Elon Musk made headlines when he offered to buy Twitter in April 2022. Not long after, he implied publicly that he wanted out of the deal. Then, his lawyers claimed Musk could opt out of the Agreement and Plan of Merger because Twitter wouldn’t disclose its true number of active users. According to their interpretation, this constituted a breach of contract.
But questions remain: Was there really a breach? What is Elon Musk doing by getting his lawyers to make these claims? Ultimately, what is the endgame for the world’s richest man?
Clients want rock-solid sale and purchase agreements, and an analysis of Musk’s contract with Twitter reveals best practices for drafting a deal that closes smoothly for all involved.
Questions in this Episode
- Is Musk entitled to receive the information regarding Twitter spam accounts that his lawyers are demanding?
- Can the court hold if an MAE has occurred in the Elon Musk case?
- Does Elon Musk have a chance to terminate this contract?
- Did Musk waive due diligence?
- How do you draft a contract in a way that doesn’t undermine the purpose of the deal and the future state of both parties so that their mutual intentions stick?
The Background
Elon Musk invested in Twitter in early April, becoming the company’s largest shareholder. Stock prices increased significantly. Soon after, he began bidding to purchase all of Twitter, and after some back and forth, he agreed to pay $44 billion for Twitter. Things start to unravel shortly after that.
Now, the deal is subject to many closing conditions, one of which is antitrust approval, which appears to be imminent, and ultimately stockholder approval. Once those issues are resolved, there should be no reason for this transaction to be delayed. There has been some heated back and forth in recent weeks, and it appears like one of the parties is attempting to renegotiate or perhaps exit this deal.
Twitter Spam Accounts: the back and forth
This is significant because, in the conversation between Musk and Twitter, he requests information on the Twitter spam accounts, including how they arrived at that figure and how it was calculated. As you may have noticed in the media, Musk has been mentioned or it has been claimed that Musk waived due diligence. That is, he entered into this deal primarily solely on Twitter’s public filings and did not do his own independent due diligence. The information he is requesting at this time is more typical of what you would have requested before signing an agreement or during a due diligence review.
The contractual question is whether he has the right to that information. Section 6.4, specifically states that he must promptly provide to the representatives all information concerning the business, etc., as may reasonably be requested in writing in each case for any reasonable business purpose related to the consummation of the transactions contemplated by this agreement, is where his lawyers are attempting to hang their hat.
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Section 6.4 Access to Information; Confidentiality. Upon reasonable notice, the Company shall (and shall cause each of its Subsidiaries to) afford to the representatives, officers, directors, employees, agents, attorneys, accountants and financial advisors (“Representatives”) of Parent reasonable access (at Parent’s sole cost and expense), in a manner not disruptive in any material respect to the operations of the business of the Company and its Subsidiaries, during normal business hours and upon reasonable written notice throughout the period commencing on the date of this Agreement until the earlier of the Effective Time and the termination of this Agreement pursuant to Article VIII, to the properties, books and records of the Company and its Subsidiaries and, during such period, shall (and shall cause each of its Subsidiaries to) furnish promptly to such Representatives all information concerning the business, properties and personnel of the Company and its Subsidiaries as may reasonably be requested in writing, in each case, for any reasonable business purpose related to the consummation of the transactions contemplated by this Agreement; provided, however, that nothing herein shall require the Company or any of its Subsidiaries to disclose any information to Parent or Acquisition Sub if such disclosure 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. No investigation or access permitted pursuant to this Section 6.4 shall affect or be deemed to modify any representation or warranty made by the Company hereunder. Each of Parent and Acquisition Sub agrees that it will not, and will cause its Representatives not to, use any information obtained pursuant to this Section 6.4 (or otherwise pursuant to this Agreement) for any competitive or other purpose unrelated to the consummation of the transactions contemplated by this Agreement. Parent will use its reasonable best efforts to minimize any disruption to the respective business of the Company and its Subsidiaries that may result from requests for access under this Section 6.4 and, notwithstanding anything to the contrary herein, the Company may satisfy its obligations set forth above by electronic means if physical access is not reasonably feasible or would not be permitted under applicable Law as a result of COVID-19 or any COVID-19 Measures. Prior to any disclosure, the Company and Parent shall enter into a customary confidentiality agreement with respect to any information obtained pursuant to this Section 6.4 (or otherwise pursuant to this Agreement). |
The question is, is the provision of information about these spam accounts reasonably related to consummating the transactions under this agreement?
