I offered JB Heaton and Todd Henderson an opportunity to do a guest post responding to my post, Does Twitter's Lawsuit Against Elon Musk Really Look "Like a Loser"?, which had commented on their WSJ oped on the lawsuit:
J.B. Heaton and Todd Henderson
July 18, 2022
Thank you to the inestimable Steve Bainbridge for allowing us the opportunity to discuss the Twitter v. Musk lawsuit here. In our discussions with investors betting on the outcome, we heard that they all read Steve’s blog, confirming it as the essential place for corporate law commentary. This is a close case, and we are grateful for and fascinated by the ongoing debate.
Our Wall Street Journal commentary has provoked considerable discussion. Some of it serious and excellent (such as Steve Bainbridge on this blog and Yair Listokin Jonathon Zytnick in the New York Times); some of it the equivalent of the ranting of a hypoglycemic child. Some of it agrees with us; some of it does not. Of course, that’s why we have such opinion pieces: to state an opinion, usually on one side of an issue that might be seen differently by different people. Our original piece rose out of our own discussions on the Twitter v. Musk lawsuit, and primarily in response to what we saw as a chorus of agreement that Elon Musk was almost certain to be forced to close the deal he and his holding corporations made with Twitter, Inc. Clinical professors of marking, professional pundits, news anchors, and even constitutional law professors were suddenly experts on corporate law and M&A, and they all thought it was obvious that Musk would be forced to buy Twitter, even though it is far from clear this is something anyone (other than merger arbs invested in Twitter stock) wants to happen. If the Delaware courts are going to get this right, we thought it important to offer the other side of the case.
Our point is that specific performance is by no means the sure thing many pundits claim. The proof of the reasonableness of our view is in the pudding of Twitter, Inc.’s stock price. That stock price closed on Friday, July 15, 2022 at $37.74. The deal price that so many believe Musk will be ordered to pay is $54.20. As a back of the envelope calculation, if the average of all of the possibilities for the stock price without specific performance is, say $30.00, then the current stock price reflects about a 32% chance of specific performance. Maybe the case will settle for an amount less than $54.20, but if it were clear specific performance was an obvious option for Twitter, that settlement would be about $54.20 minus the cost of litigation, or about $54.20. There are many ways to think about the possible outcomes of course, but there is no question that people with real money on the line are not viewing specific performance as even more likely than not, and definitely not as the slam dunk many commentators claim.
Could the Delaware Chancery Court order specific performance and could that ruling be affirmed on appeal? Of course. We don’t think otherwise. Has the same court ordered specific performance in the past? Of course. Enough times so that “rarely” is the wrong word? Perhaps. Remember, we had editors at the Wall Street Journal and they love to punch up their pieces. If we’d been mealy mouthed and hedged like lawyers do, we are doubtful the debate today would be as joined and as valuable as it is.
The question is whether specific performance is likely here. This case is not the same as the prior cases. For one thing, Musk’s lawyers at Quinn Emanuel will leave no stone unturned on the remedy of specific performance. This will not be IBP v. Tyson Foods, the 2001 case where then-Vice Chancellor Leo Strine observed that “[a]lthough Tyson’s voluminous post-trial briefs argue the merits fully, its briefs fail to argue that a remedy of specific performance is unwarranted in the event that its position on the merits is rejected” and where VC Strine observed that “[t] his gap in the briefing is troubling.” Quinn Emanuel won’t make that mistake. This case will be as much about the remedy as Musk’s defenses on the merits.
It should also be noted that the Tyson case was under New York law, not Delaware as in the Twitter case, that the court took into consideration the impact on all of the various corporate stakeholders, not just shareholders, and, most importantly, in asking whether the opportunity was truly “unique,” the court asked the same question we did in our oped, and noted that the decision to require specific performance was not one the court was confident about. In other words, in a highly contextualized analysis, the court found the case to be about a coin-flip.
