James Hanson is managing director in the investment banking practice at Opportune LLP. Views are the author's own.
CFOs and their management team colleagues might consider insisting on a fairness opinion as a condition of closing if they’re the target of a special purpose acquisition company (SPAC) merger.
Although conflicts between the SPAC sponsor — its founder and directors — and its investors over whether the acquisition makes financial sense don’t directly involve the target company, a legal battle that drags on after the de-SPAC transaction can weigh down the combined company’s management team.
A recent decision by a Delaware court complicates these kinds of conflicts by denying a SPAC sponsor’s request to dismiss a case against it by its investors.
In the Multiplan Corp. shareholder litigation, the court acknowledged the possibility of a conflict of interest between the SPAC sponsor, including its directors, and the investors because of the sponsor’s potential interest in moving forward with a merger, even if the transaction is worth less than the investment redemption price, because absent a transaction, the sponsor’s shares would be worthless.
In its key point, the court held that the fiduciary obligations of the sponsor’s directors should be evaluated under an “entire fairness” standard rather than a less stringent but more common “business judgment” standard.
Traditionally, participants in SPAC transactions have taken comfort in the conventional wisdom that, even when a potential conflict is present, an informed shareholder vote would have the effect of cleansing conflicts and defeating most lawsuits (DE 2015 Corwin v. KKR). As a result of this conventional wisdom, most de-SPAC transactions rely on a proxy statement and shareholder vote combined with the inferred structural protection of common shareholders’ redemption rights.
The MultiPlan decision not only raises questions about what the implications of challenges to transactions can have on sponsors or SPAC directors but on the transaction itself. Drawn out legal challenges not only have direct cost implications for the combined company but also can be a huge distraction for management from the target’s core business.
Entire fairness standard
Legal responsibilities of board members have evolved over the years from the application of decisions by courts into a doctrine commonly referred to as the “business judgment rule.” The basic premise is that executives and directors are not liable for decisions that are made in good faith. However, in 1983, in Weinberger v. UOP, Inc., the Delaware court introduced the concept of “entire fairness,” which encompasses both “fair price” (economic and financial considerations) and “fair dealing” (how a transaction is structured, where and how it is initiated, how it is disclosed and negotiated with directors, and what and how approvals are received).
Precedent for protections
Luckily for SPAC target acquisition management teams, protection from legal challenges in potential conflict transactions is a well-traveled path in Delaware case law. In 1985, the Delaware Supreme Court case Smith v. Van Gorkom ushered in the use of independent fairness opinions in potential conflict transactions. The court found the company’s directors negligent in the evaluation of the transaction, which the court specifically stated they could have mitigated by obtaining a fairness opinion.
It is not uncommon in regular-way merger transactions for an acquirer or target to require a fairness opinion or even solvency opinion, depending on the nature of the transaction. The good news is that relative to the other legal and advisory costs in a de-SPAC transaction, a fairness opinion represents not only best practice but also inexpensive protection against legal challenges.
While the Delaware Court in the MultiPlan case left some ambiguity as to how transactions will be evaluated in the future, we believe that all de-SPAC deal participants would benefit from the added scrutiny that would come from an independently provided fairness opinion.