Restructure This! Podcast Ep. 16
Current Trends in SPACs with Bill Kane
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Sheppard Mullin's Restructure THIS! podcast explores the latest trends and controversies in chapter 11 bankruptcy, commercial insolvency and distressed investing. In this episode, Sheppard Mullin partner and former Illinois Assistant Attorney General Bill Kane joins host Justin Bernbrock to discuss current trends in Special Purpose Acquisition Company (“SPACs”) deals, including how a cooling economy creates the potential for more SPAC-related litigation and how an uptick in such litigation could ultimately result in more restructuring activity.
Guest:
About Bill Kane
As a partner in Sheppard Mullin’s Chicago litigation group, Bill Kane's national litigation practice focuses on complex commercial litigation and advice across industry sectors in corporate governance, director and officer issues, shareholder rights, media/entertainment and regulatory issues. He has more than 30 years of experience representing clients before trial and appellate courts, administrative agencies, private mediations and arbitrations. Bill previously served as an Assistant Attorney General in the Illinois Attorney General’s office where he represented the legislative, executive, and judicial branches of state government.
He actively represents clients in contract disputes, business tort claims, antitrust, and consumer protection issues. Bill further has experience in Special Purpose Acquisition Company or SPAC litigation. In addition to his experience in SPAC-related litigation, Bill also represents clients in contract disputes, business tort claims, antitrust and consumer protection issues. His practice includes representing private equity investors, along with directors and officers in partnership and shareholder litigation.
About Justin Bernbrock
Justin Bernbrock is a partner in the Finance and Bankruptcy Practice Group in Sheppard Mullin's Chicago office, where he focuses on all aspects of corporate restructuring, bankruptcy and financial distress. He represents clients across a wide range of matters, including debtor and creditor representations. He has substantial experience in out-of-court and in-court restructurings, primarily in the Southern District of New York, Eastern District of Virginia, District of Delaware and Southern District of Texas.
Justin Bernbrock:
On this installment of Restructure This!, we welcome William Kane, Bill Kane, a business trials partner in Sheppard Mullin's Chicago office. Bill has 30 years of litigation experience in courts across the country, representing clients in arbitrations, jury and bench trials, and appeals involving commercial and regulatory disputes. Bill's practice includes representing private equity investors along with directors and officers in partnerships and shareholder litigation.
During today's episode, Bill will discuss his current trends with special purpose acquisition companies, or SPACs, and how the cooling economy is pointing towards an increase in SPAC-related litigation. The how and why SPAC litigation may or may not contribute to more restructuring activity in the future will also be addressed. As always, stay tuned after the interview for a quick rundown of current restructuring news and notable stories.
All right, as I mentioned at the outset, we're joined today by Bill Kane. Bill's a partner in Sheppard Mullin's Business Trials Group here in the Chicago office. Bill, welcome. Thank you very much for sitting with us and talking about SPACs and your experience with SPACs. Before we dive into that, however, I think it'd be interesting just to hear briefly your background, how you came to be Bill Kane, litigation partner at Sheppard Mullin.
Bill Kane:
Well, it's good to be here, Justin. It's always fun to talk about things that you're passionate about. So I became a lawyer back in the 80s and went to school at the University of Illinois Chicago. At the same time, I was a law clerk for the Illinois Attorney General's Office. At the time, Neil Hartigan was the attorney general. And we were not only as law clerks, but as lawyers, we were thrown into the courts right away.
And when I had extra time, actually as I was clerking, I'd run over to the courthouse and watch some of the great trial lawyers who were starting out, including Dan Webb, Phil Corboy at the state courthouse, a defense attorney named Pat Tuite, a brilliant defense attorney and cross-examiner named Eddie Jensen. And just really fell in love with the practice of litigation and trying cases.
Justin Bernbrock:
And when ultimately did you join Sheppard?
Bill Kane:
So I joined Sheppard Mullin five years ago from another nationally known law firm here in Chicago.
Justin Bernbrock:
Got it. Great. So I think it might be fair to say that special purpose acquisition companies or SPACs have become all the rage, or at least in recent memory for me they've become something that a lot of folks are talking about, a lot of folks are participating in or interested in. And I know that you've got some very specific experience. But Bill, what's a SPAC? Why are these popular? What's going on?
