Anyone who keeps up with the public equity markets knows that the volume of IPOs generated by Special Purpose Acquisition Companies, better known as SPACs, has exploded over the last two years. Writing for his Wealth Matters column (5/7/21), Matt Sullivan of the NY Times reports that “[s]o far this year, nearly 300 SPACs have been created and taken public, more than the 248 offerings in all of last year and up from 59 in 2019.”

For those not familiar with SPACs, essentially they are publicly traded, non-operating, shell companies formed to raise capital to acquire and convert to public ownership a privately-owned operating company. SPACs are also referred to as “blank check” companies because investors buy shares before any merger or acquisition opportunity is identified. The IPO process for SPACs avoids much of the burden, expense, and lengthier regulatory compliance associated with traditional IPOs.

The SPAC is controlled by a “sponsor” management company typically organized as a limited liability company. The sponsor receives a percentage of shares at the time of the offering — normally 20% — which are put in escrow pending consummation of a potential acquisition within a two-year period. Post-acquisition, the sponsor distributes shares to its members subject to certain triggers such as termination of a lockout period or the reaching of a specified share price. If no acquisition is consummated within the fixed period, the investors get their money back.

The sponsor LLC is subject to the same trials and tribulations of any LLC as far as rights, duties, and potential conflicts among the members. Or perhaps not quite the same, given that, unlike most small, owner-operated start-up sales or service companies formed as LLCs, often without any written operating agreement, the sponsor typically is formed under Delaware law by sophisticated investors/managers using experienced transactional lawyers from major law firms to prepare intensely considered operating agreements.

But, as we all know, having sophisticated investors with agreements prepared by experienced counsel is no guarantee that LLC members will not turn on each other. That brings me to a decision last month by U.S. District Judge Victor Marrero of the Southern District of New York in Vogel v Boris involving a falling out between members of a SPAC sponsor following the completion of an acquisition. The question presented to the court was whether the sponsor’s operating agreement contemplated a one-deal company and terminated upon completion of the one deal or, as the plaintiff contended, it prohibited the other members from organizing another SPAC transaction without his consent, effectively giving him an ongoing participation right in any subsequent SPAC transactions.

The SPAC, the Sponsor, the Operating Agreement

In late 2014, defendant David Boris founded a SPAC known as Forum Merger Corp. (“FMC I”). In 2016, defendant Marshall Kiev joined FMC I. Later that same year, plaintiff Stephen Vogel together with Boris and Kiev formed a Delaware LLC known as Forum Capital Management, LLC (“Forum Capital”) as a sponsor to manage FMC I. Vogel, Boris, and Kiev were the LLC’s managers and also held membership interests along with several family trusts.

According to Vogel’s complaint, Forum Capital’s July 2017 Amended and Restated Operating Agreement was negotiated among Vogel, Boris, and Kiev with the assistance of an experienced lawyer familiar with SPACs. Section 7.02 of the Operating Agreement, captioned “Business Opportunities; Limitation on Other Activities,” memorialized what Vogel alleged in ¶ 31 of his complaint was the parties’ intent to “commit their time and energy to FMC I and, if FMC I proved successful, to work together again on future SPAC investments.” In pertinent part Section 7.02(b) states:

. . . except as otherwise approved by all Managers, other than FMC and its Subsidiaries, no Manager or Member may, directly or indirectly, (i) perform any services on behalf of any other special purpose acquisition company, other than Pacific Special Acquisition Corp. or related entities or (ii) invest in any other special purpose acquisition company or public shell company other than as a passive investor.

Section 11.01 provides that Forum Capital “shall be dissolved and its affairs wound up upon,” among other events, “[t]he sale, disposition or distribution of all securities and assets held by the Company” or “[t]he election to dissolve the Company made in writing by all the Members.”

Vogel Sues After Kiev and Boris Form a Second SPAC

In early 2018, FMC I merged with a tech services company called ConvergeOne. According to Vogel, around that time he reached out to Boris and Kiev about doing a second SPAC and Kiev verbally confirmed that Section 7.02(b) still required approval by Forum Capital’s managers and members before any party could provide services to another SPAC. Soon afterward, Kiev and Boris allegedly formed plans for a second SPAC without Vogel. To that end, and in what was alleged by Vogel as an effort to avoid the restriction on squeezing him out, they prepared a draft plan of dissolution and liquidation for Forum Capital containing a provision under which Vogel waived his consent rights under Section 7.02(b). After Vogel rejected the plan, Kiev and Boris allegedly informed Vogel that Forum Capital and FMC I had been dissolved and wound up.