Twitter’s lawyers may claim that it has nothing to do with them or that it is a phishing exercise, and that if you needed that information, you could have asked for it previously, but it’s difficult to take that stance. Musk’s attorneys would most likely claim that they don’t need this since they need to convince their financiers to put up the money. Everyone must be confident that the spam account count claimed to be the spam account count is accurate or close to it, which is why it is significant. It’s not a no-brainer, but it appears that Twitter has opted to provide this information for the time being, and it’s an interesting piece of gamesmanship.
Twitter has referenced spam accounts in its public filings. They use the number 5% and highlight how difficult it is to compute that figure. They caution everyone reading the document that these are estimations and should not be relied on. The number is significant because if it is much greater than the fundamental metric that drives Twitter, mDAU (monetizable daily users), which is less than what they’ve been showing, Musk will go ahead with this.
From a contractual legal perspective, if the information provided to Musk proves Musk’s theory that the spam accounts count is significantly higher, is it grounds for him to terminate this contract, exit, and prove a material adverse effect?
Does it have a Material Adverse Effect?
If this deal ends up in Delaware Chancery Court, the interpretation of this clause will be crucial. If you wanted to get out of the agreement, you might argue that the spam account count— let’s say it’s 20% or higher—is an effect or circumstance that either constitutes a material adverse effect or is otherwise a breach of a different representation.
It’s crucial because contracts like this, and essentially every purchase agreement, will include conditions to closure, which must be met in order for the parties to be required to close the deal. There must be a material adverse effect in this case for the buyer to be obligated to close the deal.
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“Company Material Adverse Effect” means 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; provided, however, that changes, events, effects or circumstances which, directly or indirectly, to the extent they relate to or result from the following shall be excluded from, and not taken into account in, the determination of Company Material Adverse Effect: (i) any condition, change, effect or circumstance generally affecting any of the industries or markets in which the Company or its Subsidiaries operate; (ii) any change in any Law or GAAP (or changes in interpretations of any Law or GAAP); (iii) general economic, regulatory or political conditions (or changes therein) or conditions (or changes therein) in the financial, credit or securities markets (including changes in interest or currency exchange rates) in the United States or any other country or region in the world; (iv) any acts of God, force majeure events, natural disasters, terrorism, cyberattack, data breach, armed hostilities, sabotage, war or any escalation or worsening of any of the foregoing; (v) any epidemics, pandemics or contagious disease outbreaks (including COVID-19) and any political or social conditions, including civil unrest, protests and public demonstrations or any other COVID-19 Measures that relate to, or arise out of, an epidemic, pandemic or disease outbreak (including COVID-19) or any change in such COVID-19 Measures, directive, pronouncement or guideline or interpretation thereof, or any continuation or of any of the foregoing, in the United States or any other country or region in the world; (vi) the negotiation, execution, announcement, performance, consummation or existence of this Agreement or the transactions contemplated by this Agreement, including (A) by reason of the identity of Xxxx Xxxx, Parent or any of their Affiliates or their respective financing sources, or any communication by Parent or any of its Affiliates or their respective financing sources, including regarding their plans or intentions with respect to the conduct of the business of the Company or any of its Subsidiaries and (B) any litigation, claim or legal proceeding threatened or initiated against Parent, Acquisition Sub, the Company or any of their respective Affiliates, officers or directors, in each case, arising out of or relating to the this Agreement or the transactions contemplated by this Agreement, and including the impact of any of the foregoing on any relationships with customers, suppliers, vendors, collaboration partners, employees, unions or regulators; (vii) any action taken pursuant to the terms of this Agreement or with the consent or at the direction of Parent or Acquisition Sub (or any action not taken as a result of the failure of Parent to consent to any action requiring Parent’s consent pursuant to Section 6.1); (viii) any changes in the market price or trading volume of the Company Common Stock, any failure by the Company or its Subsidiaries to meet internal, analysts’ or other earnings estimates or financial projections or forecasts for any period, any changes in credit ratings and any changes in any analysts’ recommendations or ratings with respect to the Company or any of its Subsidiaries (provided that the facts or occurrences giving rise to or contributing to such changes or failure that are not otherwise excluded from the definition of “Company Material Adverse Effect” may be taken into account in determining whether there has been a Company Material Adverse Effect); and (ix) any matter disclosed in the Company SEC Documents filed by the Company prior to the date of this Agreement (other than any disclosures set forth under the headings “Risk Factors” or “Forward-Looking Statements”). |
A material adverse effect is defined as something that has a material effect on the business’s operations, with a number of exceptions. These exceptions are intended to transfer risk. A material adverse effect clause addresses the commercial risk of anything happening intrinsically to the company, such as losing a customer or having faults in your product. Demand may fall, and supply issues may arise. These are inherent in the industry. There are also occurrences over which you have no control. For example, COVID, changes in law, cyberattacks, and general market developments. These are risks that a seller cannot usually mitigate.