Bill Kane:
Yeah, sure, Justin. Well, SPACs or special purpose acquisition companies, they're really not new and they've been a financing vehicle that have been around for a long time, over 20 years. They had a brief surge in popularity in the early 2000s. In particular, we were seeing them being used in conjunction with entertainment finance, which has long been a, quite frankly, a fragmented, inefficient market due to its high-risk quotient.
More recently, we're seeing SPACs have shot up in popularity as what is sometimes referred to as the poor man's private equity vehicle, or a method to democratize private equity financing through the sale of public shares in what are referred to as a blank check company. So this is a company that has no ongoing operations, rather it's a mission statement to acquire a business in a defined sector through the use of capital rates through the SPAC issuance.
So what we typically would see in the process of launching a SPAC would include, first, corralling business executives who have a demonstrated experience in professional fields that have relevance to the SPAC’s intended industry sector. So for example, if we have a SPAC that's looking to purchase an operating company in the recreational clothing industry, and now that it's cold is all heck out here in Chicago, we would look to executives who either have operated or advised similar companies from a financial marketing or investment standpoint. So if we were looking for someone in that industry, I might pick up the phone and call Justin and, "Hey Justin, I hear you worked for REI and made down parkas and are a fly fisherman. How'd you like to be the CFO in our new SPAC? You want to join the team?"
Justin Bernbrock:
Sold.
Bill Kane:
The second phase is the organizational phase. The new board will hire lawyers, accountants, and industry sector advisors to legally form the SPAC and obtain the requisite SEC approvals to issue the securities. This phase also involves obtaining director and officer liability coverage, which is generally the largest single expense when it comes to a SPACs formation. These collective costs generally run around $3 to $5 million.
The third phase is the roadshow of sorts where the SPAC now ready to go public has investment bankers who are helping to inform the market or pre-sell the offering to institutional capital, mutual fund managers, banks, and in some instances to family offices. Of course, it's not gone public yet, but they're kind of informing the market of the upcoming IPO.
And then the fourth phase is the actual public offering of the SPAC. Organizers hope will have support at typical stock prices of about $10 a share when they go out into the market.
And the last phase is the hunt, and we'll call it the hunt and acquisition phase. Under current SEC rules, a SPAC has approximately 48 months in which to acquire a target with a few limited exceptions that allow for short extensions of this time. But in the event an acquisition is not completed, the funds raised which are held in trust need to be returned to investors.
Now, once the SPAC has found its target and a definitive agreement is signed between the SPAC and target, the financing structure generally gets finalized at this point. And it's quite common to see, Justin, in these deals additional financing entering in the picture from PIPE investors in addition to cash from the SPAC. So a PIPE is a, for those who aren't familiar with that expression, a private investment in a public entity.
Justin Bernbrock:
Got it. And just out of, I guess, curiosity, the PIPE investments, that's debt funding principally, or is it also equity funding, or can it be both?
Bill Kane:
So the PIPE investors, it depends on the agreement that they put together, and generally they'll take a strip of the business.
Justin Bernbrock:
Got it. Got it. And so your specific experience representing PE shops as well as directors and officers in litigation matters, I think folks come to you when things have not gone so well. What are the most common issues that you're seeing or have seen recently emerging from the SPAC world?
Bill Kane:
So the SPAC market has been on fire for the last few years. We have seen SPACs raising money for all kinds of ventures, and in some instances with boards or leadership that is composed of celebrity athletes or actors and actresses, people who, generally speaking, have little experience in either leading or running a business. Justin, you could say this phenomenon is the canary in the coal mine, that the SPAC market has hit the top.
So for example, NFL player Colin Kaepernick formed a SPAC and raised $250 million. The mission statement was to acquire a consumer marketing company at the intersection of consumer and impact. I'm not sure what that is, but he got it off the ground. Then we saw NBA player Kevin Durant launch a $200 million SPAC. The mission statement there is to merge with a company in sports, health, sustainable food technology, and cryptocurrency. Again, that's quite a mouthful. As we know now, cryptocurrency is not too healthy. I think Bitcoin's below $20,000 today here and not sporty amongst the investment world.
