The Delaware Law Series


The Corporate Law Reckoning for SPACs

Minor Myers is Professor of Law at the University of Connecticut School of Law. This post is based on his recent paper, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes SPAC Law and Myths (discussed on the Forum here) by John C. Coates.

The ascendance of SPACs in U.S. capital markets has attracted intense regulatory scrutiny from federal officials, especially the SEC. This federal attention on SPACs is natural, as at first glance the SPAC appears to be simply an alternative to the conventional IPO, itself regulated chiefly at the federal level. The SPAC, however, is critically different from the IPO. An IPO is a transaction: the issuer sells stock, and public purchasers buy it, and the issuing corporation owes no fiduciary duty to the IPO purchasers. By contrast, the SPAC is an entity, not a transaction. And in fact SPACs are a very particular kind of entity: a standard corporation, organized usually under the laws of Delaware. My paper is the first to examine the corporate law dynamics of SPACs in detail, and it makes two distinct claims.

First, it demonstrates that the SPAC industry has exhibited a striking disregard of corporate law, failing to live up to basic equitable and statutory expectations under existing doctrine. Compared to other public corporations, the SPAC adopts a highly idiosyncratic governance model. The SPAC vests near-despotic control over all substantive decision-making in the hands of the sponsor. And SPAC boards are always populated by persons selected by the sponsor and often classified, making it impossible to wrest control from the sponsor during the life of the SPAC. The merger vote is engineered to achieve success, as the redemption right and warrants induce stockholders to vote in favor of a transaction regardless of their views on its merits, and the redemption decision likewise affords public holders limited influence. At the same time, the all-powerful sponsor has a deep conflict of interest with public holders. With a business combination, the sponsor secures a 20% stake, a potentially gargantuan reward. Without one, the sponsor’s stake is worth nothing. The result is that the sponsor has two incentives at odds with the public holders: to pursue any transaction, regardless of its advisability for public stockholders, and to obscure that fact from public stockholders to minimize redemptions. The sponsor acts unconstrained by any customary corporate mechanism for handling conflicted situations, as there are no disinterested decisionmakers anywhere in the SPAC. A SPAC thus offers its business combination to the public holder as a take-it-or-leave-it proposition, from which the investor has a custom-built remedy that is reputed to be complete. I call this approach the private fund model, as it broadly characterizes the structure that prevails among private investment funds.

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Delaware and Caremark: An Update

Theodore N. MirvisDavid A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? (discussed on the Forum here) by Holger Spamann.

Recent Delaware decisions have reminded boards of directors of the obligation to make a good faith effort to put in place a compliance system designed to help ensure that their companies operate within the bounds of the law and that their products, services, and operations do not cause harm to consumers, community members, or the environment. That duty—famously associated with the Delaware Court of Chancery’s 1996 decision in Caremark—is a core responsibility of independent directors, working in concert with company management, that requires them to make a good faith effort to identify the key compliance risks the company poses to others and faces itself, and to put in place a reasonable oversight structure to address them.

In 2019, the Delaware Supreme Court’s decision in Marchand reminded boards that although the Caremark standard only requires a good faith effort to put in place and attend to a reasonable compliance structure, a plaintiff could state a claim against directors by pleading facts suggesting that the board failed to make any effort to ensure that a board-level system of oversight was in place to address a mission critical risk. In that case, the company’s sole business was to make ice cream and there was no board-level process for monitoring the safety of its products, which caused the death and illness of consumers in a listeria outbreak. Just last year, the Court of Chancery issued a high profile decision in the Boeing case, applying Marchand in the face of detailed fact pleadings suggesting that the company had no board-level process for overseeing the company’s effort to ensure the safety of its aircraft.

In those and other cases, the increasing use of books and records demands by plaintiffs to plead their claims has been illustrated. Because the Delaware courts have long made clear—including in Marchand and Boeing—that Caremark requires a good faith effort by the board, not perfection, and that the board will only face liability if the evidence demonstrates that a board has not made a good faith effort to fulfill its duties, plaintiffs have sought books and records to sustain their difficult burden to plead a viable claim. When these books and records do not reflect that a company had in place a board structure that attended to core business and legal risks, the plaintiffs cite to that lack of effort in an effort to plead a complaint that cannot be dismissed on motion.

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Chancery Decision Expands the Court’s Approaches on Director Independence

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Brian T. Mangino are Partners at Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Matthew V. SoranRandi Lally, and Mark H. Lucas, and is part of the Delaware law series; links to other posts in the series are available here.

Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders (discussed on the Forum here) by Lucian Bebchuk and Assaf Hamdani.

The Goldstein v. Denner (May 26, 2022) litigation arose out of the $11.6 billion cash acquisition of Bioverative, Inc. (which had recently been spun off from Biogen, Inc.) by Sanofi, S.A. The Delaware Court of Chancery held, at the pleading stage of litigation, that certain directors and officers of Bioverative may have breached their fiduciary duties in connection with the sale process. The plaintiff claimed that the defendant directors and officers sold the company (in a single-bidder process) too quickly after the spinoff; at a price far below the company’s stand-alone value (as indicated by the company’s projections prepared in the ordinary course of business); at a time when the universe of potential buyers was limited (due to tax-related restrictions following the Spinoff not expiring for another few months); and with materially inaccurate and misleading disclosure to the stockholders.

The sale process was led by an outside director, “D,” an activist investor, who allegedly was acting in accordance with his “usual playbook” of pressuring a public company into putting him on the board, then recruiting his “supporters” onto the board, and then forcing a near-term sale of the company. In this case, allegedly, he had “supercharged” the process by having the hedge fund he controlled (the “Fund”) buy a significant stake in the company after Sanofi first approached him about its in interest in acquiring the company, and then waiting until the expiration period for disgorgement of short-swing profits under Section 16(b) of the Exchange Act to inform the board of Sanofi’s interest and initiate the sale process.

In an opinion that clarifies, and arguably expands, the court’s current approaches on important topics, Vice Chancellor Laster found, at the pleading stage of litigation, that it was “reasonably conceivable” (the standard for survival of claims at the pleading stage) that all of the defendant directors and officers committed unexculpated breaches of their fiduciary duties in connection with the sale process. The court reserved judgment for a future decision on the claim that D’s Fund aided and abetted D’s alleged fiduciary breach.

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Delaware Approves Permitting Exculpation of Officers from Personal Liability

Theodore N. Mirvis, David A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

For over 45 years, Delaware law has permitted directors of Delaware corporations to be exculpated from personal monetary liability to the extent such protections are set forth in the certificate of incorporation, subject to certain exceptions. However, such protective statutory provisions did not reach officers. As contemplated in our April 2022 memorandum, Delaware has now adopted important amendments to Delaware’s General Corporation Law that would expand the right of a corporation to adopt an “exculpation” provision in its certificate of incorporation to cover not only directors (as has been allowed and widely adopted since 1986, following Smith v. Van Gorkom) but now also corporate officers

The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors—that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law—with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.” 

Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process. Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.

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Sale of Portfolio Company is Subjected to Entire Fairness Review

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Brian T. Mangino are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Matthew V. SoranRandi Lally, and Mark H. Lucas, and is part of the Delaware law series; links to other posts in the series are available here.

In Manti Holdings v. The Carlyle Group (June 3, 2022), the Delaware Court of Chancery held that entire fairness review would apply to the challenged sale of The Carlyle Group’s portfolio company, Authentix Acquisition Corp., due to the pressure Carlyle allegedly exerted to cause a quick sale so that it could close out its fund, Carlyle Holdings, that had invested in the company. The court acknowledged that controlling stockholders generally have the same incentive as other stockholders to maximize stockholder value in a sale to a third party and that, as a result, a controller’s desire for liquidity typically has not been a basis for rejecting business judgment review of a challenged transaction. In this case, however, the court viewed Carlyle’s alleged desire to close out its fund as having rendered it conflicted such that the more stringent entire fairness standard of review was applicable. Vice Chancellor Glasscock wrote: “[T]he reality is that rational economic actors sometimes
do place greater value on being able to access their wealth than on accumulating their wealth.”

Key Points

  • The decision reinforces the court’s trend in recent decisions in finding it plausible that a sponsor’s desire for liquidity may create a disabling conflict. Notably, however, the factual context in which the court reached its decision included the board not having established a special committee to exclude the sponsor-affiliated directors; testimony that Carlyle exerted pressure on the directors to approve the merger; and a non-ratable benefit from the merger for the sponsor in obtaining a profit on its preferred stock investment while the holders of the common stock received almost nothing.

