Aastha Bhandari and Arnav Doshi are fourth-year students at OP Jindal Global University.
The US-phenomenon of a Special Purpose Acquisition Company (“SPAC”) has been the new buzzword in news and the legal community. According to a research study by Refinitiv, relying on data as of April 19 2021, US-listed SPAC volumes surged to USD 160 billion in the first quarter of 2021 as compared to USD 80 billion in the entire financial year of 2020. India has also taken a step in this direction to enable the listing of SPACs. As per the Consultation Paper on Proposed International Financial Services Centres Authority (Issuance and Listing of Securities) Regulations, 2021 (“Listing Regulations”) the IFSCA has proposed to enable a consistent regulatory framework for the listing of SPACs within its jurisdiction “in order to facilitate sponsors, raise capital to undertake an acquisition of a company or assets."
However, this article is focused towards analysing the surge in SPAC litigation globally which has fundamentally arisen due to the increased underperformance of the de-SPAC entity and resulting loss of the investor’s money. We aim to give an early warning signal to Indian regulators by providing a detailed analysis of the surge in SPAC litigation in two jurisdictions, namely, the United States of America and the United Kingdom and the significant jurisprudential principles that have emerged from it. Thereafter, we illustrate that the Listing Regulations in their current state are inadequate and must adopt certain provisions of the Securities and Exchange Commission (SEC) or the Financial Conduct Authority (FCA). This will provide guidance to create a sound and regulatory environment for the functioning of SPACs in India.
I. THE WAVE OF SPAC LITIGATION IN FOREIGN JURISDICTIONS
The uptick of litigation against SPACs have been tracked by the Stanford Law School Securities Class Action Clearinghouse that has postulated a total of 22 securities class actions brought against SPACs, with most suits filed in New York and California, as of August 2021. Through the following jurisdictions, the paper will demonstrate the rising wave of lawsuits against SPACs.
A. United States of America (“USA”):
Owing to the guidance regarding disclosure consideration for SPACs issued by the SEC in 2020, the increase in threshold of fiduciary duties of directors towards shareholders as well as the standard for fair and full disclosure has been the root of most lawsuits against SPACs. Although the fundamental precepts governing SPACs are nascent, the Delaware Court of Chancery In re MultiPlan Corporation Stockholder Litigation (“MultiPlan”) scrutinised the fiduciary duties of a director in terms of de-SPAC transactions- the first time any court has addressed the applicable standard of review for breach of fiduciary duty claims in the context of a de-SPAC merger. To adumbrate the issue in the aforesaid case, the Court primarily discussed whether the transaction between parties involved the application of the heightened fair and full disclosure standard. The Delaware Court identified entire fairness as the relevant standard of review, the court applied that standard to the breach of fiduciary duty claim, which in this case was based on the allegation that the directors prioritized their own interests in approving an unfair merger and failing to disclose information regarding the development of a competing platform by one of MultiPlan’s largest customers.
In furtherance to the Delaware Court spinning a new cocoon of jurisprudence, the New York state court in a similar vein, observed lawsuits against SPACs and their directors with allegations involving misleading or inadequate disclosure by the special purpose companies. Truesdale v. Altimar Acquisition Corp., Acker v. Churchill Capital Corp II,1 Ezel v. GigCapital3,2 Inc. and Quarles v. InterPrivate Acquisition Corp.,3inter alia, are ongoing lawsuits pivoting around inadequate SPAC disclosures. Moreover, parties are also pursuing SPAC-related litigation for purportedly false and misleading disclosures post-closing in instances where the surviving operating company’s performance turns out to be disappointing despite optimistic representations in SEC filings made in connection with the de-SPAC transaction.
B. United Kingdom (“UK”):
Despite SPACs in the UK not accelerating in number at the same momentum as the USA, an estimate of 33 SPACs were listed in the UK as on 30 April 2021. More pertinently, the regulatory and litigation risks for SPACs in the UK remain broadly untested given the current size of the SPAC market. However, the FCA’s Policy Statement on the Updated Listing Rules is clear that investors must be given sufficient disclosures on key terms and risks from an SPAC’s IPO through to the announcement and conclusion of any acquisition. Therefore, the regulatory standards on disclosure of information pose as a potential minefield of SPAC litigation.
Common law claims for misleading statements are most likely to be brought by shareholders against the SPAC. However, claims against the directors of the SPACs, in comparison to the US, are unlikely owing to the High Court’s decision in Sharp & Others v Blank & Others, where it held that such liability would run counter to the cardinal principles of company law that a company is a separate legal personality, and that the directors owe their duties to the company rather than individual shareholders. Further, there is an identified risk that the limited time available for an SPAC to identify, negotiate and complete an acquisition may compromise the due diligence process, and in turn result in SPAC litigation. In light of the same, The Lloyds/HBOS litigation observed the High Court applying a two-stage test in determining the standard which the board of directors must adhere with in relation to conducting due diligence:
Standard of Established Practice: Whether the due diligence undertaken by the board of directors fell short of the established practice in takeovers prevailing in that sector.
Reasonableness: Whether the claimant has demonstrated that no director of reasonable competence would have made the recommendation or a business decision without taking additional steps beyond market practice. This would be ascertained on a case-by-case basis.
The Lloyds/HBOS litigation soothes the SPAC litigation milieu by providing comfort to directors of SPAC who adhere to the laid down standard, thereby proving they have not behaved negligently.
