As readers of this blog know, in the last couple of years a significant number of SPAC-related securities lawsuits have been filed, often arising after the post-merger de-SPAC company stumbles following the SPAC merger. In many of these cases, the securities suit plaintiffs often allege that the pre-merger private company made misleading statements about its business or operations, the truth about which only became apparent after the merger with the SPAC was completed.
In an interesting decision in a securities suit involving the used car consignment company CarLotz, which merged with a SPAC in January 2021, the court held that the named plaintiffs, one who purchased shares of the pre-merger SPAC and another bought shares in the post-merger de-SPAC, did not have standing under the securities laws to sue for alleged misrepresentations made by the pre-merger private company. Because this issue often comes up in SPAC-related securities suits, the court’s ruling potentially could have important implications in other SPAC lawsuits. A copy of the Southern District of New York’s March 31, 2023, order can be found here.
CarLotz is in the retail used car sales business. The company sources its used car inventory through consignment from vehicle sources (such as, for example, rental car companies). Acamar Partners Acquisition Corporation is a SPAC that completed its IPO in February 2019. In October 2020, the two companies announced their plans to merge. They completed the merger in January 2021.
In the subsequently filed securities class action lawsuit, the plaintiffs alleged that between the time the planned merger was announced and the merger’s completion, pre-Merger CarLotz made investor presentations that the plaintiffs allege contained materially false and misleading statements about the company’s consignment business model. The plaintiffs allege that following the merger, CarLotz made a series of disclosures that revealed the alleged pre-merger misrepresentations.
As discussed here, in July 2021, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against CarLotz and certain of its officers. Other related lawsuits followed. The various cases were consolidated, lead plaintiffs were announced, and the plaintiffs filed an amended consolidated complaint. Lead Plaintiff David Berger purchased shares of post-merger CarLotz after the merger closed. The other named plaintiff, Craig Bailey, purchased shares of Acamar prior to the merger. The class period runs from October 22, 2020 (the day the proposed merger was first announced) and May 25, 2021 (the day before post-merger CarLotz announced concerns relating to one if its vehicle sourcing partners).
The complaint asserts claims under both the Securities Exchange Act of 1934 and the Securities Act of 1933. The defendants moved to dismiss the action, arguing that the plaintiffs lack standing under both the ’34 Act and the ’33 Act to challenge statements made by pre-merger CarLotz.
The March 31, 2023, Order
In a March 31, 2023, Opinion and Order, Southern District of New York Judge Ronnie Abrams, granted the defendants’ motion without prejudice, on the grounds that the plaintiffs lack standing to assert the statutory claims.
The basis of the Court’s conclusion that the plaintiffs lack standing to assert Section 10(b) claims is the “purchaser-seller” rule, first developed by the Second Circuit in the early 50’s, which limits the class of plaintiffs to “actual purchasers or sellers of securities.”
This rule was developed and applied by the Second Circuit in its 2022 decision in Menora Mivtachim Insurance Ltd. v. Frutarom Industries Ltd. The Frutarom case arose out of merger between International Flavors & Fragrances, Inc. (IFF) and Frutarom. The plaintiffs were purchasers of IFF securities who alleged that prior to the merger, Frutarom made misleading statements about certain of its business practices and policies.
The Second Circuit held that the plaintiff lacked standing to sue the Frutarom Defendants for statements relating to Frutarom, because the plaintiff had never purchased or sold Frutarom securities. The appellate court said that “purchasers of a securities of an acquiring company do not have standing under Section 10b) to sue the target company for alleged misstatements the target company made about itself prior to the merger between the two companies.”
Judge Abrams agreed with the defendants in the CarLotz case that “Frutarom forecloses Plaintiffs’ challenge to any statements made by Pre-Merger CarLotz about Pre-Merger CarLotz.” The plaintiffs, Judge Abrams said, “fail to establish that they bought and sold securities about which the misstatements were made.”
The plaintiffs had argued that Frutarom creates a “loophole” for SPAC transactions, because, the plaintiffs contended, “the parties to SPAC transactions can lie with impunity” in pre-merger statements. Judge Abrams said “while the Court appreciates the policy concerns implicated by Frutarom, the Court is bound by its holding.” Judge Abrams went on to note that the Frutrarom majority considered similar policy concerns and rejected them.
