Delaware Chancery Court Refuses to Stay SPAC Class Action, Highlighting the Court’s Interest in SPAC Issues—and the Risk of Duplicative State and Federal SPAC Litigation

On March 7, 2022, the Delaware Chancery Court denied a motion to stay a putative class action pending the resolution of a federal securities class action, notwithstanding that the federal action was first-filed and concerned the same Special Purpose Acquisition Company (“SPAC”) transaction.[1] This decision is the second one issued this year by Vice Chancellor Lori Will involving SPAC issues and in each of the decisions Vice Chancellor Will signaled Delaware’s interest in addressing established doctrines of fiduciary duty law in the context of special purpose entities.[2] The decision highlights that SPAC litigation is an emergent, and important, area in which Delaware courts will continue to focus their attention going forward. It also demonstrates the risk of costly and burdensome multi-track state and federal litigation being permitted to proceed arising from the same SPAC transaction.

Background

SPAC transactions, although in existence (but not common) for some time as “blank check companies,” became more frequently used vehicles for IPOs in late 2020 and early 2021 and were viewed by some as an easier way to raise IPO money. A SPAC raises money through an IPO with the intention of using the funds to acquire a company with ongoing business operations, to be identified within a designated period (typically two years) after the IPO. The target then typically merges into the SPAC to form an operating company with publicly-traded shares (called a “de-SPAC” transaction).[3] After the transaction is approved, shareholders have the option to redeem their shares for cash prior to the de-SPAC, for example if they are not satisfied with the selection of the acquisition target. The SPAC sponsors typically receive a 20% interest in the SPAC, which converts to shares of the public company following the de-SPAC transaction. In the event that a transaction is not consummated within the designated time period, the sponsors’ equity interest will, in many cases, become valueless. When a post-SPAC company does not perform as expected, shareholders often point to the sponsors’ interest in the “promote” (i.e., the return on investment for sponsoring the SPAC) as evidence of breach of fiduciary duty or conflict of interest in subsequent litigation.

Lordstown Motors Corp. SPAC Litigation

In October 2020, Lordstown Motors Corp. was acquired by DiamondPeak Holding Corp. a SPAC.[4] The newly-formed company (“Lordstown”) experienced a drop in stock price following an analyst report identifying alleged problems faced by Lordstown. This drop in stock price, in turn, resulted in the filing of multiple federal securities class action suits beginning in March of 2021 alleging violations of the Securities Act of 1933 and Securities Exchange Act of 1934 on behalf of a putative class of Lordstown investors.[5] Shareholder derivative actions were also filed, in both state and federal court.[6]

In December 2021, additional class action litigation was filed in Delaware Chancery Court asserting breach of fiduciary duty claims on behalf of a putative class of holders of shares of the SPAC (DiamondPeak Holding Corp) from the de-SPAC transaction’s record date of September 21, 2020 to its closing on October 23, 2020. The consolidated Delaware Chancery Court actions alleged that the SPAC directors and controlling shareholders breached fiduciary duties by failing to disclose information about the target company’s purchase orders and production timeline thereby depriving the shareholders of information necessary to exercise their voting and redemption rights in an informed manner prior to the closing of the de-SPAC transaction.[7] Defendants moved to stay the Delaware Chancery Court action pending the outcome of the earlier filed federal securities suits.[8] The Delaware Chancery Court denied the motion.

The Delaware Chancery Court Denies a Stay

In declining to stay the Delaware action, Vice Chancellor Will identified a number of important differences between the Delaware and federal suits, including differences in claims, remedies and parties. The Court rejected defendants’ characterization of the Delaware plaintiffs’ breach of fiduciary duty claims as a “rebranding” of securities claims about material misstatements.[9]

Importantly, in deciding the issue, the Court noted:

Here, the fundamental question is whether this court’s interest in resolving corporate governance issues under Delaware law prevails over considerations of comity and practicality. This Action concerns allegations that the defendants breached their fiduciary duties of loyalty and impaired the exercise of stockholders’ redemption rights in the context of a de-SPAC transaction. Those claims raise “novel issues” akin to those that this court was presented with in a matter of first impression earlier this year. The Court Chancery has “long been chary” about deferring to a first-filed action pending elsewhere “when a case involves important questions of our law in an emerging era.”[10]

As a result, the Court declined to stay the Delaware action, concluding that its “essential role of providing guidance in developing areas of [Delaware] law would be impaired if [it] were to denude its jurisdiction because a federal securities action resting on similar facts was filed first.”[11]

Takeaways

In the Lordstown decision, the Delaware Chancery Court sent a strong signal that it is interested in SPAC issues and has a desire to issue thought-through decisions on substantive law relating to SPAC transactions.

The Lordstown decision highlights the litigation risks and sharp judicial focus arising from SPAC transactions. Companies engaging in SPAC transactions, sponsors, and boards should recognize that the transaction could subsequently be subject to heavy scrutiny in various types of protracted litigation. These stakeholders should be careful to mitigate their risk by following best practices, including carefully reviewing disclosures for accuracy and completeness, identifying projections as forward-looking and accompanied by meaningful cautionary statements, and considering the engagement of an independent financial advisor paid a flat fee (rather than a fee contingent on the outcome of the deal) and the appointment of an independent special committee to evaluate a de-SPAC transaction to insulate against claims of conflict of interest.

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[1] See In re Lordstown Motors Corp. Stockholders Litigation, CA. No. 2021-1066-LWW (Del. Ch. Mar. 7, 2022), https://courts.delaware.gov/Opinions/Download.aspx?id=330690.

[2] Id. at 1. See In re MultiPlan Corp. S’holders Litig., --- A.3d ---, 2022 WL 24060 (Del. Ch. Jan. 3, 2022), https://courts.delaware.gov/Opinions/Download.aspx?id=328120 at 2-3 (largely denying a motion to dismiss fiduciary duty claims arising from a SPAC transaction and noting “[t]hough SPACs are a popular vehicle for private companies to access the public markets, Delaware courts have not previously had an opportunity to consider the application of our law in the SPAC context.”).

[3] See Seyfarth Shaw, Considering a SPAC Transaction? Keep Securities Litigation Risks at Top-of-Mind (Mar. 2, 2021), https://www.seyfarth.com/news-insights/considering-a-spac-transaction-keep-securities-litigation-risks-at-top-of-mind.html.

[4] Lordstown, supra n. 1 at 2.

[5] Id. at 3.

[6] Id. at 4.

[7] Id. at 4-5.

[8] Id. at 5.

[9] Id. at 10.

[10] Id. at 7-8.

[11] Id. at 2.