By Janelle M. Lewis, Attorney, Business & Legal Strategic Consultant
On April 25th, Musk agreed to buy Twitter for $52.20 per share in an unsolicited public offer, which represented a 38% premium over Twitter’s unaffected share price. On July 8th, 2022, Musk sent a letter to Twitter to terminate the agreement, citing that, “Mr. Musk is terminating the Merger Agreement because Twitter is in material breach of multiple provisions of that Agreement, appears to have made false and misleading representations upon which Mr. Musk relied when entering into the Merger Agreement, and is likely to suffer a Company Material Adverse Effect (as that term is defined in the Merger Agreement).”
While there are many lessons businesses can and will learn from the ongoing lawsuits between Twitter and Elon Musk, the purpose of this blog is to: 1) explain the argument of each side under the context of legal due diligence, representations, and Material Adverse Effect; and 2) the two lessons businesses can learn from the lawsuits (so far) is that ignoring the gap between law & business strategy can lead to an M&A transaction becoming a cautionary tale.
Twitter Suits Against Musk: Twitters Arguments
According to Twitter’s Complaint filed with the Delaware Chancery Court, Twitter accuses Elon Musk (“Musk”) of wanting to terminate the April 25th, 2022 merger agreement (“the Agreement”) he signed with Twitter because he does not want to bear the cost of the market downturn, but instead shift the cost to the stockholders. Even though Musk “…promised to use his best efforts to get the deal down….less then three months later, Musk refuses to honor his obligations to Twitter and its stockholders because the deal no longer serves his personal interest.”
Musk Made His Offer and Signed the Agreement with Twitter Without Representation Regarding the Amount of “False of Spam Accounts”
The Agreement, which Musk signed, did not have a due diligence condition. Musk expressly withdrew his prior diligence condition in his offer to to buy Twitter. In its response to Musk’s counterclaim, Twitter stated that, “Musk forwent all due diligence—giving Twitter twenty-four hours to accept his take-it-or- leave-it offer before he would present it directly to Twitter’s stockholders.” Additionally, Twitter argues that “…Musk made his offer without seeking any representation from Twitter (and with Twitter not providing any representations) regarding its estimates of spam or false accounts.” Additionally, Twitter stated that Musk never asked Twitter to verify the number of false or spam accounts before he signed the Agreement, nor does the Agreement contain any reference to “false or spam accounts.
Musk Stated at a Public Event He Would Make Eliminating Spam Bots His Top Priority, Then Changed His Mind Demanding Verification of Spam Bots
Twitter further reports that, “at a public event on April 14, Musk said eliminating spam bots would be a “top priority” for him in running Twitter.” After entering the deal, Musk said, among other things that he wanted to “…[defeat] the spam bots, and [authenticate] all humans. Twitter argues that after the market decline, Musk changed his narrative from “…defeating the spam bots, and authenticating all human…” to “…suddenly demanding “verification” that spam was not a serious problem on Twitter’s platform, and claiming a burning need to conduct “diligence” even though he had agreed to do without a due diligence conduct when he signed the Agreement.
Twitter Made Customary Representations to Musk
In its response to Musk’s counterclaim, Twitter reported that it gave Musk what he wanted – “a customary representation that Twitter’s SEC filings since January 1, 2022 did not contain any false or misleading statement of material fact, with no right to terminate the deal based on any inaccuracies in those filings unless they have a “material adverse effect” on Twitter…” Additionally, Musk never sought any “information rights” that would allow Musk to access the accuracy of Twitter’s SEC filings after the Agreement was signed, nor did Twitter provide such information. What Twitter provided to Musk was “a limited right to receive information only for “a reasonable business purpose related to the consummation” of the merger—that is, for the purpose of closing the deal, not abandoning it.” Regarding SEC disclosures provided prior to the signing of the Agreement, Twitter noted that its estimates did not include all accounts and cautioned that the number of false or spam accounts could be higher than they estimated in their filings. Further, in response to Musk’s counterclaim that “…Twitter’s disclosures misleadingly suggest that accounts counted in mDAU necessarily generate ad revenue” Twitter stated that “mDAU is a measure of monetizable daily active users, not monetized daily active users—by its nature, mDAU represents an opportunity to monetize those users, rather than a confirmation that each user has generated ad revenue on any given day.”
There is No Company Material Adverse Effect
Further, in its July 11, 2022 filing with SEC, Twitter asserted that it did not violate any of its obligations under the Agreement, and that Twitter did not or was likely to suffer a Company Material Adverse Effect (MAE).
Musk’s Arguments and Countersuit Against Twitter
Musk’s argues in its June 6th, 2022 SEC filing that after multiple request, Twitter refused to provide repeated information to facilitate Musk’s evaluation of spam and fake accounts on its platform. Musk stated he needed the data to conduct his own analysis because he did not believe in the Twitters “lax testing methodologies” were adequate. In its July 8th, 2022 SEC filing, Musk terminated the Agreement with Twitter, citing, among other things, that Twitter “…made false and misleading representations upon which Mr. Musk relied when entering into the Merger Agreement, and is likely to suffer a Company Material Adverse Effect (as that term is defined in the Merger Agreement).”
Musk Argues Twitter’s SEC Disclosures “Were Far From True”
In his counterclaim, Musk argues that Twitter’s SEC disclosures “were far from true” and that he relied on their accuracy. Musk argued that he “negotiated not only for representations and warranties about the truthfulness of Twitter’s SEC filings, but also for significant information rights entitling them to access to the company’s books and records.” This was under the expectation, Musk asserted, that Twitter would not hide anything from Musk, including, the issue of false or spam accounts. Musk believed that when he signed the Agreement, he could implement certain changes, such as the verification of all Twitter’s users; and he could eliminate false or spam accounts, based on Twitter’s representation that false and spam accounts accounted for less than 5% of Twitter’s total accounts. However, Musk claimed that he learned that “Twitter restated three years of its mDAU figures because it had been double-counting certain users,” and that Twitter failed to inform Musk that the restatement was coming before the Agreement was signed. Musk also expected “to be reassured that Twitter’s SEC filings were the product of a thoughtful, robust process.” It was at the May 6th, 2022 introductory meeting that Musk claimed that he “was astonished to learn just how meager Twitter’s processes were.”
Musk Admits He Had Better Plans to Eliminate False and Spam Accounts, So He Submitted an Acquisition Offer to Twitter
Musk admits in his counterclaim that one of his visions for Twitter was to have a more robust user verification process. Although he was asked to join the Board late March 2022, he did not believe that Twitter’s management was up to the task of fixing Twitter the way he saw fit. Musk stated that Twitter’s approach to combatting false and spam accounts was flawed and believed his approach using a verification method through authentication would be more successful in solving Twitter’s false and spam accounts. He further stated that his approach would make the the platform “…more attractive to use, driving further engagement by existing users and attracting new active users.” Resultantly, he submitted an acquisition offer on April 13th, 2022. When he signed the Agreement to purchase Twitter on April 25th, 2022, “Musk announced his intent to “defeat” the “bots” that plague the platform and degrade the user experience.”
Musk Admits to Not Executing a Due Diligence Process, But Instead Bargained For Contractual Representations
Musk also admits in his counterclaim that with respect to carrying out due diligence, he believed that “due diligence processes can be costly and inefficient…” and the focus should instead be on “…bargaining for contractual representations…” the information from which he relied upon when he decided to acquire Twitter. Musk’s asserted in his counterclaim that his reasons for investing in Twitter was based upon Twitter’s SEC disclosures. Musk other arguments that pertained to Twitter’s disclosures and representations were:
- Twitter failed to disclose that false or spam accounts comprised a disproportionate portion of the mDAU that generate material ad revenue;
- Twitter misrepresented key steps in its process for counting fraud and spam accounts;
- Twitter failed to disclose that nearly a third of its mDAU sees no ads;
- Twitter failed to disclose that a minimal portion of users drive a majority of revenue; and
- Twitter Knowingly, Or At Least Recklessly, Made False Representations;
Musk Argues Twitter Suffered Company MAE That Justifies Terminating the Deal Before Closing
In his counterclaim, Musk assertions regarding there was Company Material Adverse Effects (“Company MAE) that resulted from Twitter’s lack of disclosures and false misrepresentations when he signed the Agreement included:
- Twitter’s representations were material;
- Outside of Twitter’s fraudulent activity, since January, Twitter has suffered a Company Material Adverse Effect, as defined by the Agreement;
- The fact that Twitter’s main performance metric does not drive the performance of the business could result in a “dramatic decrease in Twitter’s valuation sufficient to constitute a MAE;” and
- A Company MAE has occurred from the impact of the market’s discovery that Twitter mDAU calculations were materially misleading.
As a result, Musk asserted, since Twitter had suffered a Company MAE, it could not satisfy its representations, specifically, that between January 2022 and April 2022, Twitter did not suffer a Company MAE. For this reason, Musk is seeking a declaration that Twitter suffered a Company MAE, thus, allowing Musk to terminate the deal before closing.
