MultiPlan decision focuses scrutiny on SPAC merger disclosures

In a closely watched case, the Delaware Court of Chancery recently denied, in significant part, motions to dismiss a complaint filed by stockholders of a special purpose acquisition corporation (SPAC) alleging that its fiduciaries had not disclosed information material to the stockholders’ decision whether to redeem their shares in connection with a business combination with an operating company (its “de-SPAC” merger). In the case, captioned In re MultiPlan Corp. Stockholders Litigation, C.A. No. 2021-0300-LWW, Vice Chancellor Lori Will dismissed claims against the target company and its CFO but denied motions to dismiss claims against all other defendants, including the SPAC’s directors and its allegedly controlling stockholder.

This is the first case from the highly respected Court of Chancery applying traditional fiduciary duty principles in the context of a de-SPAC merger. The court was careful to emphasize that its decision was informed primarily by the well-pled allegations of disclosure failures about the target company, rather than any inherent characteristics of a SPAC or a de-SPAC merger. Nevertheless, statements in the opinion concerning allegedly conflicting financial incentives between a SPAC’s fiduciaries and public stockholders heighten the risk of enhanced scrutiny for future business combinations involving SPACs.

Organizers of SPACs and participants in de‑SPAC transactions should bear in mind the court’s comments in their dealings and disclosures.

Background

Churchill Capital Corp. III was a SPAC, a specific type of “blank check” company that raises capital through an initial public offering for the purpose of seeking to identify and merge with a private operating company. Most of the capital raised is held in trust until such a business combination occurs. Churchill III was one of several SPACs founded by Michael Klein, who allegedly maintained exclusive control to appoint the company’s board of directors and also allegedly controlled the sole stockholder of the sponsor entity (the “Sponsor”) for the SPAC.

In Churchill III’s February 2020 IPO, public stockholders purchased 110 million units, with each unit comprised of one share of Class A common stock and a fractional warrant, at $10 per unit. The charter provided a 24-month period for the company to complete a business combination transaction and, as is typical for SPACs, provided public stockholders the right to redeem their shares at the $10 IPO price plus interest at the time of such a transaction. If they did not redeem, their shares would be converted in the merger into shares of the surviving company.

Klein, the Sponsor, and the members of the SPAC board of directors received shares of Class B common stock (known as “founder shares”) or interests in such shares. If a business combination was completed within the 24‑month period, the founder shares would convert into shares of Class A common stock at a one-to-one ratio. If not (and the period was not extended), public stockholders would recoup their investment plus interest in a liquidation, but the founder shares would expire worthless.

Five months after Churchill III’s IPO, the board approved a merger with MultiPlan, Inc., a healthcare industry-focused provider of data analytics and cost management solutions. Churchill III issued a definitive proxy statement to solicit stockholder approval of the merger. The proxy statement informed stockholders that they could redeem their shares at the $10 price plus interest even if they voted against the merger. It also stated that unless a stockholder voted on the merger (either for or against), it could not redeem its shares. Separately, as part of its description of the proposed transaction, the proxy statement disclosed that MultiPlan depended on a single customer for 35 percent of its revenues.

Fewer than 10 percent of Churchill III’s public stockholders exercised their redemption rights, and a majority of stockholders voted to approve the merger.

One month after the merger closed, an equity research firm published a report asserting that the 35 percent customer identified, but not named in, the proxy statement (UnitedHealthcare) intended to create an in-house data analytics platform that would compete with MultiPlan and eliminate its need for MultiPlan’s services. MultiPlan’s stock price dropped, and a few months later two stockholders filed class action complaints alleging breaches of fiduciary duty by Churchill III’s directors, officers, and Klein as controlling stockholder, based on the alleged failure to disclose the imminent loss of the UnitedHealthcare business.

The Court of Chancery decision

In moving to dismiss, the defendants argued that their decisions were protected by the business judgment rule, which is a presumption that directors who are fully informed and have no conflicts of interest act in the best interests of the company when making a business decision. The plaintiffs argued that the business judgment rule was inapplicable and that the different financial incentives between the defendants and public stockholders created conflicts of interest that subjected the claims to review under the entire fairness standard, under which defendants must show that both the process followed and the price obtained in a transaction were entirely fair.

In the opinion, the court first rejected three preliminary arguments raised by the defendants. The court held that plaintiffs’ claims had been properly styled as direct rather than derivative claims because they centered around alleged impairment of stockholders’ exercise of their redemption right, which was an alleged harm independent of and not shared with the company. The court also disagreed with defendants’ argument that the claims were for breach of contract, as opposed to breach of fiduciary duty, based on the fact that the redemption right was provided for in Churchill III’s certificate of incorporation. The court held that the obligation to disclose all material information about the proposed merger arose from the directors’ fiduciary duties, not from any contractual obligations. The court also concluded that the claims were not “holder claims” under Delaware corporate law, which are subject to limitations, including an inability to proceed as a class action, because stockholders were presented with a choice to divest or remain invested in the post-merger entity, which was “an active and affirmative choice.”