In the Twitter case, Quinn Emanuel is likely to home in on the serious legal problem in Twitter, Inc.’s case with respect to specific performance: Twitter, Inc. is not obviously even harmed by the breach.
Corporations, as all readers of this blog know, are legally separate and distinct from their shareholders. Suppose a corporation enters into an agreement to merge with another entity, and under that agreement the corporation will cancel its existing shares, giving its then-former shareholders the right to receive money from the acquirer, although that money never enters the corporation itself. If the acquirer breaches its agreement and refuses to close, the shareholders will not receive the money promised to them by the agreement but the corporation itself will receive $1 billion (in the form of a termination fee) that it did not have before and would not have received if the merger proceeded. What rights do the shareholders have under Delaware law if the merger agreement disavows them as third-party beneficiaries for purposes of enforcing the agreement? Can the corporation itself ignore the benefit it receives from breach (the $1 billion termination fee) to ask a court to specifically enforce the merger agreement and, if it does, would it be lawful for the Delaware courts to award specific performance?
We think this is the situation presented by the case of Twitter v. Musk. There is an agreement and plan of merger among Twitter, Inc., a Delaware corporation, and X Holdings I, Inc. and X Holdings II, Inc. In the merger agreement, X Holdings I, Inc. is known as the Parent and X Holdings II, Inc. is known as the Acquisition Sub. The merger agreement reflects a plan for a so-called reverse triangular merger under which Acquisition Sub merges into Twitter, Inc. with Twitter, Inc. surviving to become a wholly-owned subsidiary of the Parent. Under the merger agreement, Twitter, Inc. cancels its existing shares and replaces them with certificates that then-former Twitter, Inc. shareholders can take to a bank acting as paying agent, receiving $54.20 for every former share of Twitter, Inc. stock held as reflected in the certificates.
Twitter, Inc.’s shareholders before the merger becomes effective are not parties to the merger agreement, and the merger agreement disavows those shareholders as third-party beneficiaries except as to a provision limiting Twitter, Inc.’s money remedies to a $1 billion termination fee, the purpose of which is to bind Twitter, Inc.’s shareholders to that part of the agreement without giving them wider rights. The merger agreement also entitles Twitter, Inc. to that $1 billion termination fee as one of three possible and mutually exclusive remedies, the other two being, first, a damages remedy capped by the amount of the termination fee ($1 billion) and so no better than and possibly worse than the termination fee and, second, the right to ask for specific performance.
On July 8, 2022, Musk (who is also a party to portions of the merger agreement), Parent, and Acquisition Sub purported to terminate the agreement. Twitter, Inc. sued Musk, Parent, and Acquisition Sub in Delaware Chancery Court alleging that the termination was wrongful and that the court should order Musk, Parent, and Acquisition Sub to close under an equitable remedy of specific performance.
Suppose that the Musk termination was wrongful. Should the court grant specific performance? To both lay persons and lawyers who spend little time on the legal distinction between a corporation and its shareholders, the appealing answer is, Yes. After all, Musk, Parent, and Acquisition Sub made a deal with Twitter, Inc. and under that deal the Twitter, Inc. shareholders would receive $54.20 per share, a huge premium over the Twitter, Inc. share price before Musk’s interest in acquiring Twitter, Inc. became public. Specific performance is worth as much as $30 per share at this point, assuming that a loss on specific performance might see the Twitter stock fall to $24.20 or so. By contrast, a $1 billion termination fee paid to Twitter, Inc. (not to its shareholders) is worth only about $1.30 per share, approximately 9% of which will accrue to Musk’s benefit as owner of about that percentage of Twitter, Inc. stock. Specific performance surely is the only remedy that can compensate Twitter, Inc.’s shareholders for the lost deal premium.
