Fairness Opinion or Providing Assurance for SPAC Merger Target Companies
In SPAC mergers, target company management faces litigation risks stemming from conflicts of interest between sponsors and investors. The Delaware court in the Multiplan case adopted the 'entire fairness' standard, weakening the traditional 'cleansing' effect of shareholder votes. Obtaining an independent fairness opinion has become a low-cost, effective protective measure, and it is worth considering as a closing condition for target companies.
In a special purpose acquisition company (SPAC) merger transaction, the target company's chief financial officer and their management team colleagues should consider obtaining a fairness opinion as one of the conditions precedent to closing.
Although conflicts between SPAC sponsors (i.e., their founders and directors) and investors over whether an acquisition is financially reasonable do not directly involve the target company, if legal disputes continue to escalate after the transaction closes (i.e., post-de-SPAC), they will impose a heavy burden on the management team of the combined company.
Recently, a ruling by a Delaware court has complicated such conflicts: the court denied the SPAC sponsor's motion to dismiss the investors' lawsuit.
In theMultiplan Corp. shareholder litigation, the court found a potential conflict of interest between SPAC sponsors (including their directors) and investors, because sponsors may be inclined to push forward with a merger even if the transaction value is lower than the investment redemption price—if the transaction does not proceed, the shares held by sponsors would be worthless.
The core point of this ruling is that the court held that the fiduciary duties of sponsor directors should be subject to the "entire fairness" standard, rather than the more lenient and common "business judgment" standard.
Traditionally, participants in SPAC transactions generally believed that even if potential conflicts existed, an informed shareholder vote could "cleanse" the conflict and fend off most lawsuits (seeDelaware's 2015 Corwin v. KKR case). Based on this traditional understanding, most de-SPAC transactions rely on proxy statements and shareholder votes, supplemented by structural protections of ordinary shareholders' redemption rights.
The MultiPlan ruling not only raises questions about what impact transaction challenges might have on sponsors or SPAC directors, but also raises concerns about the impact on the transaction itself. Protracted legal challenges not only impose direct costs on the combined company, but may also seriously divert management's attention from the target company's core business.
Entire fairness standard
The legal liability of board members has evolved over many years into what is commonly referred to as the "business judgment rule" principle. Its basic premise is that officers and directors are not liable for decisions made in good faith. However, in the 1983 case ofWeinberger v. UOP, Inc., the Delaware court introduced the concept of "entire fairness," encompassing both "fair price" (economic and financial considerations) and "fair dealing" (how the transaction was structured, where and how it was initiated, how it was disclosed to and negotiated with directors, and what approvals were obtained and how).
Protective precedent
Fortunately, for management teams of SPAC target companies, defending against legal challenges in potentially conflicted transactions has a well-established path in Delaware case law. In 1985, the Delaware Supreme Court inSmith v. Van Gorkomset a precedent for the use of independent fairness opinions in potentially conflicted transactions. In that case, the court found that company directors were negligent in evaluating a transaction and explicitly stated that obtaining a fairness opinion could mitigate such liability.
In ordinary M&A transactions, it is not uncommon for the acquirer or target company to require a fairness opinion or even a solvency opinion (depending on the nature of the transaction). The good news is that, compared to other legal and advisory costs in de-SPAC transactions, a fairness opinion is not only best practice but also a low-cost protective measure against legal challenges.
Recommendation
Although the Delaware court left some ambiguity in the MultiPlan ruling regarding how future transactions will be evaluated, we believe that all participants in de-SPAC transactions would benefit from the additional scrutiny provided by an independently obtained fairness opinion.