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The SPAC Era Is Upon Us, and Related Litigation Is on The Rise

Philip R. Stein

Special Purpose Acquisition Companies (SPACs) have been in such widespread use over the last year or two that an uptick in SPAC-related litigation appears inevitable.  Indeed, the increase is already beginning.  After a brief overview of SPACs, this article will identify some of the key litigation risk areas for these entities and the individuals who govern them.

SPACs have no commercial operations when they are formed. They are shell companies that exist to raise capital through an IPO to merge with a private operating company and take it public. Taking the private company public is often referred to as a “de-SPAC transaction.”  The IPO funds are held in a trust account until that de-SPAC transaction occurs. After the target has been selected, the proposed merger is put to a shareholder vote. Prior to a merger, shareholders can opt to redeem their shares if they do not approve of the target or the terms of the deal.

SPACs are in increasing use largely because they can reduce the time and expense (including much lower capital costs) associated with taking a private company public. But these vehicles generally have structural time constraints, in that a SPAC gets liquidated — and investors receive their money back, with interest — if it does not identify a suitable acquisition target within a particular period, typically two years.  Some analysts see a striking imbalance between the current number of SPACs and the number of attractive targets.  They have expressed concerns that the strong structural incentives for SPAC sponsors to get a deal done may lead to ill-advised mergers, and/or claims by investors that the mergers were contrary to their financial interests.

The U.S. Securities and Exchange Commission (SEC) has shown growing interest in SPACs recently, particularly with respect to real or potential conflicts of interest that may influence SPACs’ selection of merger targets. The SEC appears intent on scrutinizing directors, officers, sponsors, and the sponsors’ affiliated companies for potential conflicts in circumstances the agency deems appropriate. Disclosures of conflicts, both at the IPO stage and at the time of the de-SPAC transaction, and disclosures of the extent and results of due diligence with respect to the merger target, loom large in SPAC regulatory enforcement actions and in private litigation.

Disclosures at the time of the IPO about the SPAC itself tend to be much more limited than in other (non-SPAC) IPOs.  Management personnel’s backgrounds and experience levels are almost inevitably the core subject of disclosure at that stage, because the SPAC has no business operations yet. Disclosures at the time of the de-SPAC transaction, however, are not so limited.  They must include details of the target company’s operating results and financial projections, among other things.

SPACs and their officers, directors, sponsors, and affiliates, when sued or threatened with a suit, most often face the following types of claims: assertions about inadequate or misleading disclosures at the IPO stage, or, more likely, in connection with the de-SPAC transaction; claims of breaches of fiduciary duties; and allegations related to the post-merger operations of the acquired company.  In future posts, we will delve more deeply into each of these types of litigation.