On January 4, 2023, Delaware Vice Chancellor Lori Will denied the defendants’ motion to dismiss in the breach of fiduciary duty case a shareholder of the SPAC, Gig Capital3 Inc. (Gig3), against the SPAC’s sponsor and its board of directors in connection with the SPAC’s May 6, 2021, merger with Lightening eMotors. Essentially, the plaintiff alleged that the defendants withheld information about the dilutive impact of the transaction on the cash value of the investors’ shares, depriving the investors of the information they need to decide whether or not to redeem their shares.
In a ruling substantiating well-publicized contentions of Stanford Law Professor Michael Klausner about SPACs’ structural flaws (doubly noteworthy because Klausner acted as co-counsel for the plaintiff in the Gig3 case), Vice Chancellor Will denied the defendants’ dismissal motion, raising questions about whether similar allegations could be raised against a host of other SPACs, as discussed below. A copy of Vice Chancellor Will’s opinion can be found here.
GigCapital3, 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.
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.
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 defendants moved to dismiss the plaintiff’s complaint, arguing not only that the action was in the nature of a derivative action that than a derivative action, and that it also was an impermissible “holder” action, but also that the defendants’ alleged conflicts had been disclosed and that defendants had not adequately pled a breach of fiduciary duty claim.
The January 4, 2023 Opinion
In her January 4, 2023 Opinion, Vice Chancellor Will denied the defendants’ motion to dismiss, holding that based on the plaintiff’s allegations “it is reasonably conceivable that the defendants breached [their] duties by disloyally depriving public shareholders of information material to the redemption decision.”
In reaching this conclusion, Vice Chancellor Will relied in significant part on her prior dismissal motions denial in the MultiPlan case (discussed at length, here). As a preliminary matter, and consistent with the MultiPlan decision, she ruled that the plaintiff’s claims were direct rather than derivative and that they plaintiff was not asserting a “holder” claim. She also noted that many of the allegations in this case were similar to those in the MultiPlan case, noting however that where the cases differed was “in the manner in which the stockholders’ redemption rights were allegedly compromised.”
Essentially, Vice Chancellor Will summarized, the Gig3 complaint alleged that the defendants were incentivized to undertake a value-decreasing transaction because it led to colossal returns on the Sponsor’s investment, without regard to whether the public shareholders were better served by liquidation, and that by providing inadequate disclosures about the merger the defendants could discourage redemptions and ensure greater deal certainty.
In assessing the plaintiffs’ allegations, Vice Chancellor Will applied the entire fairness standard. Upon review of the allegations in light of this standard she noted, based on plaintiffs’ allegations of the sizeable difference between the $10 of value per share that the Gig3 stockholders expected and Gig3’s net cash per share after accounting for dilution and dissipation of cash, that this is information that a reasonable investor would consider important in deciding whether to redeem or invest. If, as the plaintiff alleges, Gig3 had less than $6 per share to contribute to the merger, “the Proxy’s statement that Gig3 shares were each worth $10 per share was false – or at least materially misleading.”
By the same token, the information that the investors were given about the target company consisted of “lofty projections that were not counterbalanced by impartial information,” adding that “shareholders were kept in the dark about what they could realistically expect from the combined company.” Given the allegations, “it is reasonably conceivable that the Board deprived Gig3’s public shareholders of an accurate portrayal of Lightning’s financial health.
In short, Vice Chancellor Will concluded that the plaintiff had sufficiently pleaded that the Proxy “contained material misstatements and omitted material, reasonably available information.” She could not, she concluded “conclude that the transaction with the product of fair dealing.”
It is important to recognize that this case’s survival of the motion to dismiss follows the prior dismissal motion survival of the MultiPlan case, the two rulings together representing a short but significant track record that suggests the promising potential (from the plaintiffs’ perspective) of these kinds of Delaware SPAC-related direct action breach of fiduciary duty suits. It is significant, in that regard, that after the motion to dismiss in the MultiPlan case, the case subsequently settled for $33.75 million.
I know I am not alone in speculating on what the case might mean for the prospects for the plaintiffs in other kinds of cases raising similar allegations. The reason I know I am not alone is that, following Vice Chancellor Will’s decision in this case, at least one news report appeared asking that very question. Roy Strom’s January 13, 2023, Bloomberg column entitled “SPAC Defenders Fear Professor’s Victory Means Lawsuit Gold Rush” (here), expressly asks the question whether the plaintiff’s success in this case, and in particular the success of Professor Klausner’s theory about the misleading nature of the SPAC’s undisclosed diluted cash value in connection with merger transactions, could open the floodgates to similar claims.
In his article, Strom notes that in oral argument, Vice Chancellor Will had expressly asked Klausner whether the upshot of his arguments was that there had been “a massive, industrywide breach of fiduciary duty.” Klausner reported answered that he only could speak about the three cases in which he as directly involved (that is, the one involving Gig3, plus one involving Gig2 and another involving Pivotal Investment Corp.), saying further that he does not expect the courtroom to be “flooded with lawsuits.”
However, the article goes on to quote defense counsel, including defense counsel in the Gig3 case, that the ruling could “lead to a deluge of lawsuits.” Another defense lawyer is quotes as saying that the decision “will be the full employment act for lawyers and judges in Delaware.”
It certainly is true that Klausner’s academic research, published independently of his activity in this case, relates to the basic structure of SPACs – the structure of Gig3 was not unique or even unusual. To be sure, it may be that the undisclosed dilution of the share price cash value was distinctive in the Gig3 case; however, the point of Klausner’s research was that the cash value dilution was not a standard part of SPAC transaction disclosures.
Strom’s article quotes one defense side commentator as saying about the Gig3 allegations that “if that’s a viable disclosure claim, every SPAC has a viable disclosure claim.” Of course, making that point does not answer the question whether the dilution should have been disclosed in any particular case, and if it was not disclosed whether investors were deprived of the information they needed to make an informed redemption decision. If there were to be further cases based on this undisclosed dilution theory, they could provide further insight into what degree of undisclosed dilution is sufficient or some other threshold that could make the non-disclosure material.
Strom’s article concludes by quoted Stanford Law Professor Joseph Grundfest as saying whether there could be a host of other cases proceeding on this theory will depend a lot on whether or not prospective lead plaintiffs will come forward and whether or not there are sufficient other cases big enough to support big damages. Grundfest is quoted as saying “If the plaintiffs’ base can find the sweet spot – a cohort of plaintiffs who have standing combine with SPACs that will generate sufficient damages – then there is more business here,” adding that “the larger the settlement, the more litigation we can expect.”
It is worth noting that the Gig3 defendants may well appeal Vice Chancellor Will’s opinion. In the meantime, I leave you with this closing thought – Strom’s article quotes one commentator as saying that “Every plaintiff lawyer is going to stare at SPACs, and when they’re trading at less than $10 a share, you can bet they’re going to bring copycat lawsuits.”