Musk would argue that the increase in spam accounts, or the misleading number of spam accounts, has a material adverse effect on the business as a whole.
The other party may argue that if this was so essential and something that the other party should have known, then they should have made this an exception. Furthermore, this provision refers to affecting the business as a whole, and it is unclear to us that spam accounts make a substantial difference. The recast figures and mDAU difference were 214 million to 216 million. It wasn’t a huge difference, and it’s hard to understand how it translates to the bottom line. It will be fascinating to see how this argument develops around this clause.
A Chance to Terminate
The simple interpretation is that if he breaches this commitment, he must pay a billion dollars. That may seem like a lot of money, but it’s not when you’re on the hook for $44 billion. If he does not have valid grounds for terminating the agreement and does not close or terminate it, or if he terminates it wrongfully, one of two things can happen. Under clause 8.3 (b), Twitter might pursue payment of the billion-dollar termination fee, or, more riskily, they could seek to enforce the agreement and specific performance.
According to Section 9.9 (b), Twitter may have an option between trying to collect the billion dollars or going to court and asking the court to enforce this agreement to be consummated and for the entire amount to be paid over. That would be the main concern if I were on the buyer’s side and wanted to break out of the deal.
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(b) Notwithstanding anything herein to the contrary, including the availability of the Parent Termination Fee or other monetary damages, remedy or award, it is hereby acknowledged and agreed that the Company shall be entitled to specific performance or other equitable remedy to enforce Parent and Acquisition Sub’s obligations to cause the Equity Investor to fund the Equity Financing, or to enforce the Equity Investor’s obligation to fund the Equity Financing directly, and to consummate the Closing if and for so long as, (i) all of the conditions set forth in Section 7.1 and Section 7.2 (other than those conditions that are to be satisfied at the Closing; provided, that such conditions are capable of being satisfied if the Closing were to occur at such time) have been satisfied or waived and Parent has failed to consummate the Closing on the date required pursuant to the terms of Section 2.2, (ii) the Debt Financing (or, as applicable, the Alternative Financing) has been funded or will be funded at the Closing if the Equity Financing is funded at the Closing, and (iii) the Company has confirmed that, if specific performance or other equity remedy is granted and the Equity Financing and Debt Financing are funded, then the Closing will occur. For the avoidance of doubt, (A) while 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), 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; provided, however, that in no event shall the Company be permitted or entitled to receive aggregate monetary damages in excess of the Parent Termination Fee (except in all cases that Parent shall also be obligated with respect to its expense reimbursement and indemnification obligations contained in Section 6.11 and its applicable obligations under Section 8.3(d)(iii) and Section 8.6(b)). |
It was intentional, and both parties were aware of it—very often in contracts like this, there is a provision that states that the termination fee or damages are the only remedies and that particular performance is not, and that excludes specific performance. However, because particular performance is clearly mentioned as a remedy, that appears to be something the parties anticipated, or at least the seller anticipated. That is the major risk that Musk will end up in Delaware Chancery Court with a judge who values freedom of contract and will scrutinize this closely.
