Special Purpose Acquisition Companies Continue to Face Headwinds

The slowdown in special purpose acquisition company (“SPAC”) initial public offerings (“IPOs”) and SPAC business combination transactions (“de-SPAC transactions”) and the increase in SPAC dissolutions that were seen in 2022 has continued into 2023. After a burgeoning SPAC market in 2020 and 2021, investors, regulators and courts have applied increasing challenges and scrutiny to SPACs and de-SPAC transactions. Below, we highlight certain trends emerging in the SPAC market and recent legal developments with respect to SPACs and de-SPAC transactions.

State of the SPAC Market: Observations on Q1 2023¹

The first quarter of 2023 priced ten SPAC IPOs with aggregate gross proceeds of approximately $738 million. This is a substantial slowdown and decrease in capital raised as compared to just a year earlier in Q1 2022, when 55 SPAC IPOs were priced with aggregate gross proceeds of approximately $9 billion, and this represents a continued slowdown from Q4 2022, when eight IPOs were priced with aggregate gross proceeds of approximately $600 million. The trend seen in recent quarters of there being an equal or greater number of withdrawn IPOs as compared to priced IPOs continued to be present in Q1 2023, which brought 21 withdrawn IPOs (as compared to 55 priced IPOs).

De-SPAC transaction values have also continued to decrease over the last year. The aggregate equity value of de-SPAC transactions announced during Q1 2023 was approximately $22.5 billion, with an average equity value of approximately $479 million per transaction –this is a stark contrast to Q1 2022’s aggregate equity value of $41.8 billion, and its average equity value per transaction of $1.23 billion. Q1 2023 also saw a sharp uptick in SPAC liquidations: 71 SPACs were dissolved in Q1 2023 alone, while a total of 145 SPACs were dissolved in all of fiscal year 2022. Private investment in public equity (“PIPE”) participation in de-SPAC transactions was also markedly down with only 20% of de-SPAC transactions including a PIPE investment in Q1 2023, whereas 59% of de-SPAC transactions in Q1 2022 had PIPE participation.

A combination of factors contributed to the sustained slowdown in SPAC activity and the drop in capital raised and PIPE participation in connection with SPAC transactions—among them include macroeconomic uncertainty brought about by inflation, rising interest rates and recessionary fears. However, macroeconomic factors are not only to blame—SPAC transactions have received increasing scrutiny from the U.S. Securities and Exchange Commission as well as US courts, with a recent court decision ruling against SPAC sponsors (described further below). Further, as of the end of Q1 2023, approximately 90% of de-SPACed companies that went public between 2019 and Q1 2023 were trading below their IPO price.

SPAC Litigation

Delman v. GigAcquisitions 3, LLC (“Delman”)²

In January 2023, the Delaware Court of Chancery declined to dismiss a plaintiff’s claims against a SPAC’s sponsor and its directors for breach of fiduciary duty in connection with a de-SPAC transaction. Delman is notable because the SPAC, the de-SPAC transaction structure and the course of conduct that are the subject of the case are similar to those of other Delaware SPACs and de-SPAC transactions, and the issues presented in Delman are likely to be faced by other Delaware SPACs and their sponsors going forward.³ Delman also reaffirmed that, as a practical matter, Delaware courts will review de-SPAC transactions through the same lens they would apply to review any other transaction requiring an investment decision by stockholders of a Delaware corporation and that directors of Delaware SPACs owe the same fiduciary duties to their stockholders as the directors of any other Delaware corporation, notwithstanding the unique structures of SPACs and de-SPAC transactions.

With respect to the standard of review used to evaluate whether the defendants complied with their fiduciary duties, the court determined that the business judgment rule was not applicable and that the entire fairness standard applied, due to the inherent conflicts of interest between the SPAC’s sponsor and the SPAC’s stockholders. The court reached this conclusion based on two independent grounds: (1) the sponsor was a controlling stockholder of the SPAC and (2) a majority of the SPAC’s board was not disinterested and independent.

