According to the latest statistics from SPACInsider, there are currently over 580 SPACs seeking merger partners. Financial media reports have already speculated that many of the searching SPACs may not find a suitable merger partner within the applicable search period. One concern from this combination of circumstances is that some SPACs may feel pressure to do whatever they have to do to complete a deal, any deal. As I have noted in prior posts, deals completed under these kinds of circumstances can later subject the SPAC managers to scrutiny and perhaps even litigation.
In a Delaware Chancery Court lawsuit brought by former public shareholders of a SPAC against the former directors and officers of the SPAC and others alleging that the SPAC officials, in their push to complete a deal, misrepresented the target company as a U.S.-based manufacturer of electric vehicles, when, the plaintiff shareholders allege, the company was in fact just a vehicle dealer that buys Chinese electric vehicles that the company rebrands as its own. As discussed below, this new lawsuit may illustrate one of the kinds of circumstances in which many of the currently searching SPACs could fall.
Forum Merger III Corp., a special purpose acquisition company (SPAC), completed its IPO on August 18, 2020. On December 10, 2020, Forum Merger III Corp. announced its plans to merge with Electric Last Mile, Inc. The two companies completed their merger on June 25, 2021, with Electric Last Mile Solutions (ELMS, or the Company) as the surviving publicly traded company.
In a February 1, 2022 press release (here), the Company announced that its CEO and co-founder, James Taylor, and its Chairman and co-Founder, Jason Luo, had resigned from their positions at the Company. The press release stated that these departures followed an investigation conducted by a Special Committee of the Board of Directors, which had been formed in November 2021, following “an inquiry into certain sales of securities made by and to individuals associated with the company.” As discussed here, the circumstances surrounding the departures of the company executives and the securities sales are the subject of a previously filed securities class action lawsuit against the company, certain of its directors and officers, as well as against certain executives of the SPAC.
The recently filed Delaware Chancery Court lawsuit, which is different from the prior securities class action lawsuit, alleges that the CEO of Forum Merger III, Marshall Kiev, was instrumental in forming a number of SPAC vehicles, including Forum Merger III. The complaint alleges that Kiev’s “modus operandi” was to “pack” the boards of the SPAC vehicles with repeat directors who shared financial interests with Kiev. Among other things, the complaint alleges, he secured these directors’ financial interests by compensating them with shares in the sponsor organizations that held all of the founders’ shares of the SPAC vehicles.
As is the case for most SPAC vehicles, the public shareholders of Forum Merger III had the right to elect to redeem their shares rather than to continue to hold their shares as ownership units in the merged company. The complaint alleges that the pre-merger disclosures to the SPAC’s public shareholders were “crucial” to shareholders in order for them to determine whether to redeem their shares; the complaint alleges that the SPAC officials, including its directors, were motivated to try to reduce the number of redemptions and for that reason misrepresented the business of the target company. The complaint alleges that the merger documents presented the target company, Electric Last Mile, Inc. (ELM), as a U.S.-based manufacturer of electric vehicles, when, in fact, the complaint alleges, it was just a dealer electric vehicles manufactured in China and rebranded as the company’s own. The complaint alleges that the merger documents further misrepresented the company’s revenue projections and financial capabilities.
On July 25, 2022, plaintiff shareholders filed a class action lawsuit in Delaware Chancery Court against Kiev and the other former directors and officers of Forum Merger III; against the sponsor of Forum Merger III; against certain of the directors and officers of ELM. A copy of the Chancery Court complaint can be found here.
The complaint asserts breach of fiduciary duty claims against the former directors and officers of the SPAC and aiding and abetting claims against certain directors and officers of ELM, as well as against the SPAC sponsor. The shareholder plaintiffs assert direct action claims on behalf of a class of investors who were common shareholders at the time of the merger.
In essence, the complaint alleges that Forum Merger defendants had financial incentives to get “any deal” done regardless of the risk. The complaint alleges further that the defendants waited until after the public shareholder redemption deadline had passed to “surprise investors with the fact that ELM was simply a dealer flipping Chinese electric vehicles, not a United States manufacturer.” The complaint alleges further that “Given that ELM’s financial projections were pure fantasy, the purported valuations based thereon were also pure fantasy.” ELM’s actual revenues, the complaint alleges, were a small fraction of the projected revenues.
This new Delaware Chancery Court lawsuit has only just been filed and it remains to be seen how it will fare. It is worth emphasizing that the allegations in the complaint are unproven and also that the defendants have not yet had a chance to respond to the allegations.
This new complaint is nevertheless interesting to me in light of the current circumstances in which hundreds of SPACs are currently searching for merger partners. In the current tough economic circumstances, it will be challenging for many of the SPACs to locate suitable merger partners. The SPAC merger transactions that are completed will face challenging operating conditions, and some of the merged companies may stumble or even fail. When the merged company’s stumble, the merger transactions will come under harsh scrutiny; disappointed investors, like the ones involved in the recently filed Delaware Chancery Court action, may try to allege that the investors only approved the soured merger transactions because they were misled.
The real danger here for everyone involved is the possibility that the parties interested in the merger may well be incentivized to portray a proposed merger transaction as advantageous in order just to get the deal done — without meaning to suggest in any way that that is in fact what happened here in connection with the ELM merger. Disappointed investors operating with the benefit of post-transaction hindsight may well try to contend that the operations and financial condition of the target company were misrepresented in order to get investors to approve a deal. All of these risks arguable are heightened where the SPAC executives are straining to try to get a deal done before the end of the applicable search period.
One important aspect of this latest lawsuit that should not be overlooked is that the primary targets of the plaintiffs’ claims are the former director and officers of the SPAC itself. I emphasize this because it is important to think about the scope and duration of SPAC officers’ potential liability exposure; this is important not just in and of itself, but also because it underscores the importance of having runoff insurance coverage in place for the former SPAC officials. It is also important to note that the defendants named in the lawsuit include the SPAC Sponsor; the SPAC sponsor may have its own coverage under the SPAC D&O policy on a co-defendant coverage or it may have standalone coverage for its own potential liabilities. The identities of the various defendants in this lawsuit and their separate interests underscore the complexity of the insurance arrangements needed in connection with SPAC transactions.