaintiffs assert breach of fiduciary duty claims.
There are a number of other considerations that also should be taken into account in assessing the extent of the implications of Vice Chancellor Will’s opinion. The first is that the ruling is first and foremost a reflection of Delaware law. Not all SPACs are Delaware corporations. Indeed, as time has gone by, increasing numbers of SPACs (particularly those involving sponsors based outside the U.S.) are organized under the laws of Cayman Islands or of other jurisdictions. Vice Chancellor Will’s opinion may or may not have relevance in future SPAC-related lawsuits alleging breaches of fiduciary duty under the laws of jurisdictions other than Delaware.
It is also noteworthy that a critical element in the underlying allegations in this SPAC-related lawsuit involve factual allegations first raised in a short seller’s report. Short seller reports have proven to be a significant factor in many of the SPAC-related lawsuits that have been filed. Indeed, as I noted in my year-end survey of top D&O stories in 2021, 14 of 31 (45%) SPAC-related securities class action lawsuits filed in 2021 involved allegations based on short-seller reports. The defendants in this case had tried to argue that the court should give little weight to the allegations derived from the short-seller’s report, contending that the report itself had been “shown to be false” and that the firm that issued the report had been accused of market “deception.” Vice Chancellor Will rejected these contentions, noting that the arguments relied on material from outside the complaint that could not be taken into account at the motion to dismiss stage. The way these issues played out here may suggest that plaintiffs in other cases may also be able to rely on allegations from short-sellers’ reports, at least for purposes of trying to survive a motion to dismiss, which could have important implications in other SPAC-related lawsuits that have been filed.
There is another aspect of the allegations in this complaint that are important to consider, and that is the fact that the only defendants in the lawsuit are the SPAC, the SPAC sponsor, the SPAC directors, the SPAC controlling shareholder, and the SPAC controlling shareholder’s financial vehicle. The directors and officers of the target company and of the go-forward company were not named as defendants. (The go-forward company was named as nominal defendant but dismissed out because there are no substantive claims against the company.) In addition, the claimants in the case are SPAC investors only. Investors in the target company or the post-merger company are not a part of this lawsuit. All of these factors are worth considering because there is often confusion on the part of SPAC founders and officials about where liability and litigation risk may reside; this case shows that there is liability risk within and for the SPAC.
I want to emphasize that this is lawsuit against the SPAC organizers and officials, and it is a lawsuit about the SPAC itself. I emphasize this because some people I have spoken with about SPACs have tried to suggest to me that the SPAC-related lawsuits to date are really not about SPACs at all but really are about the activities and actions of the target company or the go-forward post-merger company. To those who have tried to make the argument to me, I say: take a look at the complaint in this action and at Vice Chancellor Will’s opinion. This lawsuit is about the SPAC, not about the target or the post-merger company.
Vice Chancellor Will’s opinion does have important risk-management implications for directors and SPAC officials seeking to reduce or eliminate the risk of potential liability in this type of litigation. In particular, Vice Chancellor Will’s opinion does suggest there are steps SPAC executives can take to try to minimize the risk that the SPAC’s directors could be found to have a conflict of interest or to lack independence from the SPAC’s sponsors. Well-advised SPACs seeking to avoid the kind of scrutiny and concern that was applied to this SPAC will structure directors’ compensation so that the directors are compensated not in sponsors’ shares but rather in cash or in securities that align their interest with those of the public shareholders. In addition, in constituting their boards, SPACs would be well-advised to avoid board candidates who have long term financial relationships with the SPAC sponsors or who stand to benefit from the SPAC sponsor’s other activities. (For more about these risk management considerations, please refer to the law professors’ paper to which I referred above, as discussed here.)
Indeed, these considerations about board avoidance of conflicts of interest and board independence have important implications for D&O underwriters’ consideration of SPAC transactions. D&O underwriters will want to look closely at how the SPAC directors are compensated and will want to look closely at the extent of the directors’ financial interconnection with the SPAC sponsor. The key is to assess the ability of the directors to act independently and in the best interests of the public shareholders.