Now, they might just be figure heads for these businesses. I'm not sure. I'm not saying great athletes cannot also be successful business leaders, but it gives me some pause as to where we are in the market.
With all this money sloshing around from the explosion in SPAC offerings, the competition for deals, really good deals has become fierce. The amount of dry powder in the market between PE firms and SPACs is extraordinary. Both are chasing the same game fish in various market sectors.
The problem for SPACs, however, is they have a fuse lit the minute they go public. So by law, they have 48 months to write the check. The SPAC time horizon, some would say, has been leading to the purchase of companies without performing adequate due diligence at inflated valuations and companies with dim or at least thin futures.
So what we're seeing, starting to see here, Justin, familiar patterns as trial lawyers involved in the dispute resolution side of the business deals, and specifically here, the SPAC market, we are seeing investors upset with the type of SPAC transactions taking place. Deals are being viewed as overly expensive, poorly negotiated, executed, or unfairly more favorable to SPAC management and its organizers than the common shareholder in the SPAC.
We're also seeing PIPE investors backing out of commitments on some deals to co-invest with the SPAC. This is creating obvious stress on the deal side, and some contestable issues are being raised regarding the commitments made from the PIPEs. A last minute walk away, for example, from a PIPE can negatively impact the capital structure of the SPAC deal. But with the pressure to close, these deals are getting done, albeit now with a lighter balance sheet, Justin, and that can lead, as we know, to trouble down the road, particularly as the economy is cooling. I think, for example, we've seen recently in The Wall Street Journal that economists are predicting the probability of recession has gone up to over 63% next year.
So on top of all the market pressure creating these issues that can lead to business disputes, we have Gary Gensler joining the party at the SEC, and he's been very vocal that it will maintain a close eye on SPACs and is taking steps to increase regulatory burden on SPAC market participants. So for example, we saw last year a very significant change in how warrants are to be treated by a SPAC. So initial funding for SPACs often include warrants that were typically classified as equity, but the SEC last year determined that these warrants should rather be classified as liabilities rather than equity. And this led to a massive number of restatements being filed and market disturbance last year. And as we know when a public company issues a restatement, Justin, the securities class action lawyers join and move into the neighborhood.
Justin Bernbrock:
Yeah, along with the bankruptcy lawyers. But it's all very interesting. And as you mentioned, The Wall Street Journal, and I think others, got an article here that is showing distress is on the rise in Q4, or at least based on league tables, restructuring activity is on the rise. So there's clearly cooling in the capital markets. And so as you look at this from a dispute resolution perspective, what types of disputes do you expect will become more common arising from the boon in SPAC activity over the past couple of years?
Bill Kane:
I think you're going to see more suits by investors, Justin, against the SPAC's management or the directors and officers. You're going to see more actions by the SEC taken against SPAC promoters. As things go south, they're going to be hearing from the investors themselves and getting lots of complaints and they're going to react to those complaints and may open investigations. And you're going to see SPACs suing PIPEs who back out of deals at the last minute because they know the market's getting slow, the economy's slowing down, and their management or their boards are saying, "Why are we putting money into this deal?"
And when deals unravel, investors are unhappy with returns, finger pointing starts happening, and we see that in lawsuits. And the usual suspects, as far as claims go, include conflicts of interest between the SPAC sponsors, who typically stand to make handsome returns upon the closing of a deal, and investors claims of material misrepresentations regarding the SPAC, de-SPAC transactions from investors who claim they were misled into investing into the SPAC.
You're going to see run-of-the-mill breach of fiduciary duty claims as always against the directors and officers of the SPAC, or even the target company who agreed to the deal with the SPAC. They're going to have their own issues even if they were a private business. And since more SPAC deals have increasingly turned to PIPE investors, disputes between PIPEs and SPACs are on the rise with breach of contract claims against the PIPEs who back out of these subscription agreements.
