The recently filed complaint in Franchi v. Multiplan Corp., et al. is one to watch because it alleges breach of fiduciary duties by the directors and controlling shareholders of Churchill Capital Corp. III (Company), a special purpose acquisition corporation, or SPAC, after the de-SPAC transaction left investors with devalued shares shortly after the de-SPAC transaction closed. The Franchi complaint is also on the heels of the recently published statement by the Acting Director of the Securities and Exchange Commission’s (SEC) Division of Corporate Finance titled SPACs, IPOs and Liability Risk under the Securities Laws. This and similar statements issued by the SEC express concern regarding the sheer amount of capital that is pouring into SPACs and the potential conflicts of interest in the SPAC structure and indicate that the SEC may be more focused on filings and disclosures by SPACs and de-SPAC transaction target companies.
A SPAC is a blank-check or shell company with no operations that raises funding in an initial public offering of redeemable securities. The proceeds of the offering are placed into a trust in anticipation of a future acquisition of a privately-held company (a de-SPAC transaction). A SPAC that fails to complete a de-SPAC transaction within a certain time frame, typically 18-24 months, must return the funds to its original investors. Investors typically have the opportunity to vote on the de-SPAC transaction and to have their stock redeemed in connection therewith. After the de-SPAC transaction, the target company operates as a publicly-held company without having undergone the rigors of the typical IPO process. Directors of the SPAC typically acquire equity in the SPAC or the sponsor of the SPAC for little or nominal consideration and stand to benefit greatly if the de-SPAC transaction is successful.
The complaint in Franchi was filed after the price of the Company plummeted due to a report that was published shortly after the de-SPAC transaction which disclosed that the target company was about to lose the business of a customer that provide 35% of the target company’s revenues. The complaint alleges that (a) the directors and officers of the Company violated their fiduciary duties by pursuing a de-SPAC transaction that was not in the best interests of the shareholders, (b) the Company’s board of directors was “conflict laden” and therefore “invited fiduciary misconduct” and (c) the disclosures to the shareholders who voted on the de-SPAC transaction prior to its consummation were fundamentally flawed.
In February 2020, the Company received $1.1 billion in its IPO at a value of $10 per share. Additionally, the founding sponsor held 20% of the outstanding equity of the Company as “Class B” founder shares acquired pre-IPO for little consideration. The sponsor held all of the Class B shares of the Company and as a result controlled the board of directors (the “Board”), to which the sponsor also provided a significant amount of founder shares that increased in value by over 1.2 million percent upon consummation of the de-SPAC transaction.
The root of the complaint is that the Company and its Board made the decision to merge the Company with MultiPlan Corp. (MultiPlan), a private company in the business of healthcare technology and analytics. Prior to the merger, the share price of the Company hovered around the $10 mark, but upon the release of a market research report of MultiPlan was released post-merger, the Company’s share price fell to $6.27. The report asserted that MultiPlan’s largest client, which accounted for 35% of its revenues, planned to end its relationship with MultiPlan in order to utilize its own newly-formed healthcare technology division, thus decreasing MultiPlan’s expected revenues and adding a new competitor to the market. The report also stated that the proxy statement released in advance of the merger provided the Company’s investors with overly optimistic revenue growth rates and presented a misleading 2018 adjusted EBITDA number.
Analysis of the Complaint
At the heart of the issue in this case is whether the SPAC structure created an inherent conflict of interest among the Company’s Board and the Company’s shareholders. The Complaint asserts that the Board and the Sponsor were motivated to pursue a de-SPAC transaction regardless of whether it was likely to prove fruitful for the Company’s shareholders. Due to the nominal price paid for the founder shares, the Board and the sponsor stood to large gains as long as a deal was entered into prior to the 2-year acquisition window (at which point their founding shares would become worthless), even if it meant that the share price would ultimately drop for the other investors. The Complaint notes that the SPAC structure, in combination with founder shares transferred to directors and sponsors for little or no consideration, misaligns the interests of the directors and shareholders.
The complaint asserts that the process surrounding the MultiPlan merger would fail the entire fairness review because (1) rather than using an independent financial advisor to assess the merger, the Company used services from a financial advisor that was controlled by the Chief Executive Officer of the SPAC and paid that advisor a fee of $30 million, (2) the Board either failed to perform diligence on MultiPlan before closing the de-SPAC transaction or concealed basic facts about MultiPlan from the investors and (3) the disclosures surrounding the deal were misleading. The complaint further contends that, as a result of the foregoing, less than 10% of the investors redeemed their shares prior to the merger while the remaining shareholders felt comfortable with the transaction and subsequently experienced the share price drop.
Franchi is still in its early stages and presents only the plaintiff’s position, but it highlights the issues that can arise when the value received by directors or a sponsor is solely conditioned upon closing a de-SPAC transaction and may misalign the interests of directors and shareholders. Allegations that the directors and affiliates failed to disclose information to shareholders due to a strong desire to close the de-SPAC transaction and reap the reward of founder shares obtained at a huge discount highlights the certain conflicts that are inherent to the SPAC structure. Regardless of the outcome in Franchi, the key takeaway is that this litigation is one to watch for its potential ramifications on the structure of SPAC and sponsor boards and the mechanics to accomplish de-SPAC transactions.