After addressing these threshold issues, the court turned to the applicable standard of review. The court agreed with the plaintiffs that the entire fairness standard should apply because of the structural conflicts – but that conclusion was inextricably linked to the specific and very unique facts alleged.

First, the founder shares held by the defendants would be worthless if Churchill III did not complete a business combination, meaning that even a bad deal would be better for them than no deal at all. At the same time, public stockholders would benefit from a transaction only if the share price subsequently rose.

Second, because consideration for any transaction was reliant upon the IPO proceeds, the court concluded that “Klein effectively competed with the public stockholders for the funds held in trust and would be incentivized to discourage redemptions if the deal was expected to be value decreasing, as the plaintiffs allege.”

Finally, the court concluded that the plaintiffs had sufficiently alleged conflicts based on allegations that Klein appointed the other directors, retained unilateral power to remove them, and had placed several of them on other SPAC boards. For these reasons, the court concluded that plaintiffs had alleged sufficient facts to rebut the business judgment rule.

The court acknowledged that the differing economic incentives between the two classes of stock were fully disclosed before the IPO, but concluded that the defendants had a duty to disclose all material information relating to a future business combination and that the complaint had adequately alleged misstatements and omissions in the proxy statement concerning MultiPlan’s business and prospects – namely, omitting information regarding the intention of the 35 percent customer.

Having addressed the allocation of burdens, the court held it was reasonably conceivable that a public stockholder would have considered the information regarding the risk that MultiPlan would soon lose the business of its largest customer to be material to that stockholder’s decision whether to redeem and that Churchill III’s failure to disclose that information suggested a lack of overall fairness sufficient to permit discovery and further proceedings on plaintiffs’ claim for breach of fiduciary duty.

What does the court’s ruling mean in practical terms?

The MultiPlan opinion emphasized the importance of the specific allegations to the court’s conclusions:

“Critically, I note that the plaintiffs’ claims are viable not simply because of the nature of the transaction or resulting conflicts. They are reasonably conceivable because the Complaint alleges that the director defendants failed, disloyally, to disclose information necessary for the plaintiffs to knowledgeably exercise their redemption rights. This conclusion does not address the validity of a hypothetical claim where the disclosure is adequate and the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure.”

The court thus left for another day the question of whether the structural incentives inherent in SPACs would be sufficient on their own to permit a claim to proceed for alleged breach of fiduciary duty in a de-SPAC merger.

The court could have based its decision solely on the structural incentives built into the SPAC structure, but did not. Instead, the court emphasized that it was not reaching such a conclusion and based its decision on the totality of the unique facts and disclosure issues presented.

This should be viewed with some significance. A fair reading of MultiPlan is that the structural incentives in SPACs standing alone will not be enough to state a viable cause of action and that the structural incentives can be seen as an attractive part of the entity structure. The unique structure itself aligns all of the interests with the equally unique purpose of a SPAC, which is to seek out and consummate an attractive merger. In other words, the unique SPAC structure is an attribute of, rather than an inherent defect in, the entity. With full disclosure of material facts, the redemption right essentially eliminates the downside risk to public stockholders from any alleged conflicts created by the structure of a SPAC, leaving investors uniquely poised to benefit from a de-SPAC transaction.

The business judgment rule developed under Delaware law because courts concluded they should not second-guess business decisions by corporate directors. Delaware courts traditionally have placed a high burden on plaintiffs to identify particularly troubling facts before the presumption will be rebutted and the burden shifted to fiduciaries to establish the entire fairness of a decision.

Nevertheless, some may interpret MultiPlan to suggest that the fully disclosed structural incentives arising from the nature of founder shares – the value of which depend on the corporation completing a transaction within a finite period – is sufficient to rebut the business judgment rule and require entire fairness review. Such a reading would appear be contrary to the court’s careful articulation of the narrow scope of its opinion, but we expect that argument will be made in future legal challenges to SPAC mergers.

If MultiPlan suggests a course that future decisions might follow based on arguments about incentives arising from the SPAC structure, SPACs ultimately could find it difficult to attract directors willing to serve in the period between the IPO and a de-SPAC merger out of concerns about their risk of personal liability. SPACs already are facing a difficult environment for obtaining directors and officers liability insurance.

Even if MultiPlan continues to be limited to its specific facts, SPAC directors should continue to be vigilant. In particular, directors should continue to exercise diligence in their deliberations about any potential business combination, and to ensure full disclosure of all material facts concerning any potential transaction.

See the court’s decision here. To learn more, contact any of the authors.