Saturday, October 23, 2021

Still thinking about SPACs

No, not that SPAC.

Actually, I’m thinking about the SPAC I blogged about here, GigCapital3, which merged with Lightning Systems.  It’s the subject of a lawsuit in Delaware Chancery; the allegation is that the de-SPAC transaction was bad for the SPAC investors, and rushed through in order to benefit the sponsor, before the eighteen month deadline passed and the sponsor was forced to liquidate.

There are some claims that the proxy statement was misleading – I’ll get back to that – but one claim is that this was a bad deal, the SPAC shareholders would have been better off if the SPAC had simply liquidated, and it was approved and recommended by the board because they either benefitted personally or had ties to the sponsor. 

Ordinarily, if you claim that a conflicted board approved a bad deal, that claim is reviewed for entire fairness unless it’s cleansed.  And in this case, theoretically any board breaches were cleansed by the shareholder vote in favor of the merger.  To address that, the complaint claims that the SPAC sponsor was actually a controlling shareholder, suggesting that cleansing could only come via MFW protections.

The problem is, it’s really hard to transpose ordinary corporate concepts into the SPAC context.

Start with:  Every SPAC shareholder had the right to redeem their shares at the same price they’d get in liquidation.  So, if you put aside, for the moment, the piece about a misleading proxy statement, it’s not clear why it would matter whether the board chose a bad merger over liquidation; the SPAC shareholders are in the same position either way.  And absolutely, one could make an argument about shareholders relying on the board to make good judgments about this, the whole point of having a board is that shareholders believe they know better than the shareholders, and their recommendation in favor of a deal carries particular weight, etc etc, but Delaware’s Corwin decision allowing a particularly extreme degree of cleansing via shareholder vote has really undermined the idea that shareholders are dependent on board decisionmaking in that substantive way.  The message of Corwin is, once shareholders have full information, they don’t need the board at all.  Which means, in a SPAC, shareholders shouldn’t be affected by a board decision to go through with a bad merger because they can always choose to redeem instead.

So really, from the shareholder perspective, the issue is not bad deal versus liquidation.  It’s bad deal versus good deal, but the complaint doesn’t allege that a good deal was ever on the table; the bad deal was rushed through precisely because the board was out of time to find a better one.

Now consider whether the shareholder vote cleansed any fiduciary breaches on the part of the board.

As I previously posted, one problem in this context is that there’s so little shareholder voting in SPACs that some SPACs have resorted asking people who already sold their shares to vote in favor of the merger.  But the other more fundamental issue is that you can vote in favor of the merger and still redeem your shares.  And shareholders do this, because many shareholders also hold warrants to buy shares in the combined company; those warrants are worthless without a merger, but probably worth something even in a bad merger. 

This is one of the problems that Usha R. Rodrigues and Michael Stegemoller identify in the paper I highlighted a few weeks ago; they call it empty voting.

Given that, SPAC shareholders, on the whole, should actually prefer a bad deal over liquidation, if those are the only two choices.  Of course, as we know from Revlon and the note holders, the board could not and should not have worried about the warrant holders as warrant holders, even if some warrant holders were also shareholders, so saving the warrant holders could not legitimately be part of the board’s decisionmaking when it agreed to the deal.  But the SPAC shareholders may be thinking about their warrants, which means a vote in favor of the deal is meaningless; shareholders should either prefer a bad merger, or be rationally indifferent as between bad merger or liquidation.

And what that means is, it’s very hard to take the shareholder vote as some kind of Corwin ratification of the deal or the board’s conduct when it comes to SPACs; shareholders have an incentive to vote in favor if it’s a good deal, and they have an incentive to vote in favor if it’s a bad one.  Even if they think it’s bad, they have no incentive to vote no because they can redeem.  Corwin just doesn’t have the same role to play.

Take the SPAC at issue here.  Per the 8-K, they only barely had a quorum; out of 25,893,479 total shares, only 14,829,588 actually voted.  Those 14,829,588  voted overwhelmingly in favor of the deal, but – also per the 8-K – 29% of the outstanding shares chose to redeem, and some of those may also have voted in favor.  We don’t know.  But if they did, that’s as many as 7,509,108 shares redeemed out of 14,555,716 voted in favor.  If, say, all the redeemed shares also voted in favor (unlikely, but bear with me), more voted in favor and rejected the deal than not.  (For some reason, the complaint says only 5.8 million were redeemed; I don’t know why the discrepancy, it might be because I am not accounting for insider shares properly.  Whichever of us is right, it’s still a lot though.)

But if we can’t treat the shareholder vote as cleansing here, we certainly can’t apply MFW, which is (apparently) what the plaintiffs plan to argue when they claim the sponsor was a controlling shareholder.  Because the rationale for requiring MFW procedural protections when there’s a controller is that shareholders will be intimidated by the presence of a controller; they may fear the controller will retaliate against them if they vote the wrong way.  See, e.g., Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110 (Del. 1994).  But in a SPAC, what could the controller possibly do to them?  They can still redeem their shares, which is the same as a liquidation, which is what’s going to happen if the deal is rejected.

Which is why the main focus of the plaintiffs’ complaint in this case is not so much that the board breached its duties by approving a bad deal – though that’s alleged too – but the claim that the proxy statement was misleading, and shareholders were lulled into approving a bad deal and sticking with the company rather than liquidate or redeem.  Plus, shareholders are bringing this claim directly rather than derivatively, and the “we would have redeemed if we had only known” argument is kind of essential to make that work.

So, the complaint doesn’t really focus on the argument that Corwin can’t apply in a situation where you can both vote in favor and redeem your shares, and when they file their opposition to the motion to dismiss, plaintiffs may choose not to make that argument in their briefing, either, because it’s awkward to claim that shareholders were lulled into sticking with a bad deal while simultaneously pointing out how many, in fact, did not.

Which ultimately is unsatisfying because frankly I’d love to see the Delaware courts grapple with the question how ratification should work in this context.

Ann Lipton | Permalink


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