II. MAKING A CASE FOR SEBI’S INVOLVEMENT: NECESSITY FOR A STRINGENT REGULATORY ENVIRONMENT FOR SPACS
In order to tackle issues highlighted in Part I, the United States SEC and the UK’s FCA have released several public statements related to Disclosure Guidance and Investor Protection. A case for a strengthened regulatory regime conducive for SPACs and investors alike can be made through the observance of the following in India:
a. Regulation 71 of the Listing Regulations mandates the initial disclosures that are to be made in the offer document of an SPAC IPO. They include but are not limited to- objects of the issue, risk factors, previous acquisition experience of the issuer, details of sponsor’s acquisition experience, remuneration and benefits given to sponsors, related party transactions and any other material disclosures. However, this article strongly points out the inadequacy of this Regulation in tackling the aforementioned SPAC Litigation issues, as it fails to account for and consider the following factors have been dealt with in the SEC’s Corporate Finance CF Disclosure Guidance - Topic No. 11. (“CF Guidance”):
i) Firstly, the CF Guidance emphasizes that since a de-SPAC transaction must be concluded within a time bound period as mandated by law, the negotiating power of the SPAC and its sponsors, officers and directors (“SPAC Agents”) is substantially reduced when the time frame is nearing its end. Now, this reduced negotiating power in relation to negotiating the terms of the de-SPAC deal with the target is significant to note because the SPAC Agents and the shareholders may have different considerations while deciding whether going ahead with the business combination would be beneficial or not. While, the SPAC Agents may have certain financial incentives to go ahead with the de-SPAC, these incentives may differ from those of the shareholders. This becomes pertinent as SPAC Agents will not receive any benefits if the SPAC is statutorily forced to liquidate (on account of lapse of the time frame which is mandated by law to complete the de-SPAC). Such benefits refer to returns from the shares of the newly merged entity usually accompanied with share warrants. For example, in the case of Multiplan, if a business combination was completed within the SPAC’s two-year window, the Founders’ shares would convert into Class A shares in the combined company in an amount equal to 20% of the SPAC’s outstanding Class A shares but would expire worthless if there was no business combination. However, on the other hand shareholders may hesitate to give up their redemption rights (the right of investors to get back their investment by voting against the de-SPAC) due to the possibility of ending up with a huge loss of their investment in case the newly formed entity underperforms and fails. Thus, if these contrasting incentives are adequately disclosed in detail in context of the particular de-SPAC, the shareholders will be able to make a fully informed investment and there will be no question of breach of fiduciary duty as the facts were fully and fairly disclosed.
ii) Secondly, an SPAC usually has to acquire additional funds through PIPE (Private Investment in Public Equity) to complete the de-SPAC in case the IPO proceeds are not sufficient and otherwise. Since this is common practice in a large number of deals, the CF Guidance recommends that “accurate disclosure should be made about the sources of the additional financing and how the terms of the additional financing may impact the public shareholders.” Further, if the company desires to gain additional financing in the future, that must also be disclosed. This is important because any added or extra financing may have a direct impact on the relative shareholding of each investor and may dilute their stake.
b. Regulation 70(2) of the Listing Regulations provides that the lead managers appointed by the SPAC shall conduct due diligence and satisfy themselves with the veracity of the disclosures made. However, litigation related to inadequate due diligence generally arises because of the time-bound nature of the transaction and thus the company’s own lead managers may not stop investors from bringing forth claims on grounds of credibility. The following is suggested:
i) The information given to the acquirer by the target must not form the sole basis for the preparation of the Due-Diligence Report. The acquirers must make reference to information available in the public domain. Further, the SEBI must mandate the opinion of an independent and qualified financial adviser on the proposed business combination, which must be informed to the non-founder shareholders.
ii) More importantly, this article recommends that it be mandated that the SPAC has to undertake a Representations and Warranties Insurance (“RWI Insurance”), which is becoming an increasingly common practice within deal-making in India. It enables parties to effectively allocate the risks of breach of the agreement among themselves. This will be helpful as the Insurance Company will conduct its own thorough Due Diligence before granting the RWI Insurance to the Company. As a result, any question of inadequate due diligence brought forth by the investors post de-SPAC is very unlikely.
III. CONCLUDING REMARKS
An SPAC may be an arsonist disguised as a firefighter but under a robust regulatory environment, it can bulwark the economy of India through an inflow of investments. The authors posit that in India’s strive to ride the SPAC boom, SEBI must adopt the regulatory framework followed in the US and must play a proactive role in building a regulatory environment for SPACs in the context of mitigating litigation related issues. This becomes of prime importance because India is joining the race to become an attractive destination for the listing of SPACs through the proposed IFSCA Listing Regulations in order to globally standardize its capital markets. More pertinently, the unprecedented but essential standard laid by the Delaware Courts in consonance with the principles on disclosure and due diligence observed by the UK Courts must be strictly incorporated in the Indian context. The observance of these standards will ensure investor confidence and smooth operation of SPACs and steer the course towards making India an investment hub.
1 Index No. 650892/2021 (Sup. Ct. N.Y. Cnty. Feb. 8, 2021).
2 Index No. 650245/2021 (Sup. Ct. N.Y. Cnty. Jan. 12, 2021).
3 Index No. 657263/2020 (Sup. Ct. N.Y. Cnty. Dec. 23, 2020).