According to Vogel’s complaint, a few days before he rejected the plan, without Vogel’s consent Kiev and Boris created another SPAC called Forum Merger II Corp. (“FMC II”) and a sponsor for FMC II called Forum Investors II LLC. Some months later, FMC II closed a $250 million IPO, entitling Kiev and Boris to 21.7% of FMC II’s outstanding common stock. In 2020, FMC II merged with an e-commerce company that produces and markets plant-based foods under the name Tattooed Chef, following which Kiev and Boris allegedly received the economic value of their investment.

Vogel filed a single-count complaint in federal court against Kiev and Boris alleging that they breached Section 7.02(b) of Forum Capital’s operating agreement by forming a new SPAC without Vogel’s consent. The complaint seeks imposition of a constructive trust “on the economic value that flows to Defendants from the overall investment, whether through Forum
Investors II, FMC II, Tattooed Chef or other means.”

The Dismissal Motion

Kiev and Boris responded to the complaint with a letter-motion to dismiss, arguing:

  • Section 7.02(b) did not survive the dissolution of Forum Capital;
  • Section 7.02(b) was intended to prohibit a member or manager “from participating in another SPAC without the other parties’ permission because doing so while the current deal was ongoing could have harmed the [FMC I] SPAC”;
  • “Once the [FMC I] SPAC was successfully completed and Forum Capital wound up, Section 7.02(b) became moot”;
  • Vogel’s interpretation of Section 7.02(b) is “absurd and unenforceable as a matter of public policy” because it “serves no legitimate business interest.”
  • Vogel’s suit was barred under Delaware’s doctrine of election of remedies based on Vogel’s admission in his complaint that he participated in a SPAC organized by a third party after Kiev and Boris informed him they were moving forward with a second SPAC without Vogel’s consent; and
  • Vogel suffered no damages since, had his consent been required, they would not have done another SPAC deal.

In his opposition to the motion, Vogel argued:

  • under Section 11.01 of the operating agreement, dissolution of Forum Capital and termination of the agreement required Vogel’s written consent which he never gave, or the sale, disposition or distribution of all of FMC I’s assets which allegedly did not occur, therefore the operating agreement remained in effect at the time defendants organized the second SPAC;
  • even assuming defendants’ attempt to dissolve and terminate the agreement without Vogel’s consent was effective, Section 7.02(b) nonetheless survived termination;
  • Section 7.02(b)’s survival has a legitimate purpose and does not violate public policy;
  • the complaint properly pleads expectation damages; and
  • the doctrine of election of remedies does not apply.

Judge Marrero’s Decision

Judge Marrero denied defendants’ dismissal motion. Construing the complaint’s allegations in Vogel’s favor as required at the pleading stage, Judge Marrero was “not persuaded that the Operating Agreement terminated, thus [the court] need not address whether Section 7.02(b) survives termination.” Explaining further, the court wrote::

The Operating Agreement provides numerous avenues for termination, including “[t]he election to dissolve the Company made in writing by all the Members,” or “[t]he sale, disposition or distribution of all securities and assets held by the Company,” among others. (Operating Agreement §§ 11.01(b), (d).) While the allegations support Vogel’s contention that the parties never agreed in writing to dissolve Forum Capital, it is less clear whether Forum Capital’s assets were “sold, disposed, or distributed.”

The Complaint alleges that FMC I merged with ConvergeOne on February 22, 2018, “pursuant to which control and management of FMC I passed to the shareholders of ConvergeOne.” (Complaint ¶ 40.) Thus, the Operating Agreement “could be dissolved and its affairs wound up.” (Id. ¶ 41.) According to the typical SPAC process Vogel outlines, the next step would involve FMC I “distribut[ing] shares to its managers and/or members.” (Id. ¶ 19.) However, the Complaint does not allege that such “sale, disposition, or distribution” of assets ever took place. Instead, the Complaint repeatedly suggests that Forum Capital never dissolved. (E.g., id. ¶ 70 (“[T]he parties were required. . . to agree in advance to the plan of dissolution, which had not yet occurred.”); ¶ 71 (“[N]o plan of dissolution had been agreed to or executed.”); ¶ 73 (“At no time did Plaintiff Vogel give his consent for Boris and Kiev to dissolve either Forum Capital or FMC I.”))

