By: Brett S. Theisen, Esq. Director & Vice-Chair, Financial Restructuring & Creditor's Rights Group Gibbons P.C.
Among restructuring professionals, the onslaught of COVID-19 shutdowns brought swift prognostications that a “tsunami” of chapter 11 filings would soon follow. As we enter our second COVID summer, those warnings – mostly made before the federal government’s release of $5T in stimulus money into the economy – have not come to pass. In fact, as companies continue to be buoyed by cheap credit and government funds, chapter 11 filings have actually fallen to near-record lows in recent months. Notwithstanding the slowdown of in-court restructuring activity, one area that has been – and continues to be – white hot, is SPACs, or Special Purpose Acquisition Companies. As the inevitable SPAC-related bankruptcies arise, so too will the lawsuits challenging SPAC insiders’ pre-bankruptcy conduct, including the acquisition process itself.
A “Blank Check”
A SPAC is a publicly-traded company used as a vehicle to raise capital to acquire a target company. The SPAC sponsor will sell shares in the SPAC to investors in an IPO before it identifies and acquires a target; thus, SPACs have become known colloquially as “blank check companies.” Investor returns depend entirely on the sponsor’s ability to successfully acquire a target. Generally, governance documents grant the SPAC one to two years to complete an acquisition; otherwise, the SPAC must liquidate and return investors’ capital. Notably, in the absence of an acquisition, the sponsor’s investment is usually worthless. While this structure incentivizes the sponsor to complete a deal – which should prove highly profitable for investors if the target is a good one – it also creates potential conflicts of interest for sponsors who close a late-stage deal simply for the sake of acquiring something.
Target Company Bankruptcies and D&O Litigation
The SPAC craze has and will continue to give rise to many flavors of litigation, including securities class actions and SEC enforcement actions, but restructuring professionals should pay particularly close attention to situations where a SPAC’s board members become directors and officers of the acquired operating company. If the target later seeks bankruptcy protection, those individuals will find themselves squarely in the creditors’ cross-hairs for breaches of fiduciary duties and related claims. If the debtor was also acquired by the SPAC in an “eleventh hour” transaction, the former SPAC board members are also likely to face allegations of self-dealing and claims for breach of the duty of loyalty. The traditional SPAC structure, which is intended to reward sponsors above and beyond ordinary investors upon a successful acquisition, makes such claims almost inevitable. See, e.g., AP Servs., LLP v. Lobell, 2015 N.Y. Misc. LEXIS 2314 [Sup. Ct., New York County 2015].
Key Lessons for Good SPAC Governance
SPAC sponsors and boards can take steps to minimize the risks and protect themselves against future litigation. First, be mindful of timing and documentation. Late-stage transactions in particular will always result in close scrutiny, but diligent documentation at every step of the decision-making process is key to managing risk. Without an adequate record, the sponsor is open to charges that it was looking for to make any acquisition, not the best one. Second, do not minimize the role and influence of independent directors and/or special committees and, when appropriate, provide for the retention of separate counsel. These steps guard against the argument that the board is captive to the sponsor. Third, all disclosures and communications to investors must be meticulously prepared. Under Delaware law, a fully-informed shareholder vote approving a transaction will result in application of the business judgment rule, thereby insulating the transaction from subsequent attack – even against charges that the board was not disinterested.
None of the foregoing tools are unique to SPACs, and additional risk mitigation tools exist (and should be utilized). However, keeping these three key points in mind can lay the foundation for good governance and – if the time comes – a staunch defense to a committee’s or trustee’s claims. Even if the tsunami remains offshore a little longer, now is the time to prepare.
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