Thursday, April 22, 2021

BigLaw: "SPACs and Delaware Fiduciary Duties"

The mere fact folks are even talking about fiduciary duty in relation to SPACs is a major change from June 2020 when the world was fresh and new and associates and partners had not yet spied an opportunity.

From Sidley Austin's Enhanced Scrutiny blog, April 19:

Special purpose acquisition companies, or SPACs, are popular new tools for raising capital that have garnered significant attention and momentum over the past year.  In 2020, 248 SPAC initial public offerings raised over $83 billion in capital—more than quadrupling the number of such offerings from the previous year and eclipsing the amount of capital they raised in 2019 by $69 billion.  The amount and value of such offerings is set to grow exponentially again in 2021; as of April 1, 2021, 298 SPAC initial public offerings raised over $97 billion and an additional 247 SPACs filed for an IPO that had yet to close.

There have been few fully litigated cases relating to SPACs.  Although many of the cases that have been filed have focused on federal securities law, the nature of SPACs and so-called de-SPACing transactions also potentially implicate a host of state law issues, particularly in connection with the fiduciary duties of directors.  This article addresses several issues under Delaware law and how the unique features of SPACs may have an impact on the applicability of those rules.

Characteristics of SPACs

A SPAC is a publicly traded company created for the sole purpose of finding and acquiring an existing (typically private) company.  This is accomplished by raising capital from investors who fund the SPAC’s IPO before the SPAC has identified a specific company to acquire.  Because a SPAC is a new company with no operating business, its IPO process is considerably faster than the process for a traditional company and can be completed in as little as two to three months from the initial SPAC formation to its IPO closing.

Investors in a SPAC IPO generally receive a unit consisting of one share of redeemable voting common stock in the SPAC, as well as a fraction of a warrant to purchase common stock of the surviving public company if the SPAC achieves its goal of merging with or acquiring a private company.  This de-SPACing typically results in the conversion of a private company—often a late-stage startup with limited stockholders—into a publicly traded company, thus taking the company public without undergoing a traditional IPO process.

This provides some assurance to investors that, upon a successful de-SPACing, the value of their original investment will increase as both the common stock and the warrant increase in value.  The SPAC’s founders, called its sponsors, contribute a modest amount of capital into the SPAC for working capital purposes and in return receive a so-called “promote,” typically consisting of non-redeemable common shares worth 20% of the SPAC on a pro forma basis, along with additional warrants in the SPAC, which positions them to realize a substantial return upon the successful de-SPACing.  In addition, SPACs will also frequently use third party PIPE transactions (private investment in public equity) as a means of raising additional capital to finance the de-SPACing.

The funds that a SPAC raises from its public investors through its IPO are held in a trust account.  They can be released only to fund a de-SPACing, to be returned to investors upon the SPAC’s liquidation if it has failed to consummate a de-SPACing within typically 18-24 months, or to be returned to investors who elect to redeem their shares and take their money back at either the time of the de-SPACing or if the SPAC asks its stockholders to extend its life beyond that 18-24 month period, if necessary.

If a SPAC finds a private company with which to merge or acquire, its public shareholders will vote on the de-SPACing pursuant to a proxy statement that sets forth relevant information about the proposed transaction.  At that time, the shareholders will have an option that is entirely separate from their voting right:  to remain invested in the transaction and/or redeem their investment from the trust in full, with interest.  This is one of the defining features of today’s SPACs.

SPAC investors retain the option of simply redeeming their shares and getting their initial investment back.  They can do so even if they vote yes on the transaction in order to, for example, ensure that the de-SPACing closes and their warrants retain some potential upside value.  If the de-SPACing fails to receive approval and the SPAC eventually liquidates, then those warrants would become worthless.  Nevertheless, these transactions are typically structured as mergers, require shareholder approval, and can involve a “change of control” within the meaning of Delaware law at either the SPAC or the target level.

As such, they potentially raise issues about the traditional rules governing mergers—including the applicability of Revlon, what information needs to be provided to shareholders being asked to vote, and whether the merger agreements should include a “fiduciary out” for the target board.

Fiduciary Duties

Section 141(a) of the Delaware General Corporation Law vests directors with the exceptional authority to manage or direct the affairs of a corporation.  As a result of this authority, a familiar and fundamental precept of Delaware corporate law is that a board of directors owes fiduciary duties to the corporation and its shareholders.  See, e.g., Aronson v. Lewis, 473 A.2d 805, 810 (Del. 1984). Delaware courts sometimes describe the purpose of fiduciary duties as “maximizing the long-term value of the corporation” for the benefit of a corporation’s shareholders.  See, e.g., In re Rural/Metro Corp. Stockholders Litig., 102 A.3d 205, 253 (Del. Ch. 2014).

The notion that fiduciary duties serve to protect a corporation’s long-term value is based on the assumption that every corporation has a “perpetual life in which the residual claimants have locked in their investment.”  Frederick Hsu Living Tr. v. ODN Holding Corp., No. CV 12108-VCL, at *18 (Del. Ch. Apr. 14, 2017), as corrected (Apr. 24, 2017).....