Finally, with the pressure to do deals in 48 months, SPACs are moving forward and making acquisitions with companies many times without performing adequate due diligence, or that's what claimants may say because of the looming deadline. So they're under a lot of pressure to close these deals, and they're competing against private equity. And they're throwing caution to the wind. They're overpaying. They're hoping for a sunny future. In some instances, the SPAC sponsors are just quite possibly not equipped to deploy the millions of dollars of capital they suddenly have in their checkbook.
So we've even seen an instance where a SPAC promoter unhappy with the time the SEC was taking to review and approve a SPAC boldly threatened to sue the SEC, presumably to make the regulators speed up. This is a highlight of a growing slowdown in SPAC approvals from the SEC and the frustration building around the sector.
Justin Bernbrock:
It's all very, very fascinating. I wonder just as you've seen recent litigation in this context, at least with some of the theories of liability that you just highlighted, it seems to me at least that some may not have much of a shot. For example, you start talking about fiduciary duty claims and my barometer for likelihood of success feels low. But then you talk about breach of contract claims between SPAC promoters and PIPE lenders or PIPE investors. It feels like there might be more there. Is that how you see it? Feel free to push back if you think that the fiduciary duty claims are solid claims. I'm just curious.
Bill Kane:
Yeah. I mean, obviously, every case is defined by its own facts. I think in the instance where you have a factual pattern, where you might have a SPAC that's got a couple months left on it, on the wick, and it has to close a deal, those SPACs who may jump into an acquisition with a target, who don't do their due diligence, who buy a business that maybe has given projections way beyond the pale, those types of cases, those are where you're going to have a more difficult time at least getting summary disposition on fiduciary duty claims.
And at the end of the day, they may have a little bit more in the way of legs or strength in terms against directors and officers. That's what I'd call not a mature market yet, because the SPAC explosion is now just slowing down, and so we're going to just start to see more of those claims.
With respect to contract claims, generally those are more black and white and the facts are less gray. And if the merger and acquisition agreements or the subscription agreements are written well, there's a lot less wiggle room. And so to your point, Justin, I think those claims might have a little bit more staying power in the court system.
Justin Bernbrock:
So you've mentioned a couple of times a key number here in connection with really any SPAC is the 48-month horizon to deploy the capital. If they don't find something, if the SPAC promoter doesn't find a sufficient target, then they have to wind this back up. I mean, first, is that correct? And secondly, are we seeing an uptick in wind-ups? How is that looking?
Bill Kane:
Yeah, that's right. I mean, generally it's a 48 month on the outside to get a transaction done. And the monies are held in trust for the benefit of those investors. And if they can't complete a deal, they have to wind down the SPAC or liquidate the SPAC. So I think the deal reported in 2022, there was 35 liquidations or return of capital over north of, I think a billion and a half in IPO capital. In 2021, last year, there was one liquidation. So we've jumped from one liquidation to 35 as of I think, the notes I have here are from the third quarter, not even the fourth quarter.
So for example, a significant liquidation was Bill Ackman's decision. He runs Pershing Square where he raised $4 billion. And Mr. Ackman is not a pro football player, but when it comes to investing, he's in the Hall of Fame. I mean, he obviously in exercising his fiduciary duties and good judgment decided he did not like the deals they were seeing. The deals they saw were not congruent with Pershing Square's investment criteria, discipline, or otherwise executable is all we can assume. And so they decided we're going to close shop.
And that's not a really an easy thing to do. I mean, when you go out shopping with billions of dollars on Rodeo Drive, if you will, and come home without spending a penny, that takes a lot of discipline, takes good judgment. And other business leaders are reaching the same conclusion as we're seeing the changing economic market, I think you mentioned, and they're exercising restraint. Even though other market participants may say it's a failure, they're exercising restraint and they're winding up.
Justin Bernbrock:
I could imagine a scenario where the investors in the SPAC are pretty disappointed in that result, albeit probably, well, almost certainly permitted under the subscription agreement. And if you're going to hold a billion dollars of my money for 48 months and I'm going to clip zero coupon on that because you couldn't find an acceptable deal, that feels like it hurts a little bit and that money was deployed into a situation where had it been otherwise deployed, you could have earned some return on that money. Do you think in these wind-up deals, there's any downside risk for the Ackmans or the SPAC promoters for having not deployed the capital?
