ProfessorBainbridge.com: Mergers and Takeovers

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

"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.”

Posted at 01:33 PM in Mergers and Takeovers | Permalink | Comments (0)

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.¹⁷We 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.

Posted at 05:18 PM in Mergers and Takeovers | Permalink | Comments (2)

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).

Posted at 05:44 PM in Mergers and Takeovers, Web/Tech | Permalink | Comments (2)

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?