Avoiding “Entire Fairness” Review in Claims against SPAC Boards through Corwin

Special purpose acquisition company (“SPAC”) business combinations have provided a novel and difficult context to apply traditional fiduciary duty doctrines in Delaware law. Recently, in In re MultiPlan Corp. Stockholders Litigation, [1] the Delaware Chancery Court issued a ruling denying a motion to dismiss breach of fiduciary duty claims brought against a SPAC’s fiduciaries in connection with the SPAC’s 2020 de-SPAC transaction. While noting that “Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context,” the Court evaluated breach of fiduciary duty claims brought against the SPAC’s directors, officers and controlling stockholder under the “entire fairness” standard of review, due to alleged conflicts between the SPAC’s fiduciaries and public stockholders in the context of a value-decreasing transaction. These conflicts included the fact that each of the SPAC’s directors held founder shares that would be worthless if the SPAC did not complete a de-SPAC transaction.

Since the issuance of the MultiPlan decision, commentators have amply covered its rationales and holdings, which will not be repeated in this post. The authors of this post believe, however, that by following the roadmap set forth by the Delaware courts in Corwin v. KKR Financial Holdings LLC [2] and its progeny, it would be possible to lower the standard of review for the conduct of a SPAC’s board in connection with its initial business combination to the more deferential “business judgement rule” without having to ensure that there are independent directors who do not hold founder shares.

Corwin and Conflicted Directors Transactions

In Corwin, the Delaware Supreme Court held that when a transaction otherwise subject to enhanced scrutiny under Revlon is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies. The Corwin court did not squarely address the question of whether Corwin’s cleansing effect applies when a majority of the directors are conflicted. However, in dicta, the Corwin court noted that “[f]or sound policy reasons, Delaware corporate law has long been reluctant to second-guess the judgment of a disinterested stockholder majority that determines that a transaction with a party other than a controlling stockholder is in their best interests,” implying that Corwin’s cleansing effect could still apply in the absence of a conflicted controlling stockholder. [3]

In subsequent Delaware Chancery Court decisions applying Corwin, including Larkin v. Shah [4] and In re Merge Healthcare Inc., [5] courts have suggested that the cleansing effect of a fully informed uncoerced vote of disinterested stockholders would apply in circumstances where a majority of the board was deemed to be conflicted, unless there is a controlling stockholder who is conflicted because its interests are not aligned with public stockholders.

In Larkin, the plaintiff alleged that certain venture capital stockholders, which held a combined 23% of the stock of the target company, “leveraged their substantial ownership stakes and Board representation in [the target company] to manipulate negotiations and secure a fast, all cash transaction that satisfied their unique liquidity needs.” The Court concluded that even if the plaintiff had sufficiently alleged that the venture capital stockholders controlled the target, [6] plaintiff would still need to demonstrate that the interests of the control group were at odds with the minority stockholder in the transaction to subject the transaction to entire fairness review. Although the plaintiff further alleged that a majority of the board was conflicted based on, among other things, post-merger employment offers with the surviving entity and certain special compensation opportunities that were offered to ensure their loyalty to the CEO, the Court held that “under Corwin and the expansive supporting authority it cites, the business judgment rule irrebuttably applies if a majority of disinterested, uncoerced stockholders approve a transaction absent a looming conflicted controller.” [7] Larkin further explained that the protections of Corwin are not available to a conflicted controlling stockholder transaction because such transactions are viewed by Delaware courts as “inherently coercive.”

Further, in In re Merge Healthcare, the Chancery Court assumed all but one of the company’s directors were beholden to a 50.1% stockholder, who was alleged to have desired to exit his investment. In evaluating the plaintiffs’ claims, the Court noted that, in the absence of a “controlling stockholder that extracted personal benefits,” the business judgment rule applies “even if the transaction might otherwise have been subject to the entire fairness standard due to conflicts faced by individual directors” if there had been a fully informed, uncoerced vote. After analyzing plaintiffs’ allegations, the Court applied the business judgment standard of review, observing that even if there was a controlling stockholder transaction, the controller “did not extract any personal benefits because his interests were fully aligned with the other common stockholders.” [8]

MutiPlan is Consistent with Corwin

In MultiPlan, while the Delaware Chancery Court determined that the transaction should be evaluated under the “entire fairness” standard of review, the Court “[did] 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.” Thus, the MultiPlan Court left the door open as to whether Corwin would apply to cleanse a de-SPAC transaction that involved a conflicted board.

