Oh Elon
I think that the simplest explanation might be that Elon Musk does not know what a merger agreement is. It is not uncommon, in the world, for two companies to get together and discuss one buying the other. And sometimes these talks will go well and they will get together and sign some sort of document — a “memorandum of understanding,” perhaps — that says, basically, “now we are going to talk really seriously about me buying you.” Sometimes they will have a price lined up when they sign this document, say $54.20, and that price will be written into the document, and the expectation will be that eventually the buyer will pay $54.20 to buy the seller. But things can go wrong. There will be continuing due diligence, where the buyer examines the seller’s business, and the buyer might change its mind. Facts might come to light in due diligence that could make the buyer walk away or want to revise the price downward. The market might crash, making the seller less valuable or making it harder for the buyer to get financing. The MOU is an agreement to talk more seriously; it reflects a general mutual desire to come to a deal at $54.20, but it is not binding. Nobody is committed to a deal at $54.20. Nothing is certain until the final deal is signed.
That, again, is a description of a thing that can happen in the world; some business acquisitions do go through a process like that. But it is not a description of US public-company merger agreements. In normal US public-company mergers, you don’t sign a memorandum saying “we’re going to negotiate seriously about buying you.”[1] You negotiate seriously, and then you sign a merger agreement saying “we agree to buy you for $54.20.” And then if the buyer changes its mind, it still has to pay $54.20. And if the market crashes, the buyer still has to pay $54.20. The deal is the deal; once it is signed, the merger agreement is binding and definitive.[2]
It is confusing, though. When you sign a public-company merger agreement, you do not immediately own the company you are buying. You are still months, perhaps years, away from the “closing” of the deal, when you actually pay the money and take over the company. The delay is necessary to get regulatory approvals (antitrust, etc.), and to write a proxy statement and submit the merger to a vote of the target’s shareholders. (You sign the merger agreement with the target’s board of directors, but they don’t get the final say; the shareholders do.) Also, if you need to borrow money to buy the target, this delay gives you time to market the debt and actually get the money. (When you sign the deal, you probably have commitment letters from your banks promising you the money, but by closing you can actually have the specific loans in place.)
And during this delay, things can go wrong. The regulators might not approve. The shareholders might vote no. The financing might fall apart.[3] When you sign the merger agreement, the buyer and seller agree to work together and use their “reasonable best efforts” to get the regulatory approvals and shareholder vote and financing and everything else needed for the deal to close, but even if they do all of that sometimes it’s not enough, and the deal falls apart. Signing a merger agreement doesn’t mean that the buyer will definitely buy the seller. It is a serious binding commitment, but it is not 100%.
If you are the buyer, you might think about other things that might go wrong. What if the seller’s business all burns to the ground in a fire? Seems unfair for you to have to buy it anyway. What if the fire was the seller’s fault? What if it turns out that the seller was running a massive fraud and the whole business is fake? Seems really unfair for you to have to buy it anyway.
And so, yes, even if you get the regulatory and shareholder approvals and the financing, there are still times when a buyer can get out of a deal between signing and closing. But they are quite limited. The main one is that the seller makes representations in the merger agreement — statements about the company that it promises are true, things like “our financial statements are true” and “we are not breaking any laws” — and if those statements are false, and they are so false that they would have a “material adverse effect” on the business, then the buyer can get out of the deal. (A typo in the financial statements is not enough to get out of the deal, but inflating revenue for years might be.) That is a high bar, and Delaware courts — which hear most big merger cases, since most public companies are incorporated in Delaware — almost never find MAEs. But in theory, yes, if the buyer was misled and the seller’s business is falling apart, the buyer can get out. And there are a very few other possible excuses; for instance, if the seller does not comply with its covenants — the things that it agreed to do between signing and closing — then the buyer might have an out. Or if the buyer was tricked into signing the merger agreement by intentional and material fraud, that would be an out.
But the buyer can’t get out because it changed its mind. Or because the market went down and it is overpaying. Or because the market went down and it doesn’t have as much money as it used to. Or because the seller’s business turns out to be worse than the buyer thought in a general way. Broadly speaking, the merger agreement is meant to be binding. Getting out of it is the exception.