Bill Kane:
First of all, the sponsors, they're out of $5 or $10 million, whatever they spend on putting it together. So they're out of money. Investors, we forget there's what's called the risk-reward trade-off that you learn in business school, and they're getting their capital back.
Will the promoters who are closing shop get sued? Maybe. There's always someone who's going to point the finger. I think that they're getting what they bargained for, which is they invested in management. They invested in someone who knows a lot about down puffies, so when it's cold as heck here in Chicago they've got someone who's going to know what companies we should have bought. And if we bought Tommy Bahama clothing line and it doesn't sell well and the company goes bankrupt, that's worse than if they executed really good judgment and said, "We're not going to spend this money," and return it. So I think those would be more difficult claims, but we're probably going to see them.
Justin Bernbrock:
Yeah. As we've talked before, our audience principally is made up of restructuring professionals and those that play in the distress sandbox. Do you have good news for those of us that play in this world? Do you foresee restructuring activity as a fallout from, I don't want to say the burst of the SPAC bubble, but the SPAC craze over the last two years?
Bill Kane:
Happy Halloween, Justin.
Justin Bernbrock:
Yeah.
Bill Kane:
Tricks and treats. So in 2021, there were 600 SPAC IPOs according to Deal Point Data.
Justin Bernbrock:
Right.
Bill Kane:
The number of priced SPAC IPOs dropped from 163 just in the fourth quarter of 2021 to 55 in the first quarter of 2022. This is not good news for corporate securities professionals, lawyers, accountants, and investment bankers who stay busy taking these companies public.
But what I think this data really foreshadows, getting to your question, Justin, is that obviously the SPAC market is turned down, but in a more subtle way, it's a message that I think we should read that the decision-makers in the capital markets are looking at what went down, what went down last year. How are all these companies that joined the SPAC parade last year doing? How might they fare in the year ahead? And if the collective wisdom was they are doing well and sunny days are ahead, then let's keep at this business of using SPACs for capital formation and let's keep making these deals. Then the number of SPAC IPOs this year would rival or be close to 2021.
But they're not. We're going into the fourth quarter here of 2022. We're looking at an objective drop in SPAC formations of nearly 125%. So now whether that just means last year was hot and we're returning to a statistical norm, I'm not sure about that. I'll leave that to the finance professors either in Evanston or Hyde Park.
But what I think it signals at the risk of being a chicken little here is exuberance for SPACs may be coming rational. And there are some bad eggs in the basket that for a variety of reasons are going to crack as the economy weakens under the strain of inflation, the inevitable economic slowing that the Fed is imposing on the economy with no end in sight for interest rate hikes. So one could say the Fed threw a Baby Ruth bar in the SPAC punch bowl, if you will, Justin.
Justin Bernbrock:
Yeah.
Bill Kane:
And we saw a bankruptcy court filing, further to your point or question, from Enjoy Technology who went public a year ago through a SPAC transaction and was led by a former Apple executive. And a recent real big one, which seems counterintuitive to the EV craze, is Electric Last Mile Solutions. And they're a commercial EV manufacturer who just went public in June of last year with a market valuation of $1.4 billion through a merger with a SPAC. They ran out of road. They're in bankruptcy court, and this is an EV manufacturer.
So my guess is for restructuring professionals, we're going to start getting calls pinged for court workouts or less gentlemanly, if you will, courtroom brawls. And we're going to see increasing claims against directors and officers related to their conduct as board members in the decision-making process to do the deal.
Justin Bernbrock:
It's one of the difficult things of being a restructuring lawyer is that while I very much don't want there to be widespread distress in the American economy, I also really want there to be widespread distress in the American economy.
Bill Kane:
I understand you play the guitar.
Justin Bernbrock:
I do.
Bill Kane:
And there's a great band called Widespread Panic.
Justin Bernbrock:
There you go.
Bill Kane:
And I think not this year, but next year we might see a little bit of widespread panic in the markets and particularly in the SPAC markets.
Justin Bernbrock:
Yeah. I have to comment on the notion of rational exuberance. The last time that I heard the phrase rational exuberance, I was at a craps table in Las Vegas.
