ProfessorBainbridge.com

Foundation announces the second edition of Bainbridge & Anabtawi's Mergers & Acquisitions casebook

Here is the book's homepage.

Twitter Pushed Stakeholders Under the Bus: Just as my new book would have predicted

Lucian Bebchuk et al.:

We just posted on SSRN a new discussion paper, How Twitter Pushed Stakeholders under the Bus.(An earlier post noting our work on this project and our take on the subject is available here.)

This paper provides a case study of the acquisition of Twitter by Elon Musk. Our analysis indicates that when negotiating the sale of their company to Musk, Twitter’s leaders chose to disregard the interests of the company’s stakeholders and to focus exclusively on the interests of shareholders and the corporate leaders themselves. In particular, Twitter’s corporate leaders elected to push under the bus the interests of company employees, as well as the mission statements and core values to which Twitter had pledged allegiance for years.

Our analysis supports the view that the stakeholder rhetoric of corporate leaders, including in corporate mission and purpose statements, is mostly for show and is not matched by their actual decisions and conduct (Bebchuk and Tallarita (2020)). Our findings also suggest that corporate leaders selling their company should not be relied upon to safeguard the interests of stakeholders, contrary to the predictions of the implicit promises and team production theories of Coffee (1986), Shleifer-Summers(1988) and Blair-Stout (1999).

A basic point of my new book is that ESG is a means to an end and not an end in and of itself. Twitter is just the latest example.

;

Insider Trading and Corporate Takeovers: A ProfessorBainbridge.com Video

Insider trading is often said to be the most common violation of the federal securities laws. Insider trading based on information relating to corporate mergers, tender offers, and other acquisitions is a common and potentially very lucrative variant. This video reviews the basic theories of insider trading liability under Rules 10b-5 and 14e-3 as applied to takeovers.

Management Buyouts: A ProfessorBainbridge.com Video

A management buyout (MBO) occurs when a public company's management team purchases the company from its shareholders. The substance of the transaction typically is a leveraged buyout. The form can be either a merger between the company and an acquisition corporate shell set up by the management group or a two-step acquisition in which management first makes a tender offer and then freezes out any remaining shareholders with a merger. Management often will seek a private equity fund to serve as a financial partner.

The transaction can produce significant gains, but it also poses a serious conflict of interest. Managers are simultaneously acting as agents of the shareholders and as buyers. In effect, they are on both sides of the deal. In addition, because management typically will have private information, some regard MBOs as simply a very large insider trading transaction.

This video explains how MBOs work and provides an overview of judicial review.

"The Rise of Anti-Activist Poison Pills"

Very interesting new paper:

We create a novel dataset of the terms of poison pill plans to examine their prevalence over time. Consistent with the hypothesis that poison pills have responded to the increase in hedge fund activism, recent adoptions have characteristics and provisions that appear to target hedge funds, such as low trigger thresholds. Moreover, using unique data on activist hedge fund views of SEC filings as a proxy for the mere threat of an activist intervention, we show that hedge fund interest strongly predicts pill adoption. Finally, the likelihood of a 13D filing declines after firms adopt “antiactivist” pills. Our analysis has implications for understanding the modern dynamics of market discipline of managers in public corporations, and evaluating policies that regulate defensive tactics.

Eldar, Ofer and Kirmse, Tanja and Wittry, Michael D., The Rise of Anti-Activist Poison Pills (August 22, 2022). Fisher College of Business Working Paper No. 2022-03-007, Charles A. Dice Center Working Paper No. 2022-07, Available at SSRN: https://ssrn.com/abstract=4198367 or http://dx.doi.org/10.2139/ssrn.4198367

Purchase versus pooling accounting

A student in my Mergers and Acquisitions class asked a question that took me back two decades:

I had a question about how pre 2001 consolidation was preferred due to accounting rules allowing pooling rather than purchase. I was taught last year and working this past summer that the form of an M&A deal was heavily influenced by tax considerations. I intuitively assumed purchase was the far superior option; doesn’t purchase accounting create an massive taxation benefit by allowing the surviving corporation deductions for goodwill even though I am ignorant as to the marked up value of assets on other considerations such as basis? I get that there are appearances to consider, but is that the only reason pooling was the preferable method of accounting?

