SPAC litigation gains momentum

2020 was a record-breaking year for SPACs, with more than $70 billion raised. The blaze of SPAC glory for the previously minor market player became an inferno in the spring of 2021, with more than $160 billion in SPAC proceeds year to date. But with this increased popularity, SPACs have become a target for shareholder litigation.

This development comes as no surprise to practitioners in the US, where public M&A is synonymous with lawsuits. While the plaintiffs’ bar has had to brush up its strategy, the basic premises of their SPAC filings are thus far the same as those employed in traditional M&A.

See also: Asian SPACs must tread carefully or face consequences

Much more will certainly be written concerning protections for board and sponsors as the SPAC path to liquidity becomes more established.  But at the outset, the best way to reduce litigation risk is likely to adhere to best practices in traditional M&A and IPO.

Disclosure-based lawsuits

The IPO of the SPAC itself provides only a limited opportunity for disclosure-based litigation, due to the fact that the SPAC has no operating history to disclose. Accordingly, we are seeing typical public M&A strike suits making disclosure-based allegations in connection with the SPAC's acquisition – such as the failure to include financial projections, details relating to negotiations (e.g. the pursuit of other potential acquisition targets), reasoning for not hiring a financial advisor, and financial analyses considered by the SPAC's board. 

To date, the suits almost universally make claims of material misstatements or omissions under Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act). Rarer are claims under Section 14(a) of the Exchange Act, which prohibits false and misleading statements in connection with proxy solicitations. Once lead counsel is certified from among the claims filed, we expect that they will invest resources and amend their complaint to more than the bare minimum of pleadings, and as a result the number of Section 14(a) claims will increase.

See also: US SPAC market makes first moves into Europe

While strike suits are typically easily settled, as certain SPACs perform poorly vis-à-vis the projections of the operating companies that they acquire, we may see cases that test the limits of the protections for forward-looking statements provided by the Private Securities Litigation Reform Act (the PSLRA). Already, the US Securities and Exchange Commission has stated that a de-SPAC transaction may be an "initial public offering" and therefore not entitled to the PSLRA's safe harbour.

Process-based lawsuits

SPACs, which typically must complete an acquisition within 18 to 24 months of their IPO, may be susceptible to fiduciary duty claims owing to the conflicts of interests of SPAC sponsors. The critique is that sponsors are incentivised to rush into an acquisition, regardless of the quality of the target, or they will lose their initial investment. Some courts have already held that the failure to adequately diligence a target in this context is not protected by the business judgment rule.

These cases are interesting because, while the potential for conflicts of interest exist, de-SPAC transactions possess features that differentiate them from traditional M&A:       

• a SPAC's directors do not sell the SPAC to the highest bidder, but rather approve a transaction that is the SPAC’s very purpose for being;

• many conflicts of interest are disclosed at the time of the IPO of the SPAC;

• an informed shareholder vote in connection with the de-SPAC transaction should cleanse such conflicts; and

• a SPAC's shareholders are not squeezed out in a SPAC transaction, but instead are protected against an unwanted acquisition through their ability to redeem their shares.

See also: European SPAC uptick expected in 2021

Michelle Heisner Partner Baker McKenzie, New York

Santiago Corcuera-Mansi Associate Baker McKenzie, New York