The Ripples Behind The SPAC Wave – Corporate/Commercial Law

The past year saw a burst in popularity of SPACs. More than half of companies that went public in 2020 did so using a SPAC
on their way to raising over $80 billion in proceeds, and so far in 2021
SPAC offerings far outpace traditional IPOs. SPACs allow
companies to go public with greater speed and with fewer hurdles
than a traditional IPO. These innovations combined with
unprecedented deal volume may signal an increased risk for
disputes, especially where the SPAC process and structure can
present unique pitfalls.

For example, SPACs must issue registration statements and
proxies in advance of acquiring a target company, which require
compliance with Sections 11 and 14(a) of the Securities Exchange
Act.  But unlike in traditional IPOs, SPAC target companies
may disclose projections of future performance before shareholders
vote on whether to move forward with a merger, and failure to meet
those projections could lead to litigation by shareholders or the
SEC. The SEC has issued guidance on the types of
disclosures that SPACs specifically should keep in mind, including
disclosures pertaining to sponsors’, officers’ and
directors’ financial incentives, prior SPAC experience, and
conflicts of interest with other entities to which they owe
fiduciary duties.  SPACs also often raise money through PIPE
(private offering in public equity) transactions, which allow for
private investment on special terms, but those require separate
disclosures and result in an additional set of shareholders who
could later bring claims. By their nature, SPACs also present a
number of other regulatory risks, including risks relating to MNPI,
valuation, and conflicts of interest.

SPAC officers and directors may also face individual liability
in connection with both the acquisition of a target company as well
as their management of operations. As a potential harbinger of
things to come, a 2015 New York state court decision suggested that
SPAC directors might not be protected by the business judgment
rule in connection with a merger where they are
incentivized to consummate a transaction before the drop-dead
date.  And if a combined company struggles after a merger,
officers and directors could face allegations that they
inadequately managed the company or did not exercise sufficient
oversight. The latter, known as
a Caremark claims, have been gaining increasing traction in the courts
in recent years after a 2019 Delaware Supreme Court decision.

Sponsors should be particularly vigilant in assessing legal and
regulatory risks involving SPACs because a significant number of
private equity-backed companies have been acquired by SPACs.
Between January 1, 2021 and March 12, 2021, SPACs have acquired, or
announced an agreement to acquire, 78 different private
equity-backed portfolio companies. If there is litigation involving
a SPAC concerning the acquisition of a portfolio company, the funds
and their sponsors are at increased risk of being dragged into the
litigation. Funds are typically significant shareholders in
portfolio companies, and often hold or control board seats. As we
have described in our parallel series, The
Portfolio Company Playbook,  these indicia of
control create litigation risk for the entire fund complex
(individual sponsors, board directors, and funds).  The same
risk persists, post-acquisition, if the fund retains a board seat.
Therefore, while SPACs are an innovative and efficient path to
liquidity, they are not risk-free.

Read more of our Top Ten Regulatory and Litigation Risks for
Private Funds in 2021.

The Ripples Behind the SPAC Wave

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