Bill, this has been really fascinating and really interesting to me. One tradition that we have with the podcast is to ask our guests, so if you were not Bill Kane, a litigation partner at Sheppard Mullin, and assuming no worldly or otherworldly limitations, what would you be doing? What would be your passion?
Bill Kane:
Well, it depends on the time of year.
Justin Bernbrock:
Summer.
Bill Kane:
If it's summer, I'm sailing, or I might strap a scuba tank on my back and head into a coral reef down in The Bahamas.
Justin Bernbrock:
Wow. That's probably one of the most adventurous answers that we've gotten thus far.
Well, Bill, thank you. Really truly, this has been interesting, informative. And of course, folks who want to hear more advice from Bill can connect with him through information on the Sheppard Mullin website. And thank you.
Bill Kane:
You're welcome. It was fun.
Justin Bernbrock:
All right. Take care.
Bryan Uelk:
Hello again, everyone. This is Bryan Uelk of Sheppard Mullin for Restructure This! with this week's restructuring news.
On October 14, 2022, the U.S. Court of Appeals for the Fifth Circuit issued an opinion in the Ultra Petroleum bankruptcy that is no doubt going to thicken the plot as to the enforceability of make-whole premiums in bankruptcy. Specifically, describing the make-whole amount at issue as a lump-sum calculated to give the lenders the present value of the interest payments they would've received but for Ultra's bankruptcy and characterizing the make-whole amount as nothing more than a lender's unmatured interest rendered in today's dollars, the court held that the make-whole amount constituted disallowable, unmatured interest under Section 502(b)(2) of the Bankruptcy Code.
And in the ordinary case, that would be the end of the matter. However, as the court acknowledges in its opinion, the Ultra Petroleum debtors' situation was no ordinary case. Ultra became solvent during the pendency of its bankruptcy, and that, at least for the Fifth Circuit, added a layer of complexity to the analysis. Thus, notwithstanding that the make-whole amount was disallowable, unmatured interest under the Bankruptcy Code, the court indicated that it was necessary to determine whether the solvent debtor exception nevertheless required payment of the make-whole amount.
Now, for those of you that don't find yourselves dealing with solvent Chapter 11 debtors every day, the court provides a fairly straightforward explanation of the solvent debtor exception. When a debtor proves solvent, that is when the debtor's assets exceed its liabilities, bankruptcy's ordinary suspension of post-petition interest is itself suspended. Thus, since the court determined that the make-whole amount was otherwise enforceable under applicable state law and Ultra was, of course, solvent, it was on the hook to pay the make-whole amount notwithstanding that the make-whole amount constituted unmatured interest under the Bankruptcy Code. Quite the whip saw of an opinion.
So to take stock of where we are at an appellate level regarding the enforceability of make-wholes in bankruptcy, the Fifth Circuit has disallowed them unless the debtor is solvent, of course, the Third Circuit allowed a make-whole in the Energy Future Holdings case in 2016, and the Second Circuit most recently disallowed a make-whole in the MPM Silicones case in 2017. Here's hoping the issue eventually gets to the Supreme Court, though I won't be holding my breath.
In other news, on October 24, 2022, Judge Glenn issued an opinion in the Celsius cases denying a motion to appoint an equity committee. Among other things, Judge Glenn said that there was a greater likelihood of duplication of efforts in the Celsius cases as the examiner and other parties are already looking at some of the same questions as the requesting equity holders. In their motion, the equity holders argued that the Committee of Unsecured Creditors whose interests are otherwise normally aligned with equity holders to maximize value was, based on the facts of the Celsius cases, looking out for customers rather than equity holders.
Finally, the city of Chicago's long-term rating for its General Obligation Bonds was upgraded by Fitch Ratings for the first time in nearly 13 years. Speaking as a Chicagoan for the better part of a decade, I'm going to chalk this up as a big win for the home team, especially for a city that's currently staring down another long winter and likely, much to our chagrin and frustration, another losing season for the Bears.
Well, that's it for this week's restructuring news. This has been Bryan Uelk of Sheppard Mullin for Restructure This!.
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