It is not entirely a surprise to those watching the goings-on in the SPAC market to see the recent wave of litigation against SPACs and SPAC-related deals. After all, the avalanche of SPAC IPOs that kept all financial, legal, and other advisors working nonstop from January to March of 2021 was bound to result in at least a few failed deals and at least a small number of unhappy investors.
And now we are seeing the results of that rush to market in the form of court case filings and even a few enforcement actions from the SEC, FINRA, and the DOJ, including the latest investigation into Digital World Acquisition Corp. and its proposed business combination with Trump Media & Technology Group Corp.
The enforcement actions and investigations are not surprising in the least. They center around misrepresentations, disclosure failures, and inadequate diligence. The lawsuits, however, are growing in inventiveness and variety. Here is the current list of the most common types of lawsuits we’ve seen throughout 2021, with more surely to come as more SPACs continue to enter the market, find targets, adjust their structures and deal terms, and be reined in or reprimanded by the regulators.
The Merger Objection Lawsuits
Merger Objection lawsuits are not new. They have existed for years in public company M&A and are frowned upon by Delaware courts as a waste of everyone’s time. In the SPAC context—much like in non-SPAC deals—as soon as a deal is announced, a plaintiff files a suit claiming that the deal is unsatisfactory in some way and should not proceed. The allegations usually revolve around insufficient disclosure about the upcoming merger. These kinds of lawsuits are typically mooted and dropped after additional disclosure is filed, and the plaintiff and their attorney walk away with a “mootness fee” of a few thousand dollars. It is interesting to note that many of these suits are now being brought in New York because Delaware has no patience for them.
Securities Class Actions
Securities Class Actions are more serious in nature. These can be brought in federal or state court against the SPAC, its directors and officers, or the private company being acquired by the SPAC, and its directors and officers. In some cases, security class actions can be brought against SPAC sponsors and other related deal parties.
Depending on the fact pattern, allegations center around violations of the Securities Act or the Securities Exchange Act and their respective rules and typically focus on misstatements or omissions in the disclosure or public statements. These kinds of cases are typically brought post-merger, but some, like the Lucid Motors case, are filed prior to the merger. Many, like the Lordstown Motors case, are brought on the heels of a negative short-seller report. While only two securities class actions were filed against SPACs in 2019 and five in 2020, as of mid-December 2021, we have already seen 28 of them. More are certain to come in 2022.
Breach of Fiduciary Duty Suits
Several Breach of Fiduciary Duty lawsuits were filed in the Delaware Chancery Court, alleging that the SPAC structure creates an inherent conflict of interest between the SPAC’s sponsor and its board and the SPAC’s investors. The allegations are that this conflict of interest diminishes the rigor with which the SPAC’s sponsor and its board consider a proposed merger, and that, as a result, the merger cannot meet the entire fairness test and the SPAC’s board is in breach of its fiduciary duty to the SPAC’s shareholders. An example of this kind of lawsuit is the Multiplan litigation.
The question in all of these lawsuits is whether the entire fairness standard should even apply or whether the actions of the SPAC sponsor and its board should be considered under the more deferential business judgment rule.
Shareholder Derivative Suits
Many shareholder derivative lawsuits have been filed in 2021 on behalf of SPACs against the SPACs’ directors and officers. Typically, these lawsuits come on the heels of a securities class action already filed against the SPAC.
These cases typically allege harm to the SPAC from false statements made by the SPAC’s directors and officers and serious breaches of fiduciary duties. Because Delaware corporations cannot indemnify derivative suit settlements, these suits can pose a severe personal financial risk to the individual directors and officers of the SPAC. For example, if the SPAC’s D&O insurance policy does not have sufficient coverage under its “Side A,” the individual directors and officers may need to cover the settlement costs out of pocket.
“Thou Art an Investment Company” Suits
An example of a shareholder derivative suit but also of a line of a new type of allegations directed against SPACs is the August 2021 lawsuit filed against Bill Ackman’s Pershing Square Tontine. The allegations are that SPACs are investment companies and should register as such under the Investment Company Act of 1940.
It is interesting to note that the plaintiff’s attorneys are led by former SEC Commissioner Robert Jackson during whose tenure at the SEC, judging by the number of SPACs that proceeded to market without registering as Investment Companies in the last few years, this question either never came up or was dismissed as a non-issue.
In response to this “creative” claim, in an unprecedented move, more than 60 law firms published a statement calling the assertion that SPACs are investment companies meritless. However, the same team, led by Jackson, brought two more suits with the same allegations against two other SPACs. It is anyone’s guess whether these suits will move forward, or if the SPACs will be forced to settle.
Shareholder Voting Suits
Another type of common lawsuit against SPACs is a shareholder voting suit. Recent examples were filed in Delaware on behalf of investors of dMY Technology Group IV and Mudrick Capital Acquisition Corporation II. These suits allege that the SPACs’ boards attempted to improperly force Class A shareholders to vote together with Class B shareholders in violation of Delaware General Corporation Law so that the SPAC could proceed with the merger.
To conclude, the worlds of SPAC deals and SPAC litigation continue to evolve. In addition to the increased numbers and types of SPAC lawsuits, there have been hefty settlements (e.g., $35 million partial settlement in Akazoo) and regulatory fines (e.g., $8 million fine in Stable Road/Momentus). But any financial tool that gains quickly in popularity is bound to be characterized by incredible inventiveness and growth as well as by teachable examples of failures and setbacks.
The current goal of the SPAC market, which most market participants are taking to heart, is to learn from these cases, correct improper deal behavior, and minimize future risk. Keeping a close eye on the developments in SPAC litigation and enforcement will continue to be a must for all future SPAC dealmakers.
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