Elon Musk is trying to get out of the merger agreement he signed in April to buy Twitter Inc. for $54.20 per share, or about $44 billion total. He has good professional lawyers, and they are working hard, and certainly they know what a merger agreement is, so all of Musk’s official statements and legal filings and so forth are phrased in terms of covenant violations and material adverse effects and fraud.
But it seems completely obvious to me that Musk doesn’t care about those magic words, and that he wants to get out of the deal for some combination of (1) the market went down and $54.20 per share looks pretty rich for Twitter, (2) the market went down and $44 billion looks like a big hit to Musk’s own wealth, and (3) he wanted to buy Twitter on a whim and he’s gotten bored by now. I have been saying this for months and I am bored of it and I’m sure you are too, so I am not going to rehash the point here.[4]
Instead I will just point out that Musk’s own statements — not the ones from his lawyers in court — suggest that he doesn’t know what a merger agreement is. The first sign that he wanted out of the deal was back in May, barely two weeks after he signed the deal, when he tweeted “Twitter deal temporarily on hold pending details supporting calculation that spam/fake accounts do indeed represent less than 5% of users.” No! No! No! As I said at the time:
“Temporarily on hold” is not a thing. Elon Musk has signed a binding contract requiring him to buy Twitter. Legions of bankers and lawyers and Twitter employees and special-purpose-vehicle promoters are working to fulfill his legal obligation to get the deal closed. “The parties hereto will use their respective reasonable best efforts to consummate and make effective the transactions contemplated by this Agreement,” says the merger agreement. (Section 6.3(a).) He can’t just put that “on hold.”
If you were in the process of negotiating a merger, and then you got nervous that some element of the company’s business might not be what you thought, you might put the negotiations “on hold.” You might demand more information about the company’s bot calculations, and you might stop negotiating other details of the deal until you got it. If the information wasn’t what you wanted, you might walk away, or demand a lower price. All of these things are things that could happen before you sign a merger agreement. Not, generally, after.
Yesterday there was a big hearing in Delaware Chancery Court on the Musk/Twitter lawsuit. Some of it was about discovery issues — Musk and Twitter have been demanding information from each other, and fighting about what they have to provide and when. But the more important part was about whether Musk can amend his claims to add more reasons to get out of the deal. Initially, Musk argued that he could get out of his deal to buy Twitter mostly for reasons relating to his apparent belief that Twitter has too many bots. But then last month Twitter’s former head of security, Peiter “Mudge” Zatko, publicized a whistle-blower complaint arguing that Twitter does a bunch of other bad things, and Musk wants to add those claims to his arguments. If Twitter has bad information security practices, then maybe that’s fraud, or maybe its representations are false and there’s a material adverse effect, and Musk might as well argue that too.
At the hearing, Musk’s lawyers argued that Zatko’s claims might be true, and if they are then they might give Musk a way out of the deal, and so we might as well find out. And Twitter’s lawyers argued that Musk is just fishing for excuses to get out of the deal. (Disclosure, Twitter’s lawyers are at Wachtell, Lipton, Rosen & Katz, where I used to work.) As Bloomberg’s Kurt Wagner and Jef Feeley report:
Bill Savitt, an attorney for Twitter, brought up a text message between Musk and one of his bankers as evidence during a Chancery Court hearing Tuesday. In the message from May 8, Musk asked the banker to slow down the deal process until after Russian President Vladimir Putin gave a speech the following day, during which Putin defended his decision to invade Ukraine.
“It won’t make sense to buy Twitter if we’re heading into World War III,” Musk wrote. He had already agreed to buy Twitter for $44 billion two weeks earlier.
Yes, right, see, if the global environment has gotten worse for business, it is perfectly reasonable for a rich businessman to text the bankers who are negotiating a merger to tell them “Let’s slow down just a few days.” You don’t want to sign a merger agreement if things are getting worse! At least you’ll want to rethink the price.
The problem is that Musk had already signed the merger agreement. There is no “on hold,” no “let’s slow down,” once you sign. You have committed to use your reasonable best efforts to get the deal done, and when you text your bankers to tell them to maybe use their third-best efforts to get it done, you are breaching the agreement.
Or:
A lawyer for Twitter also disclosed during the hearing about a discussion between/with Musk and third party banker Perella Weinberg in mid June about using a contingent value right, or CVR, as a way to renegotiate the Twitter (TWTR) deal.