Let's start with basics.

Acme Co., Inc., buys Omega, Inc., with Acme as the surviving entity. If pooling accounting was used, Acme's financial statements would be combined—“pooled”—with those of Omega, so that both companies’ assets and liabilities would be included on Acme’s balance sheet at their existing book value.[1]

If the deal is structured so as to use purchase accounting, however, the transaction is treated for accounting purposes as a purchase by Acme of Omega. In that case, Omega's assets would be marked up or down, as the case might be, to their fair market value on Acme's post-acquisition financial statements.

In addition, in purchase accounting, any control premium—defined for this purpose as the difference between the fair market value of Omega's assets and the price Acme paid to acquire Omega—would be included on Acme’s balance sheet as “goodwill.” In pooling accounting, there is no goodwill, because both companies' items are simply combined—the control premium is ignored.

Goodwill is amortized over time, which during the amortization period generates an annual expense on the company’s income statement. This reduces the company’s earnings and, as such, earnings per share.

Because the amortization period does not depend on the amount of goodwill in question, the more goodwill created in the acquisition, the greater the amount the company will recognize each year as an expense and, hence, the greater the reduction in the company’s annual earnings. Purchase accounting thus typically resulted in lower reported earnings.

Why would a company care? After all, we’re talking about a technical accounting treatment. The company’s actual cash flows are not affected. Yet, because reported earnings get so much attention from analysts and investors, falling accounting earnings are generally disfavored.

In addition, as we’ll see below, the purchase method makes it easier to assess the total purchase price paid to acquire the target, which in turn allows for more meaningful evaluation of the subsequent performance of that investment than is the case with the pooling method. Managers who would prefer that their shareholders not be able to accurately assess their performance might opt for pooling.

Given the option between purchase and pooling, companies thus would often pick pooling because management believed it made their earnings look better.

The SEC and the FASB thus worried that companies would choose between pooling and purchase based purely on how they wanted their accounting earnings to look rather than their actual financial condition.

Did the choice between purchase and pooling actually affect the stock price of the surviving entity? The answer appears to be no. Empirical studies found no statistically significant abnormal returns from one choice versus the other. Analysts and investors appear to have focused on cash earnings rather than accounting earnings. Perhaps as a result, the corporate preference for pooling was marginal. Most years, the split between purchase and pooling leaned only slightly to the latter. Still, there was a perception that companies wasted a lot of money trying to structure deals so that their preferred accounting treatment could be available and that some deals didn’t happen simply because they couldn’t get the preferred treatment.

Turning to the tax consequences, it is true that purchase accounting generates significant tax benefits. The goodwill accrued generates amortization tax deductions. The stepped-up basis means that if the surviving company sells some of the acquired assets, the company will recognize less gain and, accordingly, pay less tax.

In 2001, the FASB ruled that all acquisitions should be taxed as purchases:

The single-method approach … reflects the conclusion that virtually all business combinations are acquisitions and, thus, all business combinations should be accounted for in the same way that other asset acquisitions are accounted for-based on the values exchanged.

The FASB argued that the change would aid investors by ensuring that financial statements would:

Better reflect the investment made in an acquired entity—the purchase method records a business combination based on the values exchanged, thus users are provided information about the total purchase price paid to acquire another entity, which allows for more meaningful evaluation of the subsequent performance of that investment. Similar information is not provided when the pooling method is used.

Improve the comparability of reported financial information—all business combinations are accounted for using a single method, thus, users are able to compare the financial results of entities that engage in business combinations on an apples-to-apples basis. That is because the assets acquired and liabilities assumed in all business combinations are recognized and measured in the same way regardless of the nature of the consideration exchanged for them.

Provide more complete financial information—the explicit criteria for recognition of intangible assets apart from goodwill and the expanded disclosure requirements of this Statement provide more information about the assets acquired and liabilities assumed in business combinations. That additional information should, among other things, provide users with a better understanding of the resources acquired and improve their ability to assess future profitability and cash flows.

In addition, the FASB argued it would lower transaction costs:

Requiring one method of accounting reduces the costs of accounting for business combinations. For example, it eliminates the costs incurred by entities in positioning themselves to meet the criteria for using the pooling method, such as the monetary and nonmonetary costs of taking actions they might not otherwise have taken or refraining from actions they might otherwise have taken.

In sum, both forms had perceived advantages—but only if you assumed analysts and investors focused solely on headline earnings rather than digging into the income statement and balance sheet.

JB Heaton and Todd Henderson Respond: They Think Twitter's Lawsuit is a Loser

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.

Zohar Goshen on Twitter versus Elon Musk

Jeff Gordon on Elon Musk and Twitter

My friend Columbia University Law Professor Jeff Gordon sent along some thoughts on the Elon Musk's fight with Twitter and gave me permission to post them as a guest post:

I've been thinking about settlement possibilities.  It's now a kind of baseball arbitration, with choices between $1 BB and $44 BB.  As to settlement: I think the problem is going to be whether the Board can get out of what might be called the Revlon "box."  The $$ payout necessary to make Twitter whole in a financial sense is very large, $20 billion?  I haven't done the math.  It's this odd circumstance where the Board could have refused to sell to Musk on the grounds of some "public" value to Twitter ex Musk (perhaps with some dubious claim about maximizing long term value) but Revlon narrowly applied seems to say they (ie, board in fulfilling its fiduciary duty) can't do a "nevermind" to unwind a friendly sale to restore status quo ante.  

 

[$54/sh - standalone value (less than $37/sh which includes chance that deal goes through at a price higher than $37] x # shares outstanding.]  

 

I see that Ch McCormick is the judge.  Bad news for Musk, I think, since she is unlikely to go off on some doctrinal fancy.  The straight down the middle analysis favors Twitter.

 

A further thought:  I think the key to  specific performance will in the end be the financing conditions.  If I were a merger arb I will be looking very closely at those agreements.  If the banks have a legit basis to walk, then I think we are in the realm of Alliance Data Systems Corp v. Blackstone Capital Partners, in which parties are held to the terms of their deal structure.  

Yours truly quoted by Michael Hiltzik of LA Times re Elon Musk and Twitter

From the LA Times:

"The sensible thing...would be for everybody to sit down and work out...some face-saving solution where Musk doesn’t end up owning Twitter, but Twitter gets to take a pretty good chunk out of Musk’s hide." — UCLA law professor Stephen M. Bainbridge ...

Many legal experts believe that Twitter has a strong case. “If the case goes all the way through trial and appeal, I think Twitter will prevail in the judicial system,” says Stephen M. Bainbridge, corporate law professor at UCLA. ...

“The notion that Musk can somehow lose in Chancery Court and refuse to go forward strikes me as absurd,” Bainbridge says. “The hallmark of Delaware law is that they provide predictability and certainty.... If Delaware says ‘We’re going to make an Elon Musk exception,’ the damage to Delaware’s brand would be enormous.” 

Chancellor McCormick, moreover, is known as a tough judge. “She’s not somebody to be trifled with,” Bainbridge says. “She’s not somebody intimidated by wealth or power.”

Bainbridge agrees. “The sensible thing for everybody to do, if we were dealing with ordinary folks,” he says, “would be for everybody to sit down and work out a deal that either increases the break-up fee or is some face-saving solution where Musk doesn’t end up owning Twitter, but Twitter gets to take a pretty good chunk out of Musk’s hide.”

 

Does Twitter's Lawsuit Against Elon Musk Really Look "Like a Loser"?

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.

Elon Musk is trying to get out of the Twitter deal: My analysis of the legal arguments

Reuters:

Elon Musk, the chief executive officer of Tesla (TSLA.O) and the world's richest person, said on Friday he was terminating his $44 billion deal to buy Twitter (TWTR.N) because the social media company had breached multiple provisions of the merger agreement.

