The ascendance of SPACs in U.S. capital markets has attracted intense regulatory scrutiny from federal officials, especially the SEC. This federal attention on SPACs is natural, as at first glance the SPAC appears to be simply an alternative to the conventional IPO, itself regulated chiefly at the federal level. The SPAC, however, is critically different from the IPO. An IPO is a transaction: the issuer sells stock, and public purchasers buy it, and the issuing corporation owes no fiduciary duty to the IPO purchasers. By contrast, the SPAC is an entity, not a transaction. And in fact SPACs are a very particular kind of entity: a standard corporation, organized usually under the laws of Delaware. My paper is the first to examine the corporate law dynamics of SPACs in detail, and it makes two distinct claims.
First, it demonstrates that the SPAC industry has exhibited a striking disregard of corporate law, failing to live up to basic equitable and statutory expectations under existing doctrine. Compared to other public corporations, the SPAC adopts a highly idiosyncratic governance model. The SPAC vests near-despotic control over all substantive decision-making in the hands of the sponsor. And SPAC boards are always populated by persons selected by the sponsor and often classified, making it impossible to wrest control from the sponsor during the life of the SPAC. The merger vote is engineered to achieve success, as the redemption right and warrants induce stockholders to vote in favor of a transaction regardless of their views on its merits, and the redemption decision likewise affords public holders limited influence. At the same time, the all-powerful sponsor has a deep conflict of interest with public holders. With a business combination, the sponsor secures a 20% stake, a potentially gargantuan reward. Without one, the sponsor’s stake is worth nothing. The result is that the sponsor has two incentives at odds with the public holders: to pursue any transaction, regardless of its advisability for public stockholders, and to obscure that fact from public stockholders to minimize redemptions. The sponsor acts unconstrained by any customary corporate mechanism for handling conflicted situations, as there are no disinterested decisionmakers anywhere in the SPAC. A SPAC thus offers its business combination to the public holder as a take-it-or-leave-it proposition, from which the investor has a custom-built remedy that is reputed to be complete. I call this approach the private fund model, as it broadly characterizes the structure that prevails among private investment funds.
The operation of the private fund model in the corporate form provokes many issues, most prominently what kind of judicial review, if any, is appropriate for the business combination at the center of the SPAC’s short life. Such questions have long escaped judicial attention in Delaware, but that is changing fast. In opinion issued in early 2022, In re MultiPlan Corp. Stockholders Litigation, the Court of Chancery offered its first extended examination of the SPAC. The Court acknowledged that the context was novel, but it drew on “well-worn fiduciary principles” to conclude that “[t]he entire fairness standard of review applies due to inherent conflicts between the SPAC’s fiduciaries and public stockholders in the context of a value-decreasing transaction.” The Court, however, emphasized that its analysis was limited to the somewhat-unique facts of the MultiPlan transaction, not “a hypothetical claim where . . . the allegations rest solely on the premise that fiduciaries were necessarily interested given the SPAC’s structure.” The SPAC industry seized on that aspect of the opinion, but the MultiPlan ruling nevertheless marks the beginning of the corporate law reckoning for SPACs.
As this Article shows, the entire fairness test very likely applies to the SPAC’s business combination under existing law. All SPAC directors are generally conflicted, perhaps all materially so, and many are likely not independent of the sponsor. A SPAC sponsor also likely satisfies the test for a controlling stockholder, and the business combination is a conflicted transaction. The Corwin doctrine holds out little hope for sponsors, as public stockholders cannot be presumed to be disinterested when voting on the merger. By designing the SPAC vehicle with the conflict at its core in the first place, and by excluding disinterested decisionmakers entirely, SPAC advisors either neglected this central corporate issue or engaged in magical thinking. No one bothered to contemplate how—or whether—the corporate form can accommodate the SPAC’s private fund governance model, and what consequences might arise from any misdeeds.
The SPAC’s contempt of corporate law is, remarkably, not limited to fiduciary issues. As detailed in the forthcoming article, SPACs have also fallen short of their statutory obligations in a variety of ways. They deliberately fail to hold annual meetings to elect directors, which further cements the sponsor’s grip on control; the best way for a sponsor to avoid a contested director election is to avoid a director election altogether. Other transgressions appear to involve pure neglect. For example, many SPACs bungled the rules for approving critical amendments to their charters by failing to hold class votes limited to public stockholders. These are bush league mistakes for transactions of this magnitude. Former Chief Justice Leo Strine once mused on why Delaware judicial opinions lavish attention on fiduciary issues but rarely examine statutory problems. The explanation, he said, was that sophisticated entity clients are so well advised: “Controlling stockholders counseled by experienced lawyers rarely trip over the legal hurdles imposed by legislation.” SPACs are a striking counterexample, and no doubt more still-hidden statutory blunders will come to light in the coming years.
