The financial press is already reporting that many of the nearly 600 SPACs currently searching for merger targets may be unable to find suitable merger targets. Indeed, famous investor Bill Ackerman, unable to find a suitable merger target for his largest-ever SPAC, Pershing Square Tontine Holdings, has already thrown in the towel and liquidated the $4 billion SPAC. With hundreds of SPACs facing the end of their search period in this and the next two quarters, there are likely to be many other SPACs that choose to liquidate in the coming months.
One question I have had about this likelihood is whether or not there is a risk of litigation as SPACs redeem investors’ shares. On the one hand, litigation seemingly should be unlikely as investors are getting their money back. Where’s the harm? On the other hand, in our litigious society, the possibility of litigation always seems to be lurking whenever things don’t work out as planned. While the circumstances involved are very case-specific, a lawsuit filed last week in the Delaware Chancery Court, provides of an example of the kind of end-game squabble that could arise as more SPACs liquidate in the coming months.
FAST Acquisition Corp. is a special purpose acquisition company (SPAC). FAST Sponsor LLC is FAST’s SPAC sponsor. FAST completed an IPO on August 24, 2020. In February 2021, FAST negotiated an agreement to merge with two subsidiaries of Fertitta Entertainment, Inc., Golden Nugget and Landry’s, which together operate several gaming and hospitality businesses.
For reasons that are not clear from the subsequently filed lawsuit complaint, the proposed merger with Fertitta fell apart. In a December 10, 2021 filing on Form 8-K, FAST reported that it had entered in to a Termination and Settlement Agreement with Fertitta. Pursuant to this agreement, the parties agreed to mutually terminate the proposed payment in exchange for an exchange for an immediate termination payment and additional deferred payments by Fertitta.
The immediate termination payment consisted of Fertitta’s agreement to pay FAST $6 million within three business days, plus a further loan of $1 million within five business days. The deferred payment consisted, in relevant part, of Fertitta’s agreement to pay FAST $26 million by August 18, 2022 if it does not consummate an business combination by August 1, 2022 and determines to redeem its public shares and liquidate.
The subsequently filed complaint alleges that between January and June 2022, the SPAC “burned through” the initial termination fee payment in search of a new deal. In its August 3, 2022 filing on Form 10-Q, FAST disclosed that it would no longer seek a business combination and would instead wind down.
FAST also allegedly disclosed in its 10-Q that “any funds received pursuant to the [Termination Agreement] that are remaining after payment of expenses will not be part of any distributions with respect to the Public Shares.” Rather, FAST proposes that the SPAC stockholders will receive only the IPO funds currently held in trust with nominal interest less taxes. The subsequently filed complaint alleges that FAST proposes that the Termination Fee will be held in a separate account, the proceeds of which are to be distributed solely to the Sponsor.
On August 9, 2022, Special Opportunities, Inc., a FAST public shareholder filed a class action lawsuit in the Delaware Chancery Court against the FAST; FAST’s sponsor; and certain of FAST’s directors and officers. The complaint purports to be filed on behalf of all investors that hold FAST’s shares as of the date of the redemption. A copy of the complaint can be found here.
The complaint does not beat around the bush. It alleges that the defendants are “orchestrating a theft in broad daylight of $23.7 million [the amount of payments received and due net of expenses] right out of the pockets of the SPAC and its shareholders.”
The complaint alleges that the sponsor and the SPAC officers and directors “now have decided to simply walk away with the SPAC’s only valuable asset – a termination fee after its only potential dal deal fell through. A more flagrant breach of the duty of loyalty can hardly be imagined.” The complaint alleges further that FAST’s shareholders were “blindsided” by the announcement given that the termination fee previously had been described by FAST as an asset of the SPAC and of its shareholders.
The complaint seeks an injunction prohibiting the SPAC from distributing any funds other than those in the SPAC’s trust account until an order can be obtained instructing the SPAC to distribute its net assets pro rata to all shareholders. The complaint also seeks, in the alternative, claims for breach of fiduciary duty and unjust enrichment, and seeks to impose a constructive trust on the SPAC’s net assets (other than the trust account.)