The court determined that it was reasonably conceivable that the de-SPAC transaction was a conflicted controller transaction because:

• The sponsor had complete control of the SPAC from creation through the de-SPAC transaction;
• The sponsor had the opportunity to extract something uniquely valuable to itself in the de-SPAC transaction at the expense of the public stockholders by receiving an “enormous” return on its investment in the SPAC even if the de-SPAC transaction was unfavorable to the public stockholders; and
• The sponsor had an interest in minimizing common stock redemptions by the public stockholders (which would have been paid out of the SPAC’s trust account) because the closing of the de-SPAC transaction was conditioned on the SPAC contributing at least $150 million in cash at closing, $50 million of which was required to come from the SPAC’s trust account.

In finding that it was reasonably conceivable that a majority of the SPAC’s board of directors was not disinterested and independent, the court emphasized the following factors:

• The SPAC’s chairman and chief executive officer (the “SPAC Founder”) was a director of the SPAC, and, along with his wife, who was also a SPAC director, stood to receive a material financial benefit in the de-SPAC transaction through his ownership and control of the SPAC’s sponsor (the court calculated the sponsor’s return to be 155,900% on its initial $25,000 investment in the SPAC); and
• Despite being paid in cash for their services as directors, the remaining directors on the SPAC’s board held multiple positions with other sponsors and portfolio companies controlled by the SPAC Founder, which raised sufficient reason to doubt that they were independent of him.

The defendants argued that, if entire fairness applied because of board-level conflicts, the plaintiff’s claims should be dismissed because the SPAC board’s decision to engage in the de-SPAC transaction was subject to business judgment deference under Delaware’s Corwin doctrine.⁴ Rather than rejecting the defendants’ argument solely because the de-SPAC transaction involved a conflicted controlling stockholder or because the plaintiff had presented well-pled disclosure deficiencies (described below), the court also determined that Corwin cleansing was not available to the defendants because the SPAC’s inherent structure separated the stockholders’ voting and economic interests by allowing stockholders to vote to approve the de-SPAC transaction and also redeem their shares before closing. The court found that the SPAC structure itself encouraged stockholders that redeemed their shares to nevertheless vote to approve the de-SPAC transaction in order to preserve the value of the warrants included in the SPAC IPO units.

In its entire fairness analysis, the court determined that plaintiffs sufficiently pleaded alleged failures to disclose in the SPAC’s proxy statement certain facts material to a stockholder’s decision of whether to redeem its shares, which failures contributed to the court’s conclusion that dismissal of the plaintiff’s claims was not appropriate, including the following:

• The SPAC had failed to accurately describe the actual value of SPAC shares for public stockholders that decided not to redeem their shares in the de-SPAC transaction. The proxy statement indicated that the value of SPAC stock of non-redeeming stockholders would be $10 per share in the de-SPACed company going forward. However, the court viewed that statement as materially misleading because the $10 figure failed to disclose and account for the significant per share dilution associated with, among other things, the reduction of the SPAC’s cash due to the payment of transaction costs (including financial advisor fees) and the value of the SPAC’s warrants, as well as the increase in the number of shares outstanding, including the shares issued to the sponsor, IPO underwriters and insiders as well as the PIPE shares;⁵ and
• The proxy statement included unrealistic revenue and production projections that effectively kept stockholders “in the dark about what they could realistically expect from the combined company” after closing. The court stated that the SPAC board accepted an inflated valuation for the target company premised on unrealistic projections and then gave this misinformation to stockholders. The court noted that the problem with the projections is that they were not counterbalanced by “impartial information” that would have helped stockholders assess the risk of their investment and that even though the nature of the target company’s business model could have been known by the kind of due diligence that is expected of the board of a Delaware corporation engaged in a major transaction, the SPAC board was incentivized to turn a blind eye to the target company’s problems. Accordingly, it was reasonably conceivable that the stockholders did not receive an accurate view of the target company’s financial health.

