Delaware Chancery Decision Should Dispel Uncertainty About Validity of Share Issuances in De-SPAC Transactions

By: Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

For nearly two months, there has been a cloud of uncertainty hanging over the capital structure of Delaware incorporated special purpose acquisition companies (SPACs) concerning whether they had validly authorized the issuance of new shares in connection with de-SPAC transactions. In the first of many cases of similarly situated companies, the Delaware Chancery Court on February 21 upheld the validity of the charter amendment (and stock issued in reliance on that amendment) of Lordstown Motors Corp. (NASDAQ: RIDE) (Lordstown).¹

Over the last three years (2020 through 2022), more than 300 SPACs—formed with investor cash to buy an operating company—have achieved their goal by merging with what is oftentimes a private company, effectively taking it public (in what is commonly referred to as a de-SPAC).² More than 200 of those SPACs were formed under Delaware law,³ and many if not most of those operated under charters that arguably required the SPACs to hold separate Class A votes on the charter amendments needed to pursue the de-SPAC (given that, in order to effectuate the de-SPAC, a substantial number of additional Class A shares generally must be issued). However, it was commonplace for the SPACs to have Class A and Class B vote together as a single class.

The issue arises from the fact that, in connection with a de-SPAC business combination, in which the SPAC will issue its shares to Target shareholders as well as PIPE investors, many SPACs have needed to amend their charters to authorize the issuance of additional shares. Delaware SPACs have historically provided that both holders of Class A common stock (the public) and holders of Class B common stock (the so-called founder shares, which are entitled to vote for directors and which automatically convert into Class A at the time of the de-SPAC) will vote together as a single class on all matters submitted to a vote of the stockholders. As discussed below, recent litigation in Delaware has raised (and more recently in the Lordstown case, resolved) an issue as to whether the manner in which SPACs have obtained shareholder approval to issue additional Class A shares was valid, with the ominous possibility that a large amount of stock in the public markets was invalid and its issuance disqualified.

In October 2020, Lordstown went public by merging with a SPAC (DiamondPeak Holdings Corp.)⁴ in a de-SPAC transaction after DiamondPeak received the affirmative vote of holders of its Class A and B common stock, voting as a single class. Voting on the de-SPAC merger as well as the authorization of more Class A common stock (issued in connection with the de-SPAC and requiring a charter amendment) has usually been done by holders of Class A and B common on a combined or pooled basis even though the Class A shares issued in the SPAC IPO are often publicly traded, while the Class B shares are held by SPAC sponsors and other insiders.

But early in 2022, some Class A stockholders (the Plaintiffs) sent demand letters to a number of SPACs or their successors, including Lordstown (in March 2022), challenging the validity of these votes and arguing that a SPAC’s Class A shares are a separate class and any proposed SPAC charter amendments should receive a separate Class A vote under Delaware law.⁵ Lordstown, along with many of the other companies that had long ago completed their de-SPAC transactions, sought legal advice concluding that they had acted properly in holding combined votes for their share increase charter amendments. Some others that hadn’t yet completed their de-SPACs responded by holding standalone Class A votes.

The industry-wide problem was brought to prominence by the Chancery Court’s decision in Garfield v. Boxed, Inc.⁶ In the case involving SPAC successor Boxed, Inc., lawyers for the Plaintiffs sought payment of their fees for bringing the separate class vote problem to the attention of the SPAC in time for it to hold a statutorily compliant vote. The issue before the Chancery Court in the Boxed case was whether the Plaintiffs had conferred a corporate benefit on the company meriting an award of attorney fees. The court found that the Class A and B common were separate classes of stock, and that, as a result, Delaware General Corporation Law (DGCL) required a separate vote of Class A shareholders. Accordingly, finding that the Plaintiffs’ demand letter triggering a separate vote had “prevented a cloud from hanging over the Company’s capital structure,” it awarded $850,000 in attorney fees and expenses to Plaintiffs’ counsel.

Indeed, by finding a defect in combined Class A and B voting, the Boxed decision hurled an expansive cloud over dozens of SPACs that had substantially identical Class A and B capital structures and had used a combined vote to authorize the issuance of more Class A stock.