On the one hand, there is not a huge track record associated with liquidating SPACs. According to SPACInsider (here), only 39 SPACs have liquidated since 2009. As I noted at the outset, however, we are likely to see a burgeoning number of SPAC liquidations in the months ahead. I have no doubt that most of these liquidations, if there are in fact liquidations on the scale that I am currently imagining, will proceed in an orderly manner and there will be few difficulties.
However, as I also noted at the outset, as I have been anticipating this possibility of an upcoming spate of liquidations, I have been worrying about the possibility that in at least some cases, problems will arise, and that some of the problems may result in litigation. To be sure, in most cases, the public shareholders will have little to complain of even if they do feel aggrieved, as they will receive their initial investment plus nominal interest net of taxes and other expenses as part of the liquidation. On the other hand, whenever things don’t work out as planned, there are going to be occasions where disputes will arise, as this case shows.
This lawsuit is a reflection of the relatively unusual circumstance that the liquidating SPAC has, in addition to the remaining IPO proceeds held in trust, a valuable asset. There may be well be other circumstances involving other liquidating SPACs that could give rise to similar squabbles. This situation and the possibility for other litigation both seem very case-specific and hard to generalize about – although there undoubtedly will be similar squabbles of various kinds that do arise in at least some liquidations.
In truth, this kind of squabble is not really the kind of lawsuit I have been worrying about as I have ruminated about whether or not the coming SPAC liquidations will result in litigation. I am more worried about the kind of fights that might erupt given the fact that in a SPAC liquidation the sponsors, founder shareholders, and warrant holders will lose the entire value of their investment. Some of these parties, perhaps especially the warrant holders, may feel particularly aggrieved, perhaps based on specific representations they may have received, and may feel sufficiently aggrieved to pursue litigation.
I have other concerns, but these, while more significant, also are less concrete. I just have these concerns about the possibility that the SPAC’s public shareholders could be sufficiently aggrieved to pursue claims. To be sure, and as I have previously noted, the public shareholders who get their money back arguably will be able to show little harm. But, as I have also previously noted, tempers sometimes rise when things don’t work out as planned. Public shareholders may feel that there was an opportunity cost to their investment that is not sufficiently compensated through the mere return of principal and payment of nominal interest. Admittedly, my concerns here are vague. Some observers may say they are imagined. But I worry just the same.
I will note that there are some features of this dispute that are noteworthy from a D&O insurance perspective. For starters, the SPAC and its directors and officers are named as defendants here, in a lawsuit that includes allegations of breach of fiduciary duty. The lawsuit is of a type that would be expected to trigger the SPAC’s D&O insurance policy, subject of course to all of the policy’s terms and conditions. However, given the self-insured retentions that were put in place during the time period when FAST completed its IPO (that is, in the many millions of dollars range), expenses incurred in defense of this claim may not reach the insurance and instead would fall entirely within the retention.
Another potential insurance issue here is that the claim pertains to amounts to which the defendants allegedly are not legally entitled — and so the question of the applicability of the improper profit exclusion may arise. However, this suit does not seek the return of amounts to which the defendants are not legally entitled but rather to prevent to payment of such amounts, or, in the alternative, to recover damages for the alleged breach of fiduciary duties.
Moreover, the improper profit exclusion in many current policies only applies in the event the payments are found, after adjudication, to be found to be improper, and typically does not apply to defense expense, so the exclusion is unlikely to come into play. The fact that the Sponsor is named as defendant is also relevant; in some SPAC D&O policies, the Sponsor is an additional named insured but only on a co-defendant basis. Since the Sponsor is named here, the co-defendant coverage, if applicable, potentially could come into play.
All of these potential D&O insurance issues, and indeed the existence of this pre-liquidation claim against a SPAC and its directors and officers, shed some interesting light on the scope of the potential liabilities under a SPAC D&O insurance policy. I suspect there will be further insights of this kind as the likely liquidations in the coming months unfold.