Tumultuous, exasperating, difficult, nerve-wracking, and frustrating are all apt descriptions of the 2022 SPAC market.
Woodruff Sawyer attorneys yelena dunaevsky, Senior Vice President, Transactional insurance, and Teresa Milano, Vice President, Management Liability, examine the hard data, which, in some cases, is yielding surprising and—dare it be said —positive trends and conclusions.
SPAC Lawsuits by the Numbers
In 2021, there were 199 closed transactions, a number that is almost double the 102 de-spacs that closed in 2022. In 2021, we observed 33 securities class actions (SCAs), which were filed following 2020, a year with only 64 closed de-SPACs. Based on the average time after the merger (nine months) or the SPAC ipo (22 months) that it takes for an SCA to materialize, we were expecting a much higher number of SCAs in 2022. But, in fact, only 24 SCAs were filed in 2022—a 27% decline from 2021 numbers.
Reasons for Decline in SCAs
What could be causing the decline in the number of SPAC securities class action lawsuits? First is the increased sophistication of SPAC market participants, including SPAC teams and their advisors, over the last two years. This sophistication grew out of both new, more experienced teams and advisors entering the market and out of the increased experience of all those teams and advisors as the SPAC rush of 2020 and 2021 progressed. Many ended up handling more SPAC transactions, both on the IPO and the de-SPAC side, than they ever had before, and, naturally, they learned from previous missteps. This is the so-called self-correction that we referred to in our previous posts and podcasts.
The second reason for decreased litigation volume is the overall decline of the financial market in 2022. Many companies, including those that went public via a traditional IPO and a SPAC, have been experiencing disappointing performance. When the entire market is hurting, it is difficult for a plaintiff's attorney to claim that one particular team or merger did particularly badly.
The third reason could be the proposed SEC rules, which came out in March 2022. Even though these rules are still not finalized, many adopted them as a playbook and quickly adjusted their disclosure and transactions to comply.
SPAC Litigation Compared to SPAC Activity
Taking a look at the number of SCAs and the number of de-SPACs in each year leads to the interesting graph below. Although some SPACs and their targets were sued prior to the completion of the merger, the majority of SPAC-related SCAs occur post-merger. It typically takes a few months—nine months on average—after the merger occurs for a lawsuit to be brought. Understanding the lag between a SPAC merger and the lawsuit, it is interesting to see the decline not only in the absolute number of SCAs from 2021 to 2022 but in the number of SCAs relative to the number of completed mergers in each of those years.
Of course, the SPAC SCA is not the only type of lawsuit that exists. We saw quite a few new types of lawsuits against SPACs in 2021 and a few more novel fact patterns that resulted in disputes in 2022. For example, we saw a few skirmishes around a merger termination fee when the SPAC team decided to keep the fee without sharing it with its investors (e.g., fast acquisition corp., Concord Acquisition, and Pioneer Merger Corp.)
Other types of unusual suits that we had not seen many of in the past include:
A suit by an executive of Digital World Acquisition Corp., a SPAC tied to Donald Trump, alleging fraud at the SPAC and asserting that the executive was frozen out of the deal.
A suit against a parent of Quantum Fintech Acquisition's target for sabotaging the target's deal with the SPAC.
There have also been a few derivative (and some direct) actions filed against the directors and officers of a SPAC for breaches of fiduciary duties in proceeding with a merger that later turned out to be unsuccessful. The usual themes for a derivative suit, which is typically filed in tandem with an SCA, include rushing into a transaction, failing to conduct proper due diligence, entering into a deal outside of the SPAC's targeted industry, and the SPAC omitting information relating to potential dilutive effects of the merger.
Likelihood of Getting Sued
Companies that go public via a traditional IPO are more likely to get sued than mature public companies, and companies merging with a SPAC are more likely to get sued than those going public via a traditional IPO.
As a rough estimate, one can expect about 3% of companies that had been public for 10 years to become subject to an SCA. That number is significantly higher for newly-IPO'd and de-SPACed companies. The reason is simple—new public companies are more likely to stumble out of the gate.
An interesting risk question is whether there is a difference in likelihood of a lawsuit for companies going public via a traditional IPO and those choosing the SPAC route. The answer is yes, and the graph below illustrates that difference. Read more.
Source: SPAC Litigation by the Numbers: Surprisingly Positive Trends in 2022