But not so fast. The readers of this blog can see that the problem for the court is this: Twitter, Inc. is not obviously harmed by the breach. Form matters in these things. Twitter, Inc. is the surviving corporation in the reverse triangular merger reflected in the merger agreement. Twitter, Inc.’s assets and profits are exactly the same in the instant after the merger becomes effective as they were in the instant before the merger became effective. In fact, if Twitter, Inc. collects the $1 billion termination fee as its remedy (and we assumed it can; debate on that point is small potatoes), then Twitter, Inc. is $1 billion better off than it would have been had the merger closed.
That is, Twitter, Inc., the corporation, suffers no harm and, even if it did suffer some, there’s no indication that the $1 billion termination fee would leave Twitter, Inc. anything other than financially better off than it would have been with the merger, even if some of the $1 billion does compensate Twitter, Inc. for de minimis harm from, say, legal and consulting fees in pursuing the termination fee in court.
Twitter’s shareholders are obviously injured by the loss of the deal to have their stock cancelled and replaced with certificates that then would be presented to a paying agent funded by Parent. But shareholders have no damages remedy in the merger agreement for injuries that are separate and distinct from any injury to the corporation. Twitter, Inc. might have negotiated for that right but it did not, except that it asserted that it could seek damages for shareholder losses as well, but only up to $1 billion. Twitter, Inc.’s shareholders have no right of their own to pursue specific performance under the merger agreement.
This leaves the Delaware courts in a predicament. To order specific performance of the deal is to order contract parties to perform so that non-parties to the contract (the Twitter, Inc. shareholders) who were expressly disavowed as third-party beneficiaries for remedy purposes can receive payment for cancelled shares, even though an award of the termination fee would leave the legally distinct and actual party to the contract, Twitter, Inc., better off by $1 billion than would specific performance, which will leave Twitter, Inc. exactly as it was except for a new board of directors and new bylaws taken from the Acquisition Sub and the replacement of its pre-merger shareholders with a single shareholder, Parent.
In substance under the merger agreement, Twitter, Inc. is acting as a commission-free broker of a deal where current Twitter, Inc. shareholders agree to have their shares cancelled in return for a payment and Musk’s parent holding company agrees to make that payment in return for ownership of Twitter’s (one) new share. But rather than make a contract among shareholders and Musk and his holding companies, as a broker would do, Twitter, Inc. made itself the counter party to Musk and his entities. But as a commission-free broker, Twitter, Inc. loses nothing when the deal collapses. In fact, having negotiated a termination fee of $1 billion, Twitter, Inc. is actually better off with breach and that remedy than with either its limited (to $1 billion) damages remedy or specific performance. And shareholders, being nonparties disavowed as third-party beneficiaries, have no separate cause of action. Only by ignoring the legal distinction between Twitter, Inc., the corporation, and Twitter, Inc.’s pre-merger shareholders could specific performance make sense.
Of course, there is virtue in deal certainty. Parties may want to bind themselves, as Odysseus did to the mast. But Delaware courts scrutinize such acts of pre-commitment routinely, forbidding some kinds, as under the Unocal doctrine. One of our many points is that specific performance is, from a law and economics perspective, a bad deal device in all but a few kinds of cases. It would be better for the parties to contract in other ways, such as by including shareholders as third-party beneficiaries (and thus making the damages from a broken deal easily available). Deal structure matters. For instance, given the nature of the parties, it might have made much more sense for the Twitter board to let Musk deal directly with shareholders (as he wanted) than to force him to deal with the board. The poison pill may have been the original sin, since courts and the bluntness of specific performance would not have been needed had Musk been allowed to tender for Twitter shares.
Judges have ways of working around the law, and specific performance may well be awarded by a court that is loath to allow Musk, Parent, and Acquisition Sub to walk away from a $44 billion deal for a measly $1 billion. To do so here, however, the Delaware court will have to ignore the most fundamental fact of corporate law, namely, that the corporation is not its shareholders. Wouldn’t that be a strange outcome in Delaware, of all places. Could it happen? Sure. It is more likely than not? We think no, and the stock market, so far, agrees with us.