Judge Abrams also ruled that the plaintiffs lacked standing to assert claims under Section 11 and 12(a)(2) of the ’33 Act, because, Judge Abrams held, t the plaintiffs failed to allege that they purchased shares traceable to the registration for the merger transaction. Judge Abrams noted that the complaint alleged that the complaint alleged that the plaintiffs bought shares in the SPAC prior to the challenged offering, and therefore Judge Abrams held that those shares could not have been traceable to the offering. Judge Abrams further rejected the plaintiffs’ argument that the merger effectively transformed the SPAC shares into shares of the newly merged company, as that did not change the applicable registration statement pursuant to which the plaintiff bought his shares.
Judge Abrams holding that neither purchasers of the pre-merger SPAC’s shares nor purchasers of the post-merger de-SPAC company have standing to sue for alleged pre-merger misrepresentations of the merger target company is interesting and could have implications for other SPAC-related securities statements. As I noted at the outset, a number of other SPAC-related securities lawsuit involve allegations that the pre-merger target company made pre-merger misrepresentations about its business operations or financial condition.
However, it remains to be seen whether other district courts would reach the same conclusion as Judge Abrams in the CarLotz case about plaintiffs’ standing concerning pre-merger statements of the merger target company.
To cite another example where these same kinds of pre-merger statements are involved, the securities class action lawsuit filed in the Northern District of California against Lucid Motors (an electric car company that was acquired by a SPAC) includes allegations that prior to the company’s merger with the SPAC, Lucid’s management made misrepresentations about the company’s operations and capabilities. After the merger was completed, Lucid disclosed that its production would fall far short of the figures cited in pre-merger statements.
The defendants in the Lucid case, like the defendants in the CarLotz case, moved to dismiss on the grounds that the plaintiffs were not purchasers of the securities of the pre-merger target company, but rather were purchasers of the securities of the SPAC or of the post-merger deSPAC., and therefore lacked standing to pursue the claims. In support of these arguments, the defendants relied on the Second Circuit’s Frutarom case.
As Lyle Roberts noted in his April 20, 2023, post on his 10b-5 Daily blog (here), the district court in the Lucid Motors case did not find the Frutarom case persuasive, among other things noting that other courts have concluded that there might be an exception to the general rule if the two companies have a direct relationship, as in a merger. However, and despite finding that standing existed, the court granted the motion to dismiss, on the grounds of lack of materiality. The court found that the alleged misleading statements were made at a time when Lucid and the SPAC had not even publicly acknowledged that a merger was being considered. Given these circumstances, the court held that alleged misstatements about Lucid could not have been material to the SPAC’s investors.
The difference between the two cases on the standing issue may reflect that the fact that the CarLotz court sits in the Second Circuit, and therefore is bound to apply Second Circuit precedent (including the Frutarom decision), which the Lucid Motors court, sitting in the Ninth Circuit, is not bound by Second Circuit precedent. The fact that the district judge in the Lucid Motors case was not persuaded by the Frutarom decision and declined to apply it raises the possibility that the claimants in SPAC suits outside of the Second Circuit may hope to establish standing to assert claims for pre-merger misrepresentations of the merger target company. Within the Second Circuit, however, Frutarom will control, and other claimants may not be able to establish standing for pre-merger statements.
The plaintiffs’ argument in CarLotz about the “loophole” that Frutarom’s standing holding creates in the context of SPAC transactions is worth considering. The plaintiffs argued that as a result of this supposed loophole, “parties to SPAC transactions can lie with impunity” – or least without fear of liability for private securities claims. However, as the Frutarom court itself noted, the target companies pursuing a potential merger could still be subject to SEC enforcement liability, shareholder derivative lawsuits, and possibly to state law securities claims. In other words, there are still potential legal deterrents to discourage “lies,” even if the private securities plaintiffs lack standing under the federal securities laws to pursue liability actions for the statements. The fact that these other legal procedures might operate to deter alleged misrepresentations is, of course, cold comfort to claimants (like the plaintiffs in the CarLotz case) that believe they were misled and who want to recover their losses they believe stem from the misrepresentations.
One final note about the CarLotz decision. Judge Abrams’s granted the motion to dismiss without prejudice. She gave the plaintiffs thirty days leave to file an amended complaint. It remains to be seen whether the plaintiffs will file an amended complaint or whether any amended complaint the plaintiffs do file could cure the shortcomings of their prior complaint. It is not obvious how the plaintiffs could address the standing issues in an amended complaint; they can’t change the situation about which shares they bought. But, at least for now, Judge Abrams’s ruling is not final.