In MultiPlan, the Court found that the SPAC directors’ holdings of founder shares gave rise to potential “diverging interests” with the public stockholders to the extent that there was a potentially value-decreasing transaction and that the SPAC directors were influenced by expectations to serve on future SPAC boards of the same sponsor. However, the mere fact that directors hold founder shares does not necessarily require application of the entire fairness standard of review. First, in evaluating the plaintiff’s claims, the MultiPlan Court was focused on how the alleged inadequate disclosure impacted the plaintiff’s ability to exercise his redemption rights. The Court expressly stated that “[i]f public stockholders, in possession of all material information about the target, had chosen to invest rather than redeem, one could imagine a different outcome.” [9] Second, to the extent that the directors held diverging interests due to their holdings of founder shares or to their expectation of serving on other boards of the same SPAC sponsor, such interests are similar to the directors’ alleged conflict in In re Merge Healthcare (directors beholden to the controlling stockholder). As noted above, in In re Merge Healthcare, the Court recognized that business judgment was the appropriate standard of review following a fully informed, uncoerced vote, unless the transaction being evaluated involved a conflicted controller.

Accordingly, we believe that, applying Corwin, a fully informed and uncoerced vote of the public stockholders should help insulate a SPAC board of directors from an “entire fairness” review even if the directors are conflicted in the absence of a transaction involving a conflicted controlling stockholder.

Disinterested Stockholder Vote

Unlike a routine public company M&A transaction, the SPAC stockholder vote is subject to certain unique dynamics. Several commentators have asserted that “empty voting” exists in connection with a SPAC business combination because a stockholder may still vote “for” the transaction while exercising its redemption right to exit its investment. [10] In addition, SPAC stockholders often hold warrants. Thus, a stockholder who decides to redeem its public shares but also hold warrants may vote in favor of the transaction in the hope that its warrants will have value if the SPAC consummates the transaction, as the warrants would expire worthless if the SPAC liquidates without completing a de-SPAC transaction. According to these commentators, the potential disassociation of a public stockholder’s vote from its economic interest calls into question the effectiveness of the stockholder vote.

While Corwin and its progeny have yet to address this issue, we believe that there are strong arguments that support the conclusion that Corwin should be applied to SPAC transactions notwithstanding a potential “empty vote.” First, SPAC stockholders would always favor a value enhancing merger over a merger that does not enhance value. Second, “empty votes” are not unique to SPAC transactions. Stockholders of a public company involved in an M&A transaction may sell their stock after the record date but prior to the vote, and then vote the shares they previously sold. Absent well pled facts to the contrary, it would be entirely speculative for a court to conclude that a particular stockholder is “interested” and is supporting a transaction for reasons other than the merits of the deal. Third, it is speculative to conclude that SPAC stockholders who hold warrants would support a value decreasing business combination when confronted with a potential liquidation of the SPAC. In a value decreasing business combination, the warrants would have at most option value that would be of questionable worth, and absent a showing of materiality, the warrant holdings are insufficient to call the SPAC stockholders vote into question. [11] Additionally, if the SPAC still has sufficient shelf life that remains to consummate an alternative business combination, it would be a more rational choice for the SPAC shareholders to vote down a bad deal and send the SPAC back to hunt for a better deal.

If all of the above arguments fail and a court were to accept that stockholders who redeemed should be excluded from the Corwin analysis, the court should look at whether the votes of a majority of the non-redeeming SPAC shareholders is obtained for purposes of determining Corwin’s application. In this respect, unlike a routine public company sale process, stockholders in a SPAC have two opportunities to ratify the transaction: at the time of the stockholder vote and at the time that they are required to make a decision on redemption. Those who choose not to redeem are clearly supportive of the transaction and there is no reason to believe that the approval by these holders is ineffective or that these holders are interested in the transaction such that their votes should be excluded from a Corwin analysis. [12]

Limitation of this Approach

As noted above, an important exception to Corwin’s applicability is controlling stockholder transactions, which include both “the one-sided and two sided variety.” [13] As explained by the court in Larkin, “[c]onflicted transactions include those in which the controller stands on both sides of the deal (for example, when a parent acquires its subsidiary), as well as those in which the controller stands on only one side of the deal but ‘competes with the common stockholders for consideration.’”