With Delman, the Delaware Court of Chancery has made clear that traditional and well-worn fiduciary duty principles apply to SPACs and de-SPAC transactions. The SPAC structure used in the case is typical of other Delaware-incorporated SPACs, and de-SPAC transactions involving such SPACs appear to be ineligible for business judgment deference and, by their nature, will be subject to entire fairness review. In addition, the Delman court has clarified certain types of information that is required to be disclosed to SPAC stockholders in connection with their decision of whether to redeem their shares in connection with a de-SPAC transaction. As a result of this case and other SPAC decisions of the Chancery Court of Delaware, sponsors may be incentivized to organize their SPACs outside of Delaware going forward.⁶

Garfield v. Boxed, Inc. (“Boxed”)⁷

In December 2022, the Delaware Court of Chancery ruled in Boxed that, pursuant to Section 242(b)(2) of the Delaware General Corporation Law (the “DGCL”), a SPAC with Class A and Class B common stock was required to seek a separate class vote of the Class A common stock, in addition to the vote of the common stockholders voting together, when amending the SPAC’s certificate of incorporation to increase the number of authorized shares of Class A common stock. While many Delaware SPACs have been incorporated with two classes of common stock, prior to the Boxed decision, many such SPACs had not sought a separate class vote in similar circumstances and the failure to obtain such approvals cast doubt on the validity of the certificate of incorporation amendments and issuances of shares of common stock by these SPACs in connection with their de-SPAC transactions.

Following the Boxed decision, many companies petitioned the Delaware Court of Chancery pursuant to Section 205 of the DGCL⁸ to remedy the defective stockholder votes obtained in connection with de-SPAC transactions and the court has begun to grant the relief sought by de-SPACed petitioners. In the first of its opinions granting such relief,⁹ the court noted that “billions of shares [had been] issued” in situations similar to the company in Boxed and the failure to grant relief would “invite untold chaos” causing similarly situated companies to otherwise “face difficulties in filing Form 10-Ks and the possibility of stock exchange delisting.” The court also noted that, where the factors contemplated by Section 205(b) of the DGCL were satisfied, there did not appear to be “any legitimate harm that would result from validating” the amendment to the company’s certificate of incorporation and that “absent validation, a number of parties would face widespread harm.” In light of the significant risks resulting from the Boxed decision faced by de-SPACed companies that were formerly dual-class SPACs and the court’s subsequent decisions and rationale for ratifying defective stockholder votes, we would expect the court to continue to grant relief under Section 205 for companies that find themselves in similar circumstances.

Deadline Extensions for De-SPAC Transactions

The vast majority of SPAC charters contain a deadline by which a SPAC must complete a business combination.¹⁰ If a SPAC has not completed a business combination by the deadline, the SPAC must cease all operations except for the purpose of winding up. In that case, SPACs are required to return the funds remaining in the IPO trust account (net of any amounts permitted by the charter to be removed for taxes and dissolution expenses) to public stockholders via redemption. To avoid this result, SPACs that are approaching their deadline can seek to extend their deadline by obtaining stockholder approval to amend their charter and obtain more time to complete a business combination.¹¹ In order to compensate public stockholders for the additional time requested, SPACs often offer to deposit additional funds into their trust accounts on the theory that eventually (upon completion of a business combination or a later dissolution) public stockholders will have the opportunity to acquire these funds via redemption.

The first quarter of 2023 remained on trend with many SPACs seeking such extensions. Extensions have become more common as many SPACs that were formed during the SPAC boom years of 2020 and especially 2021 are now approaching their deadlines.