Section 7.2, (b)(i), the line right before the word “and” the Roman two— “except for such failures to be true and correct as would not have a Material Adverse Effect” appears to imply that even if there is a breach of a representation, if such breach or lack of truth does not have a Company Material Adverse Effect, then it is not always a breach that would prevent this closing condition from being fulfilled.
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Section 7.2 Conditions to the Obligations of Parent and Acquisition Sub. 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: (a) the Company shall 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; (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); and (c) no Company Material Adverse Effect shall have occurred and be continuing. |
If Elon Musk can demonstrate that the suspected or claimed erroneous statement of accounts is significant enough to warrant disclosure in Twitter’s SEC documents, he may have a chance to allege a breach of this particular provision.
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Section 4.6 Company SEC Documents; Financial Statements. (a) 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. (b) The consolidated financial statements (including all related notes) of the Company included in the Company SEC Documents fairly present in all material respects the consolidated financial position of the Company and its consolidated Subsidiaries as at the respective dates thereof and its consolidated statements of operations and consolidated statements of cash flows for the respective periods then ended (subject, in the case of unaudited interim statements, to normal year-end audit adjustments, none of which would have a Company Material Adverse Effect, to the absence of notes and to any other adjustments described therein, including in any notes thereto) in conformity with GAAP (except, in the case of unaudited statements, as permitted by Form 10-Q, Form 8-K or any successor form or other rules under the Exchange Act). |
The person drafting the contract was not thinking about how the SEC Documents section would play out. If Musk is able to prove materiality, Twitter may have a problem. - James Rannan #ContractTeardown Click To Tweet
Due Diligence Waiver
We can’t find anything stated in capital letters, but people are assuming it because of the back and forth between them, as well as the rapidity with which he moved from the position he was into closing—to signing this deal. It’s such a big deal with so many moving parts, but they finished it at lightning speed.
Many representations on the buyer’s side are made to ensure that the buyer satisfies the requirements of being an accredited investor. Section 5.1 states that the purchaser is not relying on anything not specifically stated here. In one view, this is a fairly standard clause, but when combined with the context and the fact that there is no closing requirement for having the right to do due diligence, this is how they arrive at the waiver.
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Section 5.1 Organization and Qualification. (a) Each of Parent and Acquisition Sub is a corporation duly organized, validly existing and (to the extent applicable) in good standing under the laws of the jurisdiction of its incorporation and has the requisite corporate entity power and authority to conduct its business as it is now being conducted, except where the failure to be duly organized, validly existing or in good standing or to have such power and authority would not have a Parent Material Adverse Effect. Each of Parent and Acquisition Sub is duly qualified or licensed to do business and is in good standing in each jurisdiction in which the nature of the business conducted by it makes such qualification or licensing necessary, except where the failure to be so duly qualified or licensed and in good standing would not have a Parent Material Adverse Effect. (b) As of the date of this Agreement, the authorized share capital of Acquisition Sub consists of 1,000 shares, $0.01 par value per share, all of which are validly issued and outstanding. All of the issued and outstanding share capital of Acquisition Sub is, and at the Effective Time will be, owned by Parent. Acquisition Sub was formed solely for the purpose of acquiring the Company, and it has not conducted any business prior to the date of this Agreement and has no, and prior to the Effective Time will have no, assets, liabilities or obligations of any nature other than those incident to its formation and pursuant to this Agreement and the Merger and other transactions contemplated by this Agreement. (c) As of the date of this Agreement, all of the issued and outstanding share capital of Parent is owned by the Equity Investor. |
If Elon Musk would have wanted due diligence to be a condition to closing, then it would have been a condition to closing. - James Rannan #ContractTeardown Click To Tweet
The Drafting Approach you can Incorporate
From the perspective of Twitter’s board and attorneys, there needed to be a lot of certainties that this purchase would go through. There are times when you need to be pretty inflexible. If someone is going to come in and throw a significant chip down on the table in a very public way, with all of the ramifications of being a public company, there is no room for error.
The role of Twitter’s lawyers was to give as much certainty as possible. It’s the hubris sometimes of not doing due diligence. If that is important to you or your client, you may need to be unpopular and include an extra caveat in that Material Adverse Effect clause, or even identify it as something that is specifically important, that if there is a material change in that metric, that would constitute a material adverse effect in its own right.
