As you probably know, Elon Musk has been complaining for at least the last couple of weeks that Twitter is not giving him adequate information about how many Twitter accounts are bots. Today, CNBC reported that:
Elon Musk accused Twitter of “resisting and thwarting” his right to information about fake accounts on the platform, calling it in a letter to the company on Monday a “clear material breach” of the terms of their merger agreement.
“Mr. Musk reserves all rights resulting therefrom, including his right not to consummate the transaction and his right to terminate the merger agreement,” the letter, signed by Skadden Arps attorney Mike Ringler, says.
Does Musk have the rights the letter claims?
The merger agreement between Twitter and Musk has an unusually strong specific performance clause (section 9.9). It first provides that the parties agree that monetary damages would be an inadequate remedy for a breach of the contract and therefore they agree that "the parties hereto shall be entitled to an injunction, specific performance and other equitable relief to prevent breaches of this Agreement and to enforce specifically the terms and provisions hereof, in addition to any other remedy to which they are entitled at law or in equity."
But here's the really interesting wrinkle. The parties also agreed to waive any argument that the other is not entitled to specific performance:
Each of the parties hereto agrees that it will not oppose the granting of an injunction, specific performance and other equitable relief on the basis that any other party has an adequate remedy at law or that any award of specific performance is not an appropriate remedy for any reason at law or in equity. Any party seeking an injunction or injunctions or any other equitable relief to prevent breaches of this Agreement and to enforce specifically the terms and provisions of this Agreement shall not be required to show proof of actual damages or provide any bond or other security in connection with any such order or injunction.
In other words, if Twitter seeks specific performance of the merger agreement, Musk has already agreed not to oppose that effort.
As an alternative to seeking performance, Twitter could invoke the merger agreement's termination fee clause. Usually, in M&A deals, a termination fee (a.k.a., breakup fee) provision requires the target to pay some amount (typically 1-3% of the deal price) to a frustrated buyer if the deal fails to go through. The Twitter-Musk agreement contains such a provision, but it also includes a reverse breakup fee under which Musk would have to pay Twitter $1 billion if he backs out of the deal. (See section 8.3(b) of the agreement, which cross-referenced sections 8.1(c)(i) and (c)(ii).)
Section 9.9(b) makes clear that Twitter is not entitled to both specific performance and the termination fee ("under no circumstances shall the Company be permitted or entitled to receive both a grant of specific performance to cause the Equity Financing to be funded, on the one hand, and payment of the Parent Termination Fee or other monetary damages, remedy or award, on the other hand").
On the other hand, Section 9.9(b) also provides that "the Company may concurrently seek (x) specific performance or other equitable relief, subject to the terms of this Section 9.9, and (y) payment of the Parent Termination Fee or other monetary damages, remedy or award if, as and when required pursuant to this Agreement." Another words, Twitter can sue for both and sort out which remedy it wants as the facts develop.
For the most part, if Twitter pursues monetary damages, the Parent Termination Fee remedy will function as a cap on damages. Section 8.3(c) states that "except in the case of a knowing and intentional breach of this Agreement by the Equity Investor, Parent or Acquisition Sub ..., the Company’s right to receive payment from Parent of the Parent Termination Fee pursuant to Section 8.3(b), shall constitute the sole and exclusive monetary remedy of the Company." In the event of a knowing and intentional breach, the provision explains that "the Company shall be entitled to seek monetary damages, recovery or award from the Equity Investor, Parent or Acquisition Sub in an amount not to exceed the amount of the Parent Termination Fee, in the aggregate."
Of course, all of this assumes that the agreement is enforceable. Musk may have several arguments.
Argument1: Fraud
His least likely to succeed option would be a claim that Twitter committed fraud in representations about the percentage of bot accounts. But Twitter was careful to say that its estimate of ~5% might be an underestimate, so proving Twitter intentionally lied may be very hard.
Argument 2: Breach of Representation
Musk does not need to close if Twitter is in breach of a representation. Section 7.2(b) of the agreement states:
The obligations of Parent and Acquisition Sub to consummate the Merger, are, in addition to the conditions set forth in Section 7.1, further subject to the satisfaction or waiver by Parent at or prior to the Effective Time of the following conditions: (b) (i) each of the representations and warranties of the Company contained in this Agreement (except for the representations and warranties contained in Section 4.2(a) and Section 4.2(b)), without giving effect to any materiality or “Company Material Adverse Effect” qualifications therein, shall be true and correct as of the Closing Date (except to the extent such representations and warranties are expressly made as of a specific date, in which case such representations and warranties shall be so true and correct as of such specific date only), except for such failures to be true and correct as would not have a Company Material Adverse Effect; and (ii) each of the representations and warranties contained in Section 4.2(a) and Section 4.2(b) shall be shall be true and correct in all material respects as of the Closing Date (except to the extent such representations and warranties are expressly made as of a specific date, in which case such representations and warranties shall be so true and correct in all material respects as of such specific date only) ....