Background. To encourage Carlyle to invest in and become a controller of Authentix, the stockholders had entered into a stockholders agreement pursuant to which they agreed not to oppose any sale of Authentix approved by the board and by a majority of the outstanding shares (in other words, approved by the board and Carlyle). In 2017, the board and Carlyle approved a sale of Authentix to Blue Water Energy for $70 million. Under the terms of the stockholders agreement, the holder of the company’s preferred stock was entitled to receive the first $70 million of consideration paid in a sale of the company. Thus, with a sale at $77.5 million, Carlyle (as the holder of Authentix’s preferred stock) would make a profit on its preferred stock investment but the common stockholders (including the plaintiffs) would receive almost nothing for their stock. Litigation ensued. In previous decisions in the case, the court held that the terms of the stockholders agreement (i) constituted a waiver by the common stockholders of their statutory appraisal rights and (ii) did not preclude the plaintiffs from bringing a fiduciary suit against Carlyle and the Authentix directors. In this most recent decision, the court held that the plaintiffs had adequately stated a claim for breach of fiduciary duties by Carlyle and the Carlyle-affiliated directors on the Authentix board.

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The Single-Owner Standard and the Public-Private Choice

Charles Korsmo is Professor of Law at Case Western Reserve University School of Law and Minor Myers is Professor of Law at the University of Connecticut School of Law. This post is based on their recent paper, forthcoming in the Journal of Corporation Law, and is part of the Delaware law series; links to other posts in the series are available here.

A fundamental question in corporate law is the nature of the stockholders’ ownership interest in the firm. Should a share of stock be viewed as a simple chattel, the value of which can be measured for all purposes by its trading price? Or should it be viewed as a partial claim on the firm as a whole, the value of which—for some purposes—cannot be determined without reference to the value of the entire firm to a single owner? This question arises in a number of contexts involving intra-corporate disputes, the most important of which is the merger. When examining whether a target board has satisfied its fiduciary duties, or when determining the “fair value” of the stockholders’ shares, a court must confront this fundamental question of the shareholders’ entitlement.

Delaware law has long entitled stockholders to a proportionate share of the value of the firm as a whole to a single owner and not simply the trading value of their fractionalized shares. This conception—the “single-owner” standard—was first articulated in the context of appraisal rights, and it has served for a century as the Atlas of Delaware’s corporate law, providing the theoretical foundation for its entire doctrinal universe, including merger landmarks like Unocal, Revlon, and the long line of their offspring. The single-owner standard provides the justification for allowing target boards to employ takeover defenses to fend off bids at a premium to the stock price and for the traditional measures of fair value in appraisal and breach of fiduciary duty actions.

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Delaware M&A Developments

Andre Bouchard, Kyle Seifried and Jaren Janghorbani are Partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss memorandum by Mr. Bouchard, Mr. Seifreid, Ms. Janghorbani, Laura C. Turano, and Ross A. Fieldston, and is part of the Delaware law series; links to other posts in the series are available here.

In Totta v. CCSB Financial Corp., the Delaware Court of Chancery, in an opinion by Chancellor McCormick, held that a charter provision that gave the board “conclusive and binding” authority to construe the charter’s terms did not alter the standard of review applicable to fiduciary duty claims related to those board decisions. The applicable charter provision prohibited a stockholder from exercising more than 10% of the company’s voting power. In the face of a proxy contest, the board adopted a new interpretation of that voting limitation allowing the board to aggregate the holdings of multiple stockholders that the board determined to be acting in concert. Relying on that new interpretation, the board instructed the inspector of elections not to count any votes above the 10% limit submitted by the insurgent, its affiliates or its nominees. This instruction was outcome determinative and the insurgents brought suit to invalidate the board’s instruction to the inspector of elections. The company argued that the court was required to uphold the instruction based on the board’s “conclusive and binding” interpretation of the charter provision. The court rejected that argument, reasoning that a corporate charter (unlike an alternative entity’s organizational documents) cannot modify the standards by which director actions are reviewed, and that the board’s self-serving and new interpretation of the voting limitation in the face of a live proxy contest was inequitable because the board did not have a “compelling justification” under the Blasius standard of review for their interference with the election. Because the board’s actions were inequitable, the court ordered the inspector of elections to disregard the board’s instruction and count the insurgent’s votes that had previously been excluded.

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Twitter vs. Musk: Musk’s Opposition to Expedited Proceedings

This post provides the text of the response filed July 15, 2022, by Elon Musk to the Twitter complaint (discussed on the Forum here). This post is part of the Delaware law series; links to other posts in the series are available here.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

TWITTER, INC.,

Plaintiff, v.

ELON R. MUSK, X HOLDINGS I, INC., and X HOLDINGS II, INC.,

Defendants.