It’s a matter of discussing with your client what the most essential value drivers are in a specific transaction. Then determining if any change in those drivers before the transaction is closed will lead you to reject the transaction, as well as how much they would be, and evaluate whether or not it is covered.
Show Notes
Elon Musk made headlines when he offered to buy Twitter. Then he caused a stir when his lawyers tried to absolve him from the deal by claiming breach of contract. There are still lots of questions about what is actually in the contract and if Musk’s claims are enforceable, so we enlisted the expertise of Contract Teardown veteran James Raanan. Watch as he tears down the Musk/Twitter Sale Agreement and Plan of Merger and examines where Musk’s lawyers found reason to end the deal.
THE CONTRACT: AGREEMENT AND PLAN OF MERGER by and among X HOLDINGS I, INC., X HOLDINGS II, INC. and TWITTER, INC.
THE GUEST: James Raanan is an international corporate and commercial lawyer, with both substantial in-house and private practice experience. He is especially active in the telecom and fintech spaces. He lives in Israel, practiced in the US and was raised in England. He has recently joined the Israeli firm of Amit Polak Matalon – as a partner in their technology and VC practice, as well as head of telecom.
THE HOST: Mike Whelan is the author of Lawyer Forward: Finding Your Place in the Future of Law and host of the Lawyer Forward community. Learn more about his work for attorneys at www.lawyerforward.com.
If you are interested in being a guest on Contract Teardown, please email us at community@lawinsider.com.
Interview Transcript
Mike Whelan James Raanan, welcome back to The Contract Teardown Show. How are you today?
James Raanan I’m good. Thank you for having me.
Mike Whelan I am excited because we’re getting into the dra-ma. These contracts where there’s like nerd-ness and drama at the same time is my favorite kind of venn diagram. We are talking about this document, the Agreement and Plan of Merger between Twitter and Elon Musk. What is this document? James, when are we going to see this kind of thing?
James Raanan Well, so you’re absolutely right. This is contract theater in motion. This contract is a pretty much typical agreement for a public company acquisition, a merger. And obviously, this is the agreement that’s been used between Elon Musk and Twitter.
Mike Whelan And for you coming to this kind of document, I’m assuming you’re dealing with these kinds of things a lot. We’ve talked in the past about similar agreements, but what’s your background, James? What brings you to a document like this?
James Raanan So my background is being both in-house and in private practice over the last 20 years, both in Europe and the U.S. and Israel, mainly in mergers and acquisitions and commercial work. So it’s rare that you come across, obviously, [an] agreement of such value, but they are pretty common. And in many ways this agreement has many standard clauses which you see in other merger agreements. But it’s interesting to see how they’re playing out in real life, in such a short space of time after the contract was entered into.
Mike Whelan So before we dig into it, James, just to give a little bit of background, just the facts as they are right now today that we are talking is June 13th, 2022. I think we’re about a month or so into the back and forth about this contract. Give us sort of a brief state of affairs. Where are we in terms of wrangling with this contract?
James Raanan So we kind of look at the chronology of things. So you had in early April, Elon Musk taking a position in Twitter, becoming their largest shareholder. Stock price goes up significantly. Very quickly after that, he begins bidding to buy all of Twitter and then after some back and forth, enters into this agreement to pay $44 billion for Twitter. And fairly soon after that, things start to, you could say, unravel a little bit. And it’s really speculation outside of my scope. It could be because of the reduction in stock price of Tesla or whatever it is. But very quickly, you get into a situation where the contract is subject to different conditions to closing, one of which is antitrust approval, which there seems no reason why that shouldn’t be forthcoming, and ultimately a stockholder approval. So once those items have been squared away, then there shouldn’t be any reason to hold up this deal from going through. And so, you know, as you alluded to, there’s been some heated back and forth over the last couple of weeks, several weeks, where it looks as though one of the parties is looking to try and either renegotiate or maybe even exit this agreement.
Mike Whelan Yeah, there was a moment in time, whatever their particular motivations, I mean, not just Musk’s, but also Twitter’s motivation to sