Since the financial crisis, corporate lawyers have aspired to build the ultimate iron-clad merger contract that keeps buyers with cold feet from backing out.
The "bullet-proof" modern deal agreement now faces one of its biggest tests, as Elon Musk, the Tesla boss and richest person in the world, openly entertains the possibility of ditching his $44 billion (€41.8 billion) deal for Twitter.
Musk tweeted earlier this week that the “deal cannot move forward” until the social media platform provides detailed data about fake accounts, a request that Twitter seems unlikely to meet. Twitter’s board, meanwhile, has stated its commitment “to completing the transaction on the agreed price and terms as promptly as practicable”.
Simply abandoning the deal is not an option. Musk and Twitter have both signed the merger agreement, which states “the parties . . . will use their respective reasonable best efforts to consummate and make effective the transactions contemplated by this agreement”.
With tech stocks falling – dragging down the price of the Tesla shares that form the basis of Musk’s fortune and collateral for a margin loan to buy Twitter – all eyes are on the mercurial billionaire’s next move.
Can Musk walk away for $1bn?
The agreement includes a $1 billion “reverse termination fee” that Musk would owe if he withdraws from the merger agreement. However, if all other closing conditions are met, and the only thing left is for Musk to show up at the closing with his $27.25 billion in equity, Twitter can seek to make Musk close the deal. This legal concept, known as “specific performance”, has become a common feature in leveraged buyouts since the financial crisis.
In 2007 and 2008, leveraged buyouts typically included a reverse termination fee that often allowed a firm backing the acquisition to pay a modest 2 to 3 per cent of a deal's value to get out. Sellers believed at the time that private equity groups would follow through and close their transactions in order to maintain their reputations. But some did pull the plug on those agreements, leading to several court fights involving prominent firms such as Cerberus, Blackstone and Apollo.
Since that era, sellers have implemented much higher termination fees as well as specific performance clauses that effectively require buyers to close. Most recently, a Delaware court in 2021 ordered private equity firm Kohlberg & Co to close the buyout of a cake decorations business called DecoPac.
Kohlberg had argued that it was allowed out of the deal because the DecoPac business had suffered a “material adverse effect” when the pandemic struck between signing and closing. The court rejected that argument and ruled DecoPac could force Kohlberg to close – which it did.
Can Musk sue his way out of the deal?
Should Musk choose to go to court, he might claim that Twitter misrepresented the state of its business by estimating in regulatory filings that bots comprise 5 per cent or less of its users’ base.
Filing such a lawsuit would be easy enough, but proving that the bot issue justifies ending the deal would be much harder. Under the merger agreement, Musk would have to show that any misrepresentation had a “material adverse effect”, an onerous standard that courts have rarely found to be met. He also explicitly waived doing due diligence on Twitter in his offer to the board.
"It is tough to argue in court that a material adverse event has occurred if you cannot show how it has impacted earnings – and the impact has to be large," said Gustavo Schwed, a New York University professor and former executive at Providence Equity.
Could Twitter make Musk take the deal if he tries to end it?
Twitter could sue Musk to enforce the agreement, and a person close to the company described the contract as “bulletproof”. Alternatively, it could choose to sue him for damages related to the failed deal. However, under the merger agreement, the amount of damages Musk could pay would be capped at $1 billion.
Another option, experts say, is for Twitter to first threaten to force Musk to close and then settle for damages greater than $1 billion in order to avoid a messy litigation.
"Twitter could say, 'Well, we want to get the deal done, and we're suing to enforce the contract. And you know, in your heart of hearts, Mr Musk, that the court is leaning in our direction, so let's forget the billion-dollar cap and settle for $2 billion,' " explained Charles Whitehead, a Cornell law professor and former corporate lawyer.
Can the two sides reach a compromise?
Twitter’s board could decide to accept a lower price from Musk to avoid the risk of trying to enforce the existing agreement – and the risk of remaining a standalone public company at a challenging time for tech companies.
In 2021, Tiffany & Co sued LVMH seeking to force the French luxury conglomerate to close a deal that had been struck just before the pandemic. The sides ultimately reached a deal to cut the price slightly, which Tiffany shareholders later approved.
The worry is that Musk’s public sniping on Twitter damages both the company, as well his professional reputation, which he needs to operate Tesla and the rest of his empire.
“Mr Musk might be a little more concerned about the people with whom he might do deals in the future,” added Whitehead, the Cornell Law professor. “If he walks from this deal, it may be harder for him in the future to strike deals for Tesla or on his own behalf. There’s a lot on the line here too.” – Copyright The Financial Times Limited 2022