Although there is no specific representation re bot accounts, there is a representation in Section 4.6(a) that:
Since January 1, 2022, the Company has filed or furnished with the SEC all material forms, documents and reports required to be filed or furnished prior to the date of this Agreement by it with the SEC (such forms, documents and reports filed with the SEC, including any amendments or supplements thereto and any exhibits or other documents attached to or incorporated by reference therein, the “Company SEC Documents”). As of their respective dates, or, if amended or supplemented, as of the date of the last such amendment or supplement, the Company SEC Documents complied in all material respects with the requirements of the Securities Act and the Exchange Act, as the case may be, and the applicable rules and regulations promulgated thereunder, and none of the Company SEC Documents at the time it was filed (or, if amended or supplemented, as of the date of the last amendment or supplement) contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, or are to be made, not misleading.
As Matt Levine points out:
Twitter’s securities filings have for years said some highly qualified version of that: Its most recent Form 10-Q says “We have performed an internal review of a sample of accounts and estimate that the average of false or spam accounts during the first quarter of 2022 represented fewer than 5% of our mDAU during the quarter. The false or spam accounts for a period represents the average of false or spam accounts in the samples during each monthly analysis period during the quarter. In making this determination, we applied significant judgment, so our estimation of false or spam accounts may not accurately represent the actual number of such accounts, and the actual number of false or spam accounts could be higher than we have estimated.
Musk could try to argue that Twitter is in breach of the Company SEC Document representation because the 5% bot figure is an "untrue statement of a material fact" that was contained in multiple SEC filings. The trouble with that argument is two-fold. First, as suggested above, given the highest qualified nature of the Twitter statements, the 5% figure probably is not untrue.
Second, notice that section 7.2(b)(i) has a materiality scrape coupled with a CMAE qualifier.
... each of the representations and warranties of the Company contained in this Agreement ..., without giving effect to any materiality or “Company Material Adverse Effect” qualifications therein, shall be true and correct as of the Closing Date (except to the extent such representations and warranties are expressly made as of a specific date, in which case such representations and warranties shall be so true and correct as of such specific date only), except for such failures to be true and correct as would not have a Company Material Adverse Effect;
The italicized portion of 7.2(b)(i) is the materiality scrape. The scrape has the effect of requiring all materiality qualifiers to be disregarded for purposes of determining whether a particular representation or warranty has been breached for purposes of the bringdown clause. Accordingly, for example, a representation that “the target company is not party to any material litigation” would be read for this purpose as “the target company is not party to any litigation.”
The underlined text in 7.2(b)(i) is critical to the effect of the scrape. If the underlined text were omitted, this would be a very acquirer-friendly provision, because the buyer acquirer get to walk away if any of the covered reps were technically inaccurate in any way. In contrast, including the underlined text is very target-friendly, because it is harder to prove that a material adverse event occurred than to prove that a representation was materially false.
As Matt Levine explains:
Musk thinks, or says he thinks, that [the Company SEC Documents] representation is not true. But even if he’s right, he can’t get out of the deal, unless it is untrue and would have a “material adverse effect” on Twitter’s business. If in fact 90% of Twitter’s users are bots, it knows that, and it has been lying to advertisers for years, then, uh, sure, maybe. But in any plausible case, there will not be an MAE, so he still has to close the deal and pay $54.20 per share. (Emphasis supplied.)
For explanation of the material adverse effect (a.k.a. material adverse change) issue, see Argument 4 below.
Argument 3: Breach of Closing Condition
Section 7.2(a) provides that Musk is excused from having to close if "the Company shall [not] have performed or complied, in all material respects, with its obligations required under this Agreement to be performed or complied with by the Company on or prior to the Closing Date." One of those obligations is the closing condition in section 6.4, which requires that Twitter supply "all information concerning the business, properties and personnel of the Company and its Subsidiaries as may reasonably be requested in writing."
As Matt Levine explains, this combination of provisions could be played as follows. Musk's lawyers keep asking Twitter for information until they finally find information Twitter is unwilling to disclose.
I can understand why Twitter would be nervous about sharing user data with Musk. For one thing, there are all sorts of regulatory and risk reasons to be nervous about sharing user data with someone who, for now at least, does not work at Twitter.
I'm not persuaded that that play would work. First, section 6.4 says that the information requested must be sought "for any reasonable business purpose related to the consummation of the transactions contemplated by this Agreement." Trying to get out of a merger deal doesn't strike me as a reasonable business purpose. The Delaware Chancery Court is unlikely to ignore evidence that Musk's requests for information are pretextual. And the word reasonable gives the court the wriggle room to reject his attempt to do so. As Levine correctly observes: "If he refuses to close because Twitter won’t humor his bot-fishing expedition, it seems unlikely that a Delaware court will side with him."
Second, Twitter does not need to respond to those requests if doing so "would, in the reasonable judgment of the Company, (i) cause significant competitive harm to the Company or its Subsidiaries if the transactions contemplated by this Agreement are not consummated, (ii) violate applicable Law or the provisions of any agreement to which the Company or any of its Subsidiaries is a party, or (iii) jeopardize any attorney-client or other legal privilege." Twitter will argue that "regulatory and risk reasons" satisfy clauses (i) and (ii).
Argument 4: Material Adverse Event
Musk may argue that there has been a material adverse change (MAC). The agreement contains a closing condition (section 7.2(c)) that excuses Musk from having to complete the deal if a "Company Material Adverse Effect shall have occurred and be continuing."
The definition of Company Material Adverse Effect (CMAE) is typically lengthy and complex. It begins by defining such an effect as "any change, event, effect or circumstance which, individually or in the aggregate, has resulted in or would reasonably be expected to result in a material adverse effect on the business, financial condition or results of operations of the Company and its Subsidiaries, taken as a whole ...." It then goes on to include multiple provisos, each of which is subject to various carveouts.
Delaware law is clear that you do not reach the effect of the provisos and their carveouts until you have determined that the opening definition has been satisfied. With that in mind, there are several noteworthy aspects of the definition. First, it omits any reference to Twitter's "prospects."
It formerly was common for MAC definitions to include references to the target’s “prospects.” The agreement might define a MAC, for example, as “any result, occurrence, fact, change, event or effect that has a materially adverse effect on the business, assets, liabilities, capitalization, condition (financial or other), results of operations, or prospects of Target.” In general, targets want to exclude prospects, because they believe its inclusion reduces deal certainty by allowing a MAC to depend on future developments. That preference seems somewhat odd, because the MAC is inherently forward looking. In any event, however, here prospects were omitted.
Second, absent a clear contractual provision, an effect must be “durationally significant” to constitute a MAC. Musk would have to convince the court that the bot issue will be a longterm problem.
Third, practitioners have advised that the MAC clause should set out specific, objective tests for what events will constitute an MAC. If the acquirer believes that a firm-specific adverse event, such as a negative result from a clinical trial for a drug in development would constitute an MAC, it should insist that that event be expressly included in the MAC definition. If Musk had really been worried about the bot issue, he should have included it in the CMAE definition.
Because the bot issue is not specified, Musk will be obliged to prove a material adverse impact on Twitter's EBITDA.
Delaware courts have almost never found a MAC excused the buyer from closing. In fact, the Delaware courts emphasize that has a “heavy burden” to establish the existence of a MAC.
By the way, the fact that Musk waived due diligence technically is not a factor to the MAC analysis. Targets will often request inclusion of such a knowledge qualifier, so as to exempt “any subject covered in due diligence, in the data room, or that otherwise is within Buyer’s knowledge” from the definition of a MAC.[1] In Akorn, Inc. v. Fresenius Kabi AG,[2] the Delaware Chancery Court refused to imply a knowledge-based exception to the parties’ MAC, because of the sweeping implications such a broad carveout would have for the parties’ allocation of risk.[3] Having said that, it surely will impact the optics of the analysis.
FYI: My summary of the relevant legal issues comes from my book Mergers and Acquisitions (Concepts and Insights).
[1] AB Stable VIII LLC v. Maps Hotels and Resorts One LLC, 2020 WL 7024929, at *60 (Del. Ch. Nov. 30, 2020).
[2] Akorn, Inc. v. Fresenius Kabi AG, CV 2018–0300–JTL, 2018 WL 4719347, at *1 (Del. Ch. Oct. 1, 2018), aff’d, 198 A.3d 724 (Del. 2018).
[3] See id. at *78–80 (rejecting target’s argument that the court should imply a knowledge qualifier).
