My good friend and not infrequent coauthor Todd Henderson has a coauthored op-ed in the WSJ, arguing that Twitter is unlikely to succeed in obtaining specific performance in its lawsuit against Elon Musk:
The merger agreement in this case could be read in a way that permits a court to order Mr. Musk to buy Twitter—he and two entities he controls agreed they would “not oppose” such an order—through a remedy known as “specific performance.” Although litigation is always uncertain, it is hard to imagine a court would force the purchase of a $44 billion corporation.
Specific performance is used fleetingly, and for good reason. ...
Delaware courts have rarely ordered specific performance in merger agreements.
Todd's a very smart guy with whom I rarely disagree, but as somebody once said "even mighty Homer nods." In this case, I respectfully disagree with their analysis.
(As background on the legal issues in play, my post Is Elon Musk trying to get out of the Twitter deal? (Probably.) Will he be able to do so with impunity? (Probably not.), offers a summary for readers who have not followed the case closely.)
Specific Performance
The number of cases in which Delaware courts have been asked to grant specific performance of a merger agreement is relatively small, but the percentage of those cases in which Delaware courts have granted specific performance against a buyer wrongfully seeking to renege is relatively high:
- In re IBP, Inc. Shareholders Litig., 789 A.2d 14 (Del. Ch. 2001): Beef and pork distributor sued for specific performance of merger agreement with chicken distributor. Specific performance granted.
- Channel Medsystems, Inc. v. Boston Sci. Corp., CV 2018-0673-AGB, , at *44 (Del. Ch. Dec. 18, 2019), judgment entered, (Del. Ch. 2019): "Channel is entitled to an order of specific performance requiring Boston Scientific to close the merger"
- Snow Phipps Group, LLC v. Kcake Acq., Inc., CV 2020-0282-KSJM, 2021 WL 1714202, at *56 (Del. Ch. Apr. 30, 2021): "judgment is entered in favor of Plaintiffs on their claim of specific performance of the [purchase agreement]
- Bardy Diagnostics, Inc. v. Hill-Rom, Inc., CV 2021-0175-JRS, 2021 WL 2886188, at *3 (Del. Ch. July 9, 2021), judgment entered, (Del. Ch. 2021): "Bardy is entitled to specific performance and prejudgment interest on the deal price"
In addition, Practical Law's note on drafting and enforcing specific performance clauses in the M&A context expressly states that "a Delaware court is likely to enforce an explicit specific performance clause, even in a sale to a non-competitor for cash." Drafting and Negotiating Reverse Break-Up Fee and Specific Performance Provisions, Practical Law Practice Note 6-386-5096.
Heaton and Henderson opine that:
If Mr. Musk doesn’t want to buy Twitter, it doesn’t make much sense for a court to make him do so.
But then why do targets negotiate routinely for clauses authorizing specific performance (as Twitter did)? And why, as we have seen, do Delaware courts enforce them?
In fact, the vast majority of merger agreements include a clause--like the one at issue here--authorizing specific performance in the event of breach. According to a recent study of "public and private M&A contracts in the years 2010-19 ..., we find that percentage to be in the 85-95% range." Theresa Arnold, Amanda Dixon, Hadar Tanne, Madison Whalen Sherrill, Mitu & Gulati, "Lipstick on A Pig": Specific Performance Clauses in Action, 2021 Wis. L. Rev. 359, 368–69 (2021). The authors further conclude, based on interviews with leading M&A practitioners, that these clauses are used in part because "courts in jurisdictions like Delaware also have a strong interest in giving parties their preferred remedies." Id. at 364.
The majority of M&A contracts are governed by the law of Delaware. Respondents explained that Delaware judges have traditionally been more responsive to the needs of parties in M&A deals than any other jurisdiction … because these corporate transactions provide Delaware with an important source of income and employment. More than two decades ago, starting with In re IBP, Inc. Shareholders Litigation in 2001, the Delaware judiciary, according to many of our respondents, began to signal that it was willing to grant the remedy of specific performance, particularly if it was clear that that was what parties wanted at the outset.In particular, respondents pointed to one judge--Judge Leo Strine--making public appearances at annual meetings of M&A lawyers where he made it clear that the Delaware judiciary was taking a more expansive perspective on the specific performance remedy. That “expansive perspective” was the view that sophisticated parties who know what they are getting into should get what they contract for in the absence of externalities. Still, this observation about the Delaware courts does not explain why parties prefer specific performance over money damages, but it could nevertheless account for the increase in specific performance provisions over time in the M&A world. Parties who can count on their selection of a remedy being respected by the courts may be more likely to include the provision, if that is indeed their preferred provision.