. . . No doubt, the allegations create a muddled picture of what was required for termination of the Operating Agreement, and it is unclear whether those conditions were ever satisfied. Nevertheless, Vogel asserts that termination did not occur, and he supports that assertion with allegations that Defendants took further steps to affirmatively terminate the Operating Agreement — by sending him the Draft Plan of Dissolution — which presumably would have been unnecessary had the Operating Agreement automatically terminated. Furthermore, even if Forum Capital and FMC I had dissolved on May 25, 2018 as Defendants represented, that fact would not undermine Vogel’s claims. The Operating Agreement would have been in effect on May 4, 2018 when Defendants created FMC II. Thus, construing any reasonable ambiguity or doubt in Vogel’s favor, as the Court must do at this stage of the litigation, the Court finds that Vogel has sufficiently pled that the Operating Agreement was in effect at the time of the alleged breach.

Judge Marrero also addressed and rejected the defendants’ secondary arguments:

  • To defendants’ argument that Vogel’s interpretation of Section 7.02(b) violates public policy and serves no legitimate business interest, Judge Marrero replied: “That sophisticated parties planning to undertake numerous profitable transactions together would agree to work exclusively with one another is neither ‘absurd’ nor does it lack a ‘legitimate business interest.’ To the contrary, the inclusion of Section 7.02(b) protected Vogel’s interest in maintaining an exclusive, lucrative business relationship with Defendants.” Judge Marrero also found that, “[g]iven the novelty and complexity of the transaction at issue here, the Court finds that a determination regarding the reasonableness of the scope and duration of Section 7.02(b) involves questions of fact inappropriate for resolution at the pleading stage.”
  • To defendants’ argument that Vogel elected his remedy by participating in another SPAC without defendants’ consent, Judge Marrero replied: “Vogel’s own breach was not an action to rescind the Operating Agreement nor an effort to unwind the contract he simultaneously seeks to enforce.”
  • To defendants’ argument that Vogel cannot plead damages, Judge Marrero replied: “Here, the Court is satisfied that the Complaint adequately alleges that Vogel suffered expectation damages as a result of the alleged breach. While Defendants argue that Vogel suffered no damages because they would not have entered the [Tattooed Chef] deal had they been compelled to seek Vogel’s consent, insofar as any reasonable doubt or ambiguity of interpretation exists, the Court must credit Vogel’s contrary allegations at this stage. Vogel alleges that Defendants derived ‘economic value on an investment that Vogel was contractually entitled to participate in’ and that he ‘would have participated in FMC II, had the Defendants not impermissibly formed the SPAC without him.'”

Purposeful Omission? Drafting Oversight?

Section 7.02(b) contains no durational limitation, which is why defendants were forced to argue either that the provision did not survive termination of the operating agreement upon some dissolution event, or that its requirement in perpetuity of consent to another member’s sponsoring of a subsequent SPAC is void as against public policy.

Was the omission intentional, i.e., consistent with Vogel’s contention that Section 7.02(b) was the fruit of negotiations among sophisticated parties who agreed “to work together again on future SPAC investments” and “were going to be creating an ongoing business agreement between themselves with limited exceptions as to passive investments and a specific existing investment (Pacific Special Acquisition Corp.)”? Is the intentional-omission interpretation bolstered by the express inclusion of a durational limitation in Section 7.02(a), requiring members and managers, “During the period from the date hereof until the earlier of the dissolution and liquidation of FMC or the closing of the Business Combination, to present any business opportunities that become available to such Member or Manager or its Affiliate that could reasonably be considered appropriate for FMC for the Business Combination,” where Business Combination is defined as “FMC’s initial business  combination”?

Or was the omission an unintentional oversight? Does the above-noted dissonance between subsections (a) and (b) of Section 7.02 create an irrational anomaly where, on the one hand, once the initial SPAC acquisition is consummated the members have no obligation under subsection (a) to present new business opportunities to the other members while, on the other hand, the members have an ongoing and potentially never-ending obligation to obtain the other members’ consent to participate in any subsequent SPAC transaction?

It will be up to Judge Marrero to answer these questions after trial, assuming neither side prevails on summary judgment following discovery.

Finally, I asked my law partner Alon Kapen, whose transactional practice focuses on emerging companies and venture capital, for his views on the Vogel case. Here’s what he said:

The commitment clause to work together on other SPACS is unusual.  I say that because the more common approach is the opposite of that, reflected in an “Other Business Interests” provision which acknowledges that each member may have other business interests, even interests competing with those of the company, and that the members may pursue such other interests independently and neither the company nor the other members will have any rights in those pursuits (unless otherwise agreed to).  SPAC sponsors and their lawyers would be wise to check their operating agreements to make sure they have such a provision and avoid getting “Vogeled”.