In a SPAC business combination in which the SPAC sponsor holds Class B shares that vote along with the Class A shares on all matters, there would not appear to be a controlling stockholder. However, in some SPACs, the Class B shares held by the sponsor have the exclusive right to elect directors prior to the completion of a de-SPAC transaction. This was the case in MultiPlan, where the parties agreed that the sponsor was the controlling stockholder of the SPAC. [14] However, the sponsor (even if deemed a controlling stockholder under Delaware law) is not standing on both sides of the transaction or competing with the public stockholders for a finite amount of consideration. As a result, the transaction should not be deemed “inherently coercive” along the lines discussed above. We note, however, that Delaware courts have yet to address this particular issue in the context of SPAC transactions, and unique deal structures could still raise the specter that a portion of the overall consideration is being shifted to the sponsor. This will remain an area that dealmakers should watch carefully.

Conclusion

Since the rendering of the MultiPlan decision, the prospect that the conduct of a Delaware SPAC’s board will be evaluated under the “entire fairness” standard has weighed heavily on SPAC dealmakers. As a result of MultiPlan, some sponsors are revisiting the manner in which independent directors are compensated and are considering paying the directors a fixed amount regardless of the success or failure of the initial business combination. While this represents a viable approach from a legal perspective, it could entail a significant amount of cash outlay by the SPAC sponsor, which may not always be feasible.

As discussed above, where a SPAC sponsor does not choose to pay directors a fixed amount regardless of the success or failure of the initial business combination, the business judgment standard still may apply. While not expressly quoting Corwin, the Delaware Chancery Court’s decision in MultiPlan is consistent with Corwin’s applicability to transactions involving a conflict of the board of directors in the absence of any transaction with a controlling stockholder.

Accordingly, we believe that Corwin provides a path to resolve some of the questions left open by MultiPlan. By providing full disclosure to stockholders about the transaction and any potential conflict of interest associated with the SPAC’s board and obtaining a majority vote of the public stockholders, skillful dealmakers can steer the SPAC boards out of the “entire fairness” review.

Endnotes

1268 A.3d 784, 796 (Del. Ch. 2022)(go back)

2125 A.3d 304 (Del. 2015)(go back)

3Such transactions are evaluated under the standard set forth in Kahn v. M&F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014). (go back)

42016 WL 4485447 (Del. Ch. Aug. 25, 2016)(go back)

52017 WL 395981 (Del. Ch. Jan. 30, 2017)(go back)

62016 WL 4485447 (Del. Ch. Aug. 25, 2016)(go back)

7Id. at *20.(go back)

8In re Merge Healthcare Inc., No. CV 11388-VCG, 2017 WL 395981, at *7 (Del. Ch. Jan. 30, 2017) (go back)

9In re MultiPlan Corp. S’holders Litig., 268 A.3d 784, 816 (Del. Ch. 2022)(go back)

10Rodrigues, Usha and Stegemoller, Michael A., Redeeming SPACs (2021). University of Georgia School of Law Legal Studies Research Paper No. 2021-09, Available at SSRN: https://ssrn.com/abstract=3906196 or http://dx.doi.org/10.2139/ssrn.3906196(go back)

11Cf. , In re Zale Corp. Stockholders Litig., Cf. , In re Zale Corp. S’holders Litig., C.A. No. 9388-VCP, 2015 WL 5853693, at *9 (Del. Ch. Oct. 1, 2015) (concluding that a disinterested majority of Zale’s stockholders approved the merger after rejecting plaintiffs’ argument that a $3.2 million prepayment fee was material to private equity fund such that it would render the private equity fund (or any other stockholder) interested in the merger).(go back)

12To the extent that a court found that certain SPAC stockholders were interested, it could consider the votes of a majority of those who are not interested in the transaction along the lines of MFW. (go back)

13Larkin v. Shah, No. CV 10918-VCS, 2016 WL 4485447, at *12 (Del. Ch. Aug. 25, 2016)(go back)

14“The parties agree that Klein, through his control of Sponsor, was Churchill’s controlling stockholder. Entire Fairness is not triggered by that fact alone. The Plaintiffs must also adequately plead that the controlling stockholder engaged in a conflicted transaction.” In re Multiplan Corp. S’holders Litig., 268 A.3d 784, 809 (Del. Ch. 2022). (go back)