Id. at 380-81.
In sum, specific performance clauses of the sort at issue here are routine and parties anticipate--apparently correctly--that Delaware courts will enforce them.
What if Musk Just Says No?
Heaton and Henderson ask:
What happens if the court orders specific performance and Mr. Musk refuses? The only means the court has to compel him to line up financing and affix his signature to a deal is by holding him in contempt if he refuses. But it isn’t Mr. Musk that promised to buy Twitter, but two entities under his control. The court could hold them in criminal contempt, but as Lord Thurlow observed, “corporations have neither bodies to be punished, nor souls to be condemned.” Mr. Musk promised to “cause” these entities to consummate the deal, but a court is unlikely to jail him if he shirks or refuses. Mr. Musk could play a high-stakes game of chicken that ultimately reveals that courts are extremely limited in cases like this if the parties don’t want to play along.
I understand former Delaware Supreme Court Justice Carolyn Berger raised a similar concern on CNBC today. But I don't see the problem.
First, "Courts can hold a corporation in contempt." E.E.O.C. v. Midwest Health Inc., 12-MC-240-KHV-GLR, 2013 WL 1502075, at *3 (D. Kan. Apr. 11, 2013). In particular, "the contempt mechanism may be used to enforce an order or judgment directing specific performance ...." Tarbert Realty Co., Inc. v. Manny Realty Corp., 512 N.Y.S.2d 634, 635 (N.Y. Sup. Ct. 1987).
Second, I cannot imagine the Delaware courts letting Musk blatantly scoff at a court order. Imagine what would happen to DE M&A deals if suddenly merger agreements with bullet-proof specific performance language suddenly aren’t specifically enforceable after all. It would be a huge blow to Delaware’s brand, which is literally the state's life blood.
Third, although it is not my area of expertise, I wonder whether Musk could be held personally liable for the breach under the responsible officer doctrine.
The Reverse Breakup Fee
Turning to the reverse breakup fee contained in the merger agreement, Heaton and Henderson opine that:
Breakup fees are supposed to reflect damages caused by a breach of contract. They aren’t supposed to act as a penalty. Given that Twitter isn’t obviously worse off by $1 billion—if at all—a court might balk at imposing such a high fee.
To the contrary, reverse breakup fees are routinely enforced precisely because measuring the harm from a refusal by the buyer to perform is so difficult. In effect, breakup fees function as a liquidated damages clause. See Albert Choi, George Triantis, Strategic Vagueness in Contract Design: The Case of Corporate Acquisitions, 119 Yale L.J. 848, 924 n. 122 (2010) (noting that "many acquisition agreements provide for liquidated damages (in the name of a reverse break-up fee)").
Under Delaware law, "Liquidated damages provisions are presumptively valid." Bhaskar S. Palekar, M.D., P.A. v. Batra, CIV.A. 08C-10-269JOH, 2010 WL 2501517, at *6 (Del. Super. May 18, 2010).
True, in Brazen v. Bell Atlantic Corp., 695 A.2d 43 (Del. 1997), the court treated a breakup fee as a liquidated damages provision and applied contract law to determine whether the fee was an impermissible penalty. To determine whether the breakup fee was enforceable liquidated damages or an unenforceable penalty, the court relied on the two part test set out in Lee Builders, Inc. v. Wells, 103 A.2d 918, 919 (Del. Ch. 1954); namely, whether (1) "the damages are uncertain" and (2) "the amount agreed upon is reasonable." If so, the agreement will not be disturbed.
In Brazen, the court concluded that "volatility and uncertainty in the telecommunications industry" meant "that advance calculation of actual damages in this case approaches near impossibility." 695 A.2d at 48.