Twitter's chairman, Bret Taylor, said on the micro-blogging platform that the board planned to pursue legal action to enforce the merger agreement. ...

In a filing, Musk's lawyers said Twitter had failed or refused to respond to multiple requests for information on fake or spam accounts on the platform, which is fundamental to the company's business performance. ...

Musk also said he was walking away because Twitter fired high-ranking executives and one-third of the talent acquisition team, breaching Twitter's obligation to "preserve substantially intact the material components of its current business organization."

Regular readers will recall 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.). For your convenience, here are the main arguments:

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).

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).

The Spirit Deal Shows Investors are not Embracing Stakeholder Capitalism

It is a core tenet of my forthcoming book, The Profit Motive: In Defense of Shareholder Value Maximization, that investors are far more skeptical of ESG and stakeholder capitalism than their proponents want us to believe. Sure, you can cite survey data in which a substantial number of investors say they love ESG, but things look differently when you look at concrete examples of what investors do. 

As you may know, Spirit Airlines is currently the target of competing takeover bids from Frontier and JetBlue. The union representing Spirit flight attendants reportedly supports the Spirit-Frontier deal, while the union representing JetBlue flight attendants is opposed to the deal. f shareholders are concerned with ensuring that stakeholders like the flight attendants are protected, presumably shareholders would also favor the Frontier deal. But today's WSJ reports:

On Wednesday, [Spirit Airlines] postponed a shareholder meeting scheduled for Friday that would have included a vote on the acquisition bid made by its competitor Frontier Airlines. Spirit’s board of directors retains a strong preference for this merger, which seems like a perfect cultural fit, over a rival one proposed by JetBlue Airways. But the board’s latest move betrays hesitation that shareholders might not put the same value on non-pecuniary factors.

Investing is allegedly about making money and investors can get more of it from JetBlue.

It is an anecdotal example, of course [insert joke about lawyers, anecdotes, and date here.] But it is consistent with a point I make in The Profit Motive:

Turning to shareholders, despite the acknowledged proliferation of socially responsible and ESG investors, it remains the case that when most shareholders invest “in a corporation, they do not think that they are giving their money away.”  To the contrary, they expect “to receive a healthy return on their capital.”  As a harshly critical statement on corporate purpose signed by over 6,000 stakeholder theorists and other progressive academics concluded, “left to their own devices, most capital investors will not care for the dignity of labor investors; nor will they lead the fight against environmental catastrophe.”

Is Elon Musk trying to get out of the Twitter deal? (Probably.) Will he be able to do so with impunity? (Probably not.)

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).

 

In Defense of SPACs

Rodrigues, Usha and Stegemoller, Michael A., Why SPACs: An Apologia (2022). University of Georgia School of Law Legal Studies Research Paper No. 2022-04, Available at SSRN: https://ssrn.com/abstract=4072834 or http://dx.doi.org/10.2139/ssrn.4072834

Special purpose acquisition companies (SPACs) dominated the initial public offering (IPO) market in recent years, but the Securities and Exchange Commission (SEC) has proposed rules that have chilled the SPAC market and, if made final, will likely strangle it completely. It is time to examine what, if anything, SPACs offer the capital markets.

Most commentators and regulators view SPACs as a mere regulatory sleight of hand. This Article focuses on SPACs’ fundamental—but overlooked—innovation. Traditional securities law views average investors as prone to hysteria, and therefore relegates them to investment in public companies, reserving investment in private firms for the wealthy. The traditional securities law regime thus has the effect of preventing the general public from investing in private companies until after more wealthy investors have had their turn. But SPACs allow the public to trade based on information about a still-private company. Allowing free trading of this information is a radical departure from the basic structure and original purposes of U.S. securities law.

SPACs thus challenge securities law at its core. We use an original empirical dataset to argue that their success—or, to be precise, the success of some of them—is evidence that securities law may be overly paternalistic in its attitude toward the general public. Our data provide evidence that, as long as the SEC implements reforms that realign shareholders’ interests with those of SPAC managers, SPACs can offer a valuable new opportunity in the markets.