The complaint filed in Franchi v. Multiplan Corp. et al. in the Chancery Court of Delaware on April 9, 2021 [1], has received a fair amount of attention because it claims breaches of fiduciary duties of a SPAC’s Board of Directors and officers with respect to a de-SPAC transaction, requiring entire fairness judicial review, and because it essentially alleges that, as a general matter, conflicts of interest and flawed processes in approving mergers with targets is endemic to the nature of SPACs. Given the prevalence of SPACs and the recent SEC statement regarding the risks of conflicts of interest in SPACs and related disclosure issues,[2] how this lawsuit progresses may signal much to come regarding government enforcement and private litigation regarding SPACs and what that means, in particular, for Boards of Directors of SPACs.
The Complaint
In Franchi, the plaintiff claims that the directors of a SPAC (Churchill Capital Corp.), composed of officers and other loyalists of the sponsor, breached their fiduciary duties to their shareholders in connection with the SPAC’s merger with Multiplan Corp. The stock price of the merged entity cratered when, about a month after the merger closing, a market research report disclosed that Multiplan Corp. was about to lose a customer that accounted for 35% of its business. The complaint states that the Board of Directors, as with many SPACs, is “conflict laden and practically invites fiduciary misconduct.” It cites an allegedly “deeply flawed and unfair process, including severe disclosure defects,” which should have been subject to the entire fairness standard by the Board of Directors of the SPAC. The complaint alleges the following:
Directors Appointed by Sponsor Were Not Independent and Not Aligned with Public Stockholders
- Churchill, as the sponsor, received founders shares representing the right to purchase 20% of the equity of the SPAC for nominal consideration and the voting Class B stock, which gave it Board control. The sponsor gave the directors of the SPAC a portion of these founders shares and so-called private warrants. The complaint highlights that, if an acquisition was not completed within the two year window, then this equity would be worthless, but that if an acquisition closed within that period, then these parties would stand to gain mightily. The major thrust of the complaint is that the financial incentive created by these equity stakes put the interests of the sponsor and the Board on a different level than the public stockholders, with the sponsor favoring itself above the interests of the public shareholders. Thus, the complaint claims, these financial incentives gave rise to a clear conflict of interest with respect to any deal—the Board was “hopelessly conflicted”—which warranted a review by the Board of the proposed merger under the entire fairness standard as a matter of Delaware law, which did not happen.
- The complaint alleges that the Board was composed of individuals who were beholden to the sponsor and its CEO, one being his brother, several being officers of the sponsor, and others serving on the board of directors of other SPACs affiliated with the sponsor, thus eliminating their genuine independence.
Defective Disclosure
- The plaintiff claims that the disclosure in the proxy statement regarding the merger with Multiplan Corp. was defective for reasons that the sponsor and management team should have known. The complaint suggests that the financial incentives and rush to get the deal done by the SPAC led to inadequate exercise by the Board and management of their duty of care regarding due diligence and related disclosure about the target and its risks.
Conflicted Financial Advisor
- The plaintiff notes that not only did the Board not engage an independent, third-party financial advisor to assess the proposed merger, but that the Board retained the financial advisor controlled by the Chairman and CEO of the SPAC for a $30 million fee, representing another conflict of interest.
Unreasonable Projections
- The projections regarding the combined business contained in the proxy statement, which formed the basis of public stockholders’ review of the merger, were unreasonably optimistic. There is also a suggestion, which is not clear, that the Board may have relied on a different set of projections in making their determination to proceed with the transaction.
Status & Observations
An answer to the complaint has not yet been filed, nor have the defendants filed any motion to dismiss the complaint. So, this litigation is still in the very early stages. But it raises a number of issues that are worth watching, such as whether:
- the fiduciary breach claims state a claim sufficient to withstand a motion to dismiss—meaning that, as a matter of law, if all of the facts pleaded are true, whether there is a colorable claim under Delaware law as to a breach of fiduciary duties regarding conflicts of interest of the SPAC’s Board. Cases under the entire fairness standard of review are typically difficult to dismiss at the motion to dismiss stage;
- SPAC sponsors ensure that there are more independent and disinterested directors on the board of directors, and alter the compensation paid to them so that they are less vulnerable to duty of loyalty claims;
- there is an increased reluctance of people to serve on the boards of directors of SPACs, in light of the non-exculpable exposure they face in actions alleging breach of duty of loyalty;
- boards of directors of SPACs and targets adopt different review processes regarding merger decisions, including with respect to setting up special committees, documenting their due diligence in a different manner, retaining an independent financial advisor, receiving a fairness opinion and disclosing the contents of that fairness opinion in the proxy statement;
- the proxy statements contain enhanced disclosure regarding the assumptions and risks regarding projections, and whether to include more than one set of projections (such as downside, base case and upside sets of projections), about which there has been speculation in the market; and
- future SPAC structures alter the allocation of incentives compared to what has become a fairly standard 20% sponsor promote, among other things.
Of course, the complaint only tells one side of the story, and we do not have enough information to evaluate the strengths or merits of the claim, but it is noteworthy to see these claims being raised in the SPAC context and a potential harbinger of things to come.
ENDNOTES
[1] Complaint, Franchi v. Multiplan Corp. f/k/a Churchill Capital Corp. III, et al., Case No. 2021-300-MTZ (Del. 2021).
[2] April 8, 2021 Public Statement of John Coates, Acting Director of the Division of Corporation Finance of the SEC regarding SPACs, SPACs, IPOs and the Liability Risks Under Securities Laws.
This post comes to us from Arnold & Porter Kaye Scholer LLP. It is based on the firm’s memorandum, “The Franchi SPAC Complaint: Much to Watch For,” dated June 11, 2021, and available here.