When a SPAC seeks shareholder approval for a charter extension amendment, it is obligated to offer public stockholders the opportunity to redeem their shares upon adoption of the amendment. However, SPAC charters also provide that no redemption may occur to the extent that it would result in the SPAC having less than $5,000,001 in net tangible assets.¹² When the number of stockholders exercising their redemption rights is high, it can lead to a “catch-22” where a SPAC has the votes necessary¹³ to effect a charter amendment for an extension, but the number of redemptions would reduce a SPAC’s net tangible assets below the required amount. In that case, a SPAC may be legally unable to adopt the amendment necessary to extend its deadline, and the SPAC would be forced to liquidate instead. SPACs facing this situation have undertaken a variety of maneuvers and transactions designed to avoid this result, including entering into non-redemption agreements with certain shareholders or forward purchase agreements with new or existing investors, seeking waivers to significant deferred liabilities and obtaining additional capital from the SPAC’s sponsor. These strategies have differing advantages and disadvantages and there are many factors to consider, not least of which is the SPAC’s ability to satisfy the continued listing requirements of the NYSE or Nasdaq and its prospects for timely consummating a de-SPAC transaction. The best course of action for any particular SPAC considering an extension will depend on the SPAC’s objectives and the surrounding circumstances.

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¹Data as of March 31, 2023 from Deal Point Data, SPAC Track.
²Delman v. GigAcquisitions 3, LLC (Del. Ch. January 4, 2023).
³In a typical SPAC IPO, the SPAC issues units consisting of a share of stock and a warrant to purchase a fraction of a share. IPO proceeds are kept in a trust account for the benefit of the holders of shares issued in the IPO and before the SPAC completes a de-SPAC transaction, such holders have the opportunity to redeem their shares for their pro rata portion of the funds held in trust. Notwithstanding whether a holder redeems its shares, it is entitled to keep the warrant.
⁴In the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC (Del. 2015), the Court held that, other than with respect to a self-dealing transaction involving a controlling stockholder, a fully informed vote of the disinterested and uncoerced stockholders will result in the business judgment rule applying to the transaction.
⁵The plaintiffs alleged that using this methodology, the actual per share value was $5.25.
⁶Following Delman, the Delaware Court of Chancery issued another decision in Laidlaw v. GigAcquisitions2, LLC (Del. Ch. March 1, 2023) which reflected very similar facts and circumstances as Delman. Using the same rationale first described in Delman, the court applied an entire fairness review to the plaintiff’s claims and denied the defendants’ motion to dismiss.
⁷Garfield v. Boxed, Inc. (Del. Ch. December 27, 2022)
⁸Section 205 of the DGCL allows Delaware corporations to petition and seek relief from the Delaware Court of Chancery to validate defective corporate acts that would otherwise be void or voidable.
⁹In re Lordstown Motors Corp. (Del. Ch. February 21, 2023).
¹⁰SPACs are required to complete a business combination within 36 months or face delisting on the relevant securities exchange. See NYSE Rule 102.06 and Nasdaq Rule 5101-2. However, conditions in the equity markets have forced virtually all SPACs to include a much shorter time frame (12 months or even shorter in some cases). The SEC has proposed rule changes relating to the Investment Company Act of 1940 which have the effect of putting a SPAC in jeopardy of being deemed an investment company if either (i) it has not filed an 8-K disclosing an agreement to engage in a business combination transaction within 18 months of its IPO registration statement’s effective date; or (ii) it has not completed a business combination within 24 months of its IPO registration statement’s effective date.
¹¹Some SPAC charters have a built in mechanism under which the SPAC’s deadline may be extended without a stockholder vote for a limited additional time upon the deposit by the sponsor of additional funds into the trust account. Once these “automatic” extensions are exhausted, a SPAC can still seek a stockholder vote to amend the charter and get even more time.
¹²SPACs include this requirement in order to avoid being classified a “blank check company” under Rule 419 promulgated under the Securities Act of 1933, as amended.
¹³In Delaware, the vote required for this type of amendment is usually a majority of the outstanding common stock entitled to vote thereon. See DGCL § 242(b)(1).