Defendants’ Opposition To Plaintiff’s Motion To Expedite Proceedings

1. This Court should reject Plaintiff Twitter, Inc.’s (“Twitter”) unjustifiable request to rush this $44 billion merger case to trial in just two months. Twitter’s bid for extreme expedition rests on the false premise that the Termination Date in the merger agreement (“Agreement”) is October 24, glossing over that this date is automatically stayed if either party files litigation. By filing its complaint, Plaintiff has rendered its supposed need for a September trial moot.

2. Nor does the remainder of the Motion To Expedite (“MTE”) remotely justify extreme expedition, instead highlighting the complexity of the case and the impossibility of completing discovery on the timeline proposed. In fact, Twitter has engaged in tactical delay for two months by resisting Defendants’ information requests, causing Defendants “obvious prejudice” through an overly compressed schedule. Juwell Invs. Ltd. v. Carlyle Roundtrip, L.P., C.A. No. 2020-0338-JRS, at
92 (Del. Ch. May 14, 2020) (TRANSCRIPT) (“Amex”). Twitter’s sudden request for warp speed after two months of foot-dragging and obfuscation is its latest tactic to shroud the truth about spam accounts long enough to railroad Defendants into closing.

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Lessons from the Goldstein Opinion

Ethan Klingsberg and Meredith Kotler are partners and Victor Ma is an associate at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Vice Chancellor Laster’s recent opinion in Goldstein v. Denner provides a useful reminder of the importance of documenting board meetings, updates, and communications in formal corporate board documents, as they will likely later be part of the record on any motion to dismiss in a direct or derivative action. This reminder is especially important when a sale of the company or other material determination by the board may be in the company’s future.

As is increasingly common, the Goldstein plaintiffs’ claims for breaches of fiduciary duty relating to a sale of the company were preceded by a Section 220 “books and records” demand through which the plaintiffs obtained not only board minutes and presentations to the board, but also certain electronic communications by officers, directors, and the target’s financial advisor relating to the sale process. Whenever these documents failed to reflect that the board had received certain communications or considered certain subject matter, the Court held that it was required—at least at the pleading stage—to credit the plaintiffs’ assertions that these communications and deliberations had failed to occur. In addition, at one point, the Court pointed to gaps and contradictions between the electronic communications versus the minutes, and drew the inference—again at the pleading stage—that the relevant narrative provided in the minutes was untrue.

Comprehensive minutes, coupled with equally comprehensive (and consistent) disclosure in a merger proxy statement or recommendation statement on Schedule 14D-9, may well be the best defense for target company boards and officers against the risk from Section 220 demands and post-closing “sale process” claims by plaintiffs. The merger proxy statement and recommendation statement on Schedule 14D-9, which are distributed to the stockholders after the merger agreement has been signed and announced, are not the places to start to fill in gaps in the minutes. Moreover, a board is much more likely to be able to exclude electronic communications from a Section 220 demand’s production, and to limit a Section 220 demand’s production to only minutes and the formal board packages, if the minutes are comprehensive.

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Twitter vs. Musk: The Complaint

This post provides the text of the complaint filed on July 12, 2022 by Twitter in its widely-followed case against Elon Musk. This post is part of the Delaware law series; links to other posts in the series are available here.

IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE

TWITTER, INC.,

Plaintiff, v.

ELON R. MUSK, X HOLDINGS I, INC., and X HOLDINGS II, INC.,

Defendants.

Verified Complaint

Plaintiff Twitter, Inc. (“Twitter”), by and through its undersigned counsel, as and for its complaint against defendants Elon R. Musk, X Holdings I, Inc. (“Parent”), and X Holdings II, Inc. (“Acquisition Sub”), alleges as follows:

Nature of the Action

1. In April 2022, Elon Musk entered into a binding merger agreement with Twitter, promising to use his best efforts to get the deal done. Now, less than three months later, Musk refuses to honor his obligations to Twitter and its stockholders because the deal he signed no longer serves his personal interests. Having mounted a public spectacle to put Twitter in play, and having proposed and then signed a seller-friendly merger agreement, Musk apparently believes that he—unlike every other party subject to Delaware contract law—is free to change his mind, trash the company, disrupt its operations, destroy stockholder value, and walk away. This repudiation follows a long list of material contractual breaches by Musk that have cast a pall over Twitter and its business. Twitter brings this action to enjoin Musk from further breaches, to compel Musk to fulfill his legal obligations, and to compel consummation of the merger upon satisfaction of the few outstanding conditions.

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