Lessons Learned from Twitter Musk Lawsuits (So Far) and How These Lawsuits Show That Ignoring the Gap Between Law & Business Strategy Can Lead to An M&A Transaction Becoming A Cautionary Tale
Lesson 1: Legal Due Diligence is an Important Component of the Business Decisions Process Underlying M&A Transactions
On the buyer’s side, legal due diligence (and due diligence in general) is important because it is the duty of the buyer to have a thorough understanding of the company they are buying. This is done by obtaining all the information about the company they are buying so that they may have a full understanding of the Target Company. When it comes to buying a publicly listed company, a significant amount of information is publicly available on SEC’s website. Pertinent documents, such as, Form 10-Ks, Form 10-Qs, Form 8-Ks, proxy statements and exhibits are made publicly available. Other sources of public information can come from rating agencies reports. Additionally, the Buyer has the right to request a list of requests for information from the Seller.
On the seller’s side, legal due diligence is the process of reviewing various aspects of the company prior to the transaction so that issues can be identified and addressed while the buyer is doing their legal due diligence. Additionally, sellers make representations or “reps” which are statement of facts about their company that are contractually binding. While private companies have to make extensive reps, for publicly listed companies, reps do not have to be as extensive. This is as a result of the public filings that publicly listed companies have to make, which are subject to anti-fraud and securities laws.
Analysis of How Musk and Twitter’s Disregard for Legal Due Diligence Ignored the Gap Between Law & Business Strategy and Negatively Impacted the Strategic Business Objectives Each Party Had or Could Have Had In Lieu of Litigation
Neither Musk nor Twitter engaged in legal due diligence. The sole objective of the merger transaction was to the deal done, without regard to the legal ramifications of their actions (or lack of actions) during the merger process. By Musk not engaging in the legal due diligence process (or any form of due diligence), he based his decision to buy Twitter on his experience as a Twitter user and not as a businessman entering into a merger transaction to buy a business for strategic purposes. This may come to negatively impact Musk, who may well have to close the deal and buy Twitter. These lawsuits also impact Twitter, who have to put a hold on their business activities, including the ability to continue to build their business strategy. Twitter’s coyness in not engaging in robust legal due diligence from the seller side by ensuring their representations to Musk were not the legal bare minimum has resulted in Twitter spending time in litigation with an uncertain future. Considering their bare minimum representations as a simple legal exercise instead of as an important component of their business strategy has negative impacts for Twitter as well.
Lesson 2: The Burden of Proof that there was a Material Adverse Effect that Justifies Terminating a Merger Agreement Prior to Closing is on the Buyer and has only been granted once by the Delaware Court of Chancery
Material Adverse Effect or “MAE” are provisions that allow a parties (usually the buyer) to the transactions to walk away or refuse to close between signing and closing. This mechanism allows parties to the transaction to allocate the risk of adverse events occurring between signing and closing. In the 2018 landmark case of Akorn, Ins., v. Fresenius Kabi AG et al, the Delaware Chancery Judge adjudicated that “A buyer faces a heavy burden when it attempts to invoke a material adverse effect clause in order to avoid its obligation to close. A short-term hiccup in earnings should not suffice; rather the Material Adverse Effect should be material when viewed from the longer-term perspective of a reasonable acquiror. In the absence of evidence to the contrary, a corporate acquirer may be assumed to be purchasing the target as part of a long-term strategy. The important consideration therefore is whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.”
Analysis of How Musk’s Disregard of Legal Aspects of the April 25th Agreement He Signed Will Impact His Ability to Prove to the Delaware Chancery Court that Twitter’s spam and false accounts resulted in a Company MAE That Justifies Terminating the Deal
As previously stated, Musk’s only real option to terminate the deal is to successfully prove that Twitter’s actions resulted in a Company MAE before the Delaware Chancery Court, where these lawsuits are filed. This means that Musk will have to prove and have the Chancery find that the allegedly undisclosed facts about spam and false accounts represent a Company MAE that justifies terminating the deal after the agreement has been signed. While in the case of Akorn, Ins., v. Fresenius Kabi AG et al., the Chancery found for the first and only time that there was a MAE where the buyer (Fresenius Kabi AG et al.) was justified in terminating its $4.8 billion agreement to acquire Akorn, a pharmaceutical company, before closing. Experts view Musk receiving the same judgement as a long shot at best.
What Can Be Concluded As the Twitter Musk Lawsuits Remain ongoing
What can be concluded is that it does not serve any party to a M&A transaction to consider the law as an obstacle to be dealt with – or worse – a factor to disregard. The law is an integral component of any business strategic decision, including corporate strategy and to consider it any less important than other aspects of getting the deal done is to risk becoming another cautionary tale. One that is wrapped in a myriad of lawsuits, instead of strategizing about both its short and long-term growth objectives.