Corporate obligations thus appear to be beyond the SPAC industry’s constrained field of vision. Indeed, SPACs often articulate their governance obligations not in terms of Delaware’s expectations but instead in terms of stock exchange listing requirements. A SPAC’s first order of business has been to stay one step ahead of securities regulators and exchange officials, to make sure that the offering is consummated and that the shares trade on an exchange. Otherwise, there will be no SPAC. Corporate law problems arise down the road, and SPAC offering documents bear the mark of persons who are moving quickly, and who very likely don’t expect to be around when the dust settles on any corporate law transgressions. In this sense, the SPAC’s careless approach to corporate law is consistent with SPAC infirmities documented by others: non-compliance with accounting rules, late filing of SEC reports, and skirting the boundaries of the Investment Company Act.
The policy question for Delaware is how to apply conventional corporate principles to the SPAC. I argue that Delaware should resist any calls to fashion unique rules for SPACs. The SPAC should be made accommodate corporate law, not the other way around, at least for the time being. SPAC defenders have argued against judicial scrutiny, despite the conflicts, because: (1) public holders implicitly waive corporate loyalty obligations by purchasing SPAC stock and (2) the redemption right affords stockholders a remedy that is in some sense complete. These arguments are sometimes accompanied by slogans involving private ordering, but this is rhetorical misdirection, as they get the private ordering argument exactly backwards.
SPACs have made a deliberate choice to organize as corporations, in Delaware. Private investment funds, of course, seek out the unique latitude that the limited partnership affords to draw economic distinctions among classes of partners and to limit expressly the sponsor’s fiduciary duties. A defining feature of the corporate form, by contrast, is the mandatory loyalty obligation to common stockholders, and that is thus a central element of the privately-ordered SPAC bargain.
Delaware takes a very flexible approach to how fiduciaries may satisfy the loyalty obligation, allowing almost any type of conflict to be cleansed for purposes of judicial scrutiny by disinterested directors or disinterested stockholders. But the SPAC purports to address conflicts in a corporation not by neutralizing it with disinterested decisionmakers but by offering a homebrewed remedy. Corporate law provides a limited set of mechanisms for satisfying the loyalty obligation, and a bespoke withdrawal right has never been among them. For all the much-lauded flexibility of the Delaware corporation, a SPAC exceeds its outer boundaries by allowing fiduciaries to act with unconstrained conflicts. SPACs should be held to the promises implied by their entity choice. The redemption right, of course, does not eliminate the sponsor’s conflict, and it does not render the conflict inconsequential for public investors. If anything, it allows the sponsor to direct its energy into maximizing its payoff at the expense of the public holders. In this way, the sponsor can act subject to no constraints to undermine the redemption right. Most notably, the sponsor has no incentive to put public holders in a position to make an informed decision to redeem or to vote, and thus it will systematically fail to perform a thorough investigation of the target company and fully disclose its findings. The redemption right is thus no substitute for a disinterested decisionmaker.
Delaware also faces a forward-looking policy question that is distinct from the enforcement of existing privately-ordered bargains. Suppose Delaware holds SPAC fiduciaries to customary corporate expectations. Some SPACs might live up those expectations. Others might flee Delaware for a state like Nevada, which expects less from fiduciaries. Others might encourage Delaware to change its law, creating a new entity form that embraces the SPAC’s distinctive attributes. That option might hold some attraction for Delaware, and at some point there may be grounds for the state to create a statutory form for a SPAC-like vehicle. But Delaware should not rush to accommodate the idiosyncrasies of the SPAC. For one thing, doing so would put Delaware on a collision course with the federal government, and Delaware should not cede ground when it comes to overseeing corporate conflicts. For another, the universe of SPAC misdeeds—and thus the scope of the policy problem in need of fixing—is only partly known at present. In the coming years the SPAC landscape will no doubt become even more gruesome, and only when the dust has fully settled might Delaware be in a position to craft a durable vehicle for the future.
The complete paper is available for download here.