A CVR is a way to bridge a valuation gap in a merger negotiation. If a potential buyer thinks that a company is worth $45, and a seller won’t take less than $54.20, perhaps you can use a CVR to get a deal done. “I will pay you $45,” the buyer says, “but I will pay you another $9.20 if the business hits certain revenue milestones in the year after I buy it.” And then if the business is as good as the sellers think it is they get their $54.20, but if it isn’t then the buyer only pays $45.
But the Twitter situation is the opposite of that. Twitter’s shareholders thought it was worth about $45, tops, and then Musk came along out of nowhere and bid $54.20 for it, and Twitter’s board was like “sure if you want to pay us $54.20 we’ll take it.” And then they signed a deal at a fixed price. And then Musk decided a few weeks later that that price was a bit rich, so he considered proposing a CVR. To bridge the gap between the price he agreed to pay and the price he’d rather pay. Again, it doesn’t work that way.
Or Savitt at one point in the hearing said: “You don't do due diligence to get out of a merger agreement, you do it to get into one.” Musk signed a merger agreement, and then started to do due diligence, at which point he got nervous about the bots. Savitt is right: You do the diligence before you sign the merger agreement. But if you don’t know how merger agreements work, you might get this reversed.
I think this stuff is just obviously true. I think it is clear that Elon Musk doesn’t believe in binding merger agreements, and he changed his mind about buying Twitter and now wants his merger agreement to go away. And everything else — the stuff about bots, the stuff about the whistle-blower, allegations of covenant breaches and material adverse effects and fraud — is just lawyers trying to justify that.
But that doesn’t mean he loses. If he changed his mind about Twitter because the market crashed, and also it turns out that Twitter breached its covenants or suffered a material adverse effect or was doing a massive fraud, then he (probably) gets to get out of the deal. That would be kind of a weird coincidence, but honestly not that weird. Most of the time when a merger is terminated or renegotiated, it is for some combination of (1) the buyer got market-driven cold feet and (2) it found something bad about the target that gave it an excuse. And Twitter is an odd and broken company, which is explicitly why Musk wanted to buy it, so it wouldn’t be hugely surprising if it was broken in particular ways that breached a standard merger agreement. Even if Musk is just looking for excuses to get out of the deal, that doesn’t mean he can’t find one.
Musk’s main requests at yesterday’s hearing were:
To amend his counterclaims to put in all of Zatko’s claims about fraud.
To get to do more discovery, demanding more documents from Twitter about Zatko’s claims.
To delay the trial, currently scheduled for October, so he could have more time to do all of this.
This morning the judge, Chancellor Kathaleen McCormick, ruled on his requests, and I think her opinion is a fairly clear win for Twitter. She will let Musk amend his claims, which is technically a win for him, but which to some extent limits his freedom of action. If she had said no, he could have appealed. (He would have had a good argument; the standard for amending claims is low.) He could have found another court to sue in, some other audience to listen to him. But now he has to argue about Zatko’s complaint in Chancellor McCormick’s court, alongside all of his other excuses for getting out of the deal. She has the relevant context.
She will also let Musk do a little bit of discovery on those claims, but not too much. (“Defendants are permitted only incremental discovery relevant to the new allegations. That discovery can be made through targeted document discovery and minimal additional experts and fact witnesses.”)
And, crucially, she won’t push back the trial, which is still scheduled to start on Oct. 17. If you looked at this case and thought “uh oh, Twitter has been running a massive fraud and Elon Musk just learned about it,” you would want to push back the trial to let him find out more about the fraud. If you looked at it and thought “wow, Elon Musk keeps coming up with new excuses to get out of the merger agreement he signed, and here’s another one,” you would let him argue about that excuse, but you wouldn’t give him any more time. You would want to make sure that you’ve heard all of his arguments before rejecting them, but you wouldn’t let him drag the case out forever.
It is relevant here, I think, that Chancellor McCormick definitely knows how merger agreements work. She is a Delaware chancellor. They do all the public-company M&A litigation. She has seen buyers who want to get out of mergers before, and she has seen Musk’s claims so far. “I am reticent to say more concerning the merits of the counterclaims at this posture before they have been fully litigated,” she wrote in today’s opinion. “The world will have to wait for the post-trial decision.”
