On March 1, 2023, Vice Chancellor Lori Will of the Delaware Court of Chancery declined to dismiss a putative class action brought by stockholders of special purpose acquisition company (or “SPAC”) GigCapital2, Inc. (“Gig2”) against Gig2’s controlling stockholder and directors, asserting that they breached their fiduciary duties in connection with Gig2’s acquisition of UpHealth Holdings, Inc. and Cloudbreak Health, LLC in a so-called “de-SPAC” merger. Laidlaw v. Gigacquisitions2, LLC, et. al.
, C.A. No. 2021-0821-LWW (Del. Ct. Ch. Mar. 1, 2023) (“Gigacquisitions2
”). Plaintiffs alleged that defendants issued a false and misleading merger proxy to obtain approval of a value-destructive de-SPAC transaction and thereby enrich themselves through their unique ownership interests. Defendants moved to dismiss, arguing that (i) plaintiffs’ claims were derivative (alleging harm to the company rather to individual stockholders) but plaintiffs failed to make a demand or plead demand futility, and (ii) the business judgment rule applied. The Court held that plaintiffs’ claims were direct, not derivative, and that entire fairness—Delaware law’s most stringent standard of review—applied because inherent conflicts of interest existed between defendants and Gig2’s public stockholders.
Gig2’s structure was typical of SPACs, with 20% of its equity (known as founder shares) at incorporation issued to its sponsor and certain affiliates for an aggregate price of $25,000 (or $0.0058 per share). The remaining 80% of Gig2’s equity was sold to public stockholders in an IPO for an aggregate $150 million (at $10 per share). If Gig2 failed to complete a merger within the time allotted under Gig2’s charter, Gig2 would liquidate, and its public stockholders would receive their $10 per share, plus interest, while the founder shares would be worthless. If Gig2 identified a merger counterparty, then its stockholders could either vote in favor of the merger, thereby staying in the investment, or redeem their shares at the original purchase price, plus interest. If stockholders approved the merger, then the founder shares would own 20% of the post-closing company.
Over 94% of Gig2’s stockholders voted in favor of the merger. As of closing, the founder shares were worth $37 million (a 147,900% gain). After closing, the stock price of the company (now known as UpHealth, Inc.) declined significantly and traded at $3.75 per share as of the filing of the complaint, representing a more-than 64% loss. The founder shares were still worth $15.1 million at the time the complaint was filed, or a 60,400% gain.
The Court found plaintiffs’ claims were direct because the injury—an impairment of stockholders’ right to redeem their shares—was suffered only by stockholders and any recovery would flow to stockholders.
The Court also concluded that the entire fairness standard applied for two reasons. First
, the Court found that plaintiffs adequately alleged that the merger involved a conflicted controlling stockholder who stood to receive a unique benefit to the detriment of public stockholders. Defendants conceded that the SPAC’s sponsor was a controller (despite owning less than 50% of the SPAC’s shares), and the Court found that a conflict existed because of the “dramatically different outcomes [the sponsor and the public stockholders] could experience from a de-SPAC merger.” The Court reasoned that, even though the sponsor “would prefer a good deal over a bad one,” because “it would still receive a windfall in the latter [bad deal] scenario,” a bad deal was better than no deal for the sponsor, who would otherwise have worthless founder shares. By contrast, for public stockholders, “no deal was preferable to one worth less than $10.10 per share.” Second
, the Court found that plaintiffs adequately alleged that a majority of the board was conflicted because they were either self-interested or lacked independence from the controller-sponsor. One director, Avi Katz, held a controlling interest in the sponsor and therefore stood to benefit from the sponsor’s founder shares. The Court concluded it was reasonably conceivable that the remainder of board lacked independence because they held unspecified indirect economic interests in the founder shares and held various director, officer, and advisory roles with Katz’s other companies.
Applying the entire fairness standard of review to plaintiffs’ claims, the Court concluded that plaintiffs adequately alleged that defendants omitted material information from the proxy. Plaintiffs alleged that the proxy omitted to disclose that (i) Gig2’s net cash per share was just $5.19, despite representing that the Gig2 shares used as acquisition currency were worth $10 per share, and (ii) certain existing financing transactions would be renegotiated to the public stockholders’ detriment. The Court concluded that the omission of the actual net cash per share value was likely material because it implied that Gig2 stockholders would hold a smaller ownership interest in UpHealth. The Court further found that it was reasonably conceivable that dilutive modifications to financing arrangements before the close of the merger would have been material to stockholders and that it was reasonable to infer that defendants knew the modifications would be necessary but failed to disclose that need in the proxy.
The Court found these disclosure allegations inextricably intertwined with issues of loyalty because plaintiffs alleged that the omissions were motivated by defendants’ self-interest to ensure the merger closed and maximize the value of the founder shares. Accordingly, the Court conclude that defendants were not protected by the Gig2 charter’s exculpatory provision.
The Court’s decision in Gigacquisitions2
is the latest in a series of cases applying the entire fairness standard to sustain fiduciary duty claims against SPAC directors, including Delman v. Gigacquisitions3, LLC, et. al.
, C.A. No. 2021-0679-LWW (Del. Ct. Ch. Jan. 4, 2023) (a case involving the same SPAC sponsor) and In re MultiPlan Corp. Stockholders Litigation
, 268 A.3d 784 (Del. 2022) (described in our prior post