As to the second prong, the court explained that:
Two factors are relevant to a determination of whether the amount fixed as liquidated damages is reasonable. The first factor is the anticipated loss by either party should the merger not occur. The second factor is the difficulty of calculating that loss: the greater the difficulty, the easier it is to show that the amount fixed was reasonable. In fact, where the level of uncertainty surrounding a given transaction is high, “[e]xperience has shown that ... the award of a court or jury is no more likely to be exact compensation than is the advance estimate of the parties themselves.” Thus, to fail the second prong of Lee Builders, the amount at issue must be unconscionable or not rationally related to any measure of damages a party might conceivably sustain.
Here, in the face of significant uncertainty, Bell Atlantic and NYNEX negotiated a fee amount and a fee structure that take into account the following: (a) the lost opportunity costs associated with a contract to deal exclusively with each other; (b) the expenses incurred during the course of negotiating the transaction; (c) the likelihood of a higher bid emerging for the acquisition of either party; and (d) the size of termination fees in other merger transactions. The parties then settled on the $550 million fee as reasonable given these factors. Moreover, the $550 million fee represents 2% of Bell Atlantic's market capitalization of $28 billion. This percentage falls well within the range of termination fees upheld as reasonable by the courts of this State.17 We hold that it is within a range of reasonableness and is not a penalty.
17 See, e.g., Kysor, 674 A.2d at 897 (where the Superior Court held that a termination fee of 2.8% of Kysor's offer was reasonable); Roberts v. General Instrument Corp., Del. Ch., C.A. No. 11639, slip op. at 21, Allen, C., 1990 WL 118356 (Aug. 13, 1990) (breakup fee of 2% described as “limited”); Lewis v. Leaseway Transp. Corp., Del. Ch., C.A. No. 8720, slip op. at 6, Chandler, V.C., 1990 WL 67383 (May 16, 1990) (dismissing challenge to a transaction which included a breakup fee and related expenses of approximately 3% of transaction value); Braunschweiger v. American Home Shield Corp., Del. Ch., C.A. No. 10755, slip op. at 19-20, Allen, C., 1989 WL 128571 (Oct. 26, 1989) (2.3% breakup fee found not to be onerous).
In this case, a $1 billion breakup fee seems perfectly reasonable. It represents 2.2% of the planned purchase price, which is well within the range Brazen indicates is deemed reasonable. It's also noteworthy that the fee in this case is actually on the low end of current market expectations. "For deals that include a reverse break-up fee payable by the buyer, the study found a median fee of exactly 6 percent of the deal's equity value, up slightly from [2014]." Practical Law Report Offers Insight in M&A Buyer Breach, 33 Law. PC 6 (June 15, 2016).
Like the telecommunications industry at issue in Brazen, moreover, the technology market in which Twitter functions is plagued by volatility and uncertainty, which means "advance calculation of actual damages in this case approaches near impossibility," which in turn argues for the reasonableness of the termination fee.
It's also noteworthy that the merger agreement between Twitter and Musk specifically provides that:
Each of the parties hereto acknowledges that (i) the agreement contained in this [i.e., the $1 billion reverse breakup fee] is an integral part of the transactions contemplated by this Agreement, (ii) the Termination Fee is not a penalty, but is liquidated damages, in a reasonable amount that will compensate Parent and its Affiliates in the circumstances in which such fee is payable for the efforts and resources expended and opportunities foregone while negotiating this Agreement and in reliance on this Agreement and on the expectation of the consummation of the transactions contemplated by this Agreement, which amount would otherwise be impossible to calculate with precision, and (iii) without the agreement contained in this Section 8.3, the parties would not enter into this Agreement ....
Where an agreement is "heavily negotiated by sophisticated parties," a court is less likely to determine that the clause is an unenforceable penalty. CRS Proppants LLC v. Preferred Resin Holding Co., LLC, CVN15C08111MMJCCLD, 2016 WL 6094167 (Del. Super. Sept. 27, 2016).
More important, the Court will give substantial deference to the parties' agreement that the fee is not a penalty:
The Court finds that the damages were difficult to ascertain. First it should be noted that the parties stipulated to that fact in the contract. Paragraph 4(c) states, “The parties agree that actual damages would be difficult to calculate[.]” This Court has held, “[W]here the parties themselves have unambiguously concluded that such a value is difficult to ascertain should the agreement be breached, this Court will not construe that conclusion differently.”The Court relies on that objective manifestation of the parties' intent, as stated in the Agreement, to establish that damages were difficult to ascertain when the Agreement was executed. Put simply, it should come as no surprise that the Court will hold a party to the contract he signed.
Bhaskar S. Palekar, M.D., P.A. v. Batra, CIV.A. 08C-10-269JOH, 2010 WL 2501517, at *7 (Del. Super. May 18, 2010) (emphasis supplied). The Twitter agreement does exactly what the employment agreement in Batra did. The parties agreed actual damages would be difficult to calculate. They agreed it is not a penalty. The court deferred to their agreement. It seems safe to assume that Musk and Twitter had even more sophisticated counsel than a physician and his employer. So I would be surprised if a Delaware court were not to hold Musk to the contract (or, more precisely, the acquisition entities).
Who's Got the Best Lawyers?
Heaton and Henderson go out of their way to bash Twitter's lawyers:
Twitter could have raised the stakes for Mr. Musk by including a requirement that he pay damages to its shareholders if he walked away. In that case, the shareholders could have sued for the difference between the amount Mr. Musk agreed to pay and the price any other suitor would pay—like the homeowner finding another painter. But the merger agreement doesn’t give shareholders this remedy. ...
This case highlights an important risk to shareholders in mergers and acquisitions: The corporation that negotiates the deal may not have much of a case against a breaching counterparty because the corporation, unlike its shareholders, usually isn’t harmed when the counterparty walks away. The easy fix is to give shareholders the right to sue for their losses. But either Mr. Musk’s lawyers were too smart for that or Twitter’s weren’t smart enough.
As we have seen, Musk--a sophisticated party represented by sophisticated counsel--agreed in advance that Twitter would be harmed if Musk walked way. Second, I've read a lot of merger agreements and I haven't seen provisions expressly authorizing shareholders to sue if the deal craters. Instead, you see reverse breakup fees.
It's also noteworthy that the Twitter-Musk agreement actually does allow Twitter to recover any damages incurred by the shareholders. Section 8.2 provides, in pertinent part, that termination of the agreement under the termination provisions shall not "relieve any party hereto of any liability or damages (which the parties acknowledge and agree shall not be limited to reimbursement of Expenses or out-of-pocket costs, and, in the case of liabilities or damages payable by Parent and Acquisition Sub, would include the benefits of the transactions contemplated by this Agreement lost by the Company’s stockholders) (taking into consideration all relevant matters, including lost stockholder premium, other combination opportunities and the time value of money), which shall be deemed in such event to be damages of such party, resulting from any knowing and intentional breach of this Agreement prior to such termination.” To be sure, although Section 8.2 thus would let Twitter collect any damages Musk might owe the Twitter shareholders, Section 8.3 provides that any damages would be capped at $1 billion. Since, under Section 8.3(b), Twitter is entitled to that amount as a breakup fee, there probably would not be any litigation on shareholder damages, but the main point is that Twitter's deal lawyers don't deserve the criticism leveled at them.
In any case, apropos of Heaton and Henderson's suggestion that Musk may have better lawyers, a friend passed along this thought, which strikes me as exactly right:
Why didn’t Musk’s lawyers move first to file a complaint? In a case like this it would seem to me that Musk wants to set the terms of the issues and tell his story. Instead we heard Twitter’s story which talk about how much Musk’s conduct is damaging it. I can only assume that Skadden is having some client control issues. Big surprise.
Discovery is Going to be Fun
The same friend also passed along this thought:
Assuming Matt Levine is mistaken and Musk is not just playing games when he decides to buy a company but now wants to retrade his deal, the discovery in this case is going to be very interesting. Musk is going to want to demonstrate that Twitter has significantly undercut the number of bots. The chances of winning on that issue seems very low but discovery (and possible public disclosure) will put tremendous pressure on Twitter and also on Musk who, if he loses, may be stuck with a flawed business model that has become even more flawed due to his insistence on discovering (and disclosing) the details. All of this is a bit of a nightmare for Twitter’s lawyers who have to be also thinking of possible downsides (Musk not required to buy). Should be very interesting to watch this play out.
My guess is that Musk's deposition will be epic. I hope it goes viral. On Twitter.
Conclusion
As regular readers know, I think Twitter has a strong case. I still do.