Lordstown filed a petition in the Chancery Court on January 26, 2023, asking the court to validate and declare effective the charter amendment authorizing additional Class A shares pursuant to the company’s combined vote in 2020 in connection with its de-SPAC transaction. Delaware law provides two ways that a corporation may validate certain corporate actions that may have otherwise been defective. DGCL Section 204⁷ provides procedures for the board to ratify the action with a subsequent shareholder vote. DGCL Section 205⁸ authorizes the Chancery Court to validate corporate actions on its own, and it was under this authority that Lordstown filed its petition.

The court required Lordstown to provide notice to its stockholders of a hearing on its petition, which was done on a Form 10-K. No stockholders filed objections to the petition or appeared at the February 20 hearing.⁹ Noting that there would be significant impediments to the company’s making use of the self-help ratification mechanisms in Section 204, the court granted relief under Section 205.  

Importantly, the court in In re Lordstown Motors Corp. did not concede that any of Lordstown’s corporate acts were in fact defective. Rather, the court determined it needed to act, because “the Company has encountered sudden and pervasive uncertainty as to its capitalization.”¹⁰

Applying a five factor test¹¹ suggested (albeit not mandated) by Section 205, the court found that the company had proceeded in the good faith belief that it followed proper procedures and had only begun to doubt this after the Boxed decision. The court also found that the company and nearly all third parties (market participants, financing sources and others) had relied on the assumption that the shares were validly authorized, that authorizing the charter amendment would not harm any stockholder or other party and that there would be significant and widespread harm if the court did not validate the charter amendment. Therefore, to provide certainty, “assuage market fears” and avoid the potential for substantial damage, the court validated and declared effective both the Lordstown charter amendment and the additional shares issued pursuant to such amendment. Based on input from Delaware counsel, we are confident that the result will be the same in the many other SPAC petitions with substantially similar facts.

One or more authors may have positions in stocks referred to in this article. Akin may represent individuals or entities that may have positions in stocks referred to in this article.

Akin Gump Strauss Hauer & Feld LLP has a full tax team closely following developments in this area. Please feel free to contact any of them with any questions.

^{1 Although the opinion in In re Lordstown Motors Corp., No. 2023-0083-LWW (Del. Ch. Feb. 21, 2023) was decided Feb. 21, 2023, it follows from a series of bench rulings Feb. 20, 2023 in which Vice Chancellor Lori W. Will retroactively ratified share issuances and other defective corporate acts for not only Lordstown but also three other companies (the first among dozens of former SPACs seeking relief). Lordstown was the first to seek Section 205 relief.}

^{2 According to a search of Intelligize, Mergers & Acquisitions, de-SPAC Transactions, deal status completed, date range 01/01/2020-12/31/2022.}

^{3 Id, but further refined to include only those deals in which acquirer was incorporated in Delaware.}

^{4 Following the merger, DiamondPeak changed its name to Lordstown Motors Corp., which is the public company that is the subject of the Delaware litigation.}

^{5 8 Del. C. §242(b).}

^{6 Garfield v. Boxed, Inc., No. 2022-0132-MTZ (Del. Ch. Dec. 27, 2022).}

^{7 8 Del. C. §204.}

^{8 8 Del. C. §205.}

^{9 Noting several places in the opinion that numerous other cases involved substantially the same issue, the judge stated that she heard five similar Section 205 petitions on the same day as Lordstown’s.}

^{10 Supra, note 1.}

^{11 The five factors are: (1) whether the defective corporate act was originally approved or effectuated with the belief that it was in compliance with DGCL, the certificate of incorporation or bylaws of the corporation; (2) whether the corporation and board of directors has treated the defective corporate act as a valid act or transaction and whether any person has acted in reliance on the public record that such defective corporate act was valid; (3) whether any person will be or was harmed by the ratification or validation of the defective corporate act; (4) whether any person will be harmed by the failure to ratify or validate the defective corporate act; and (5) any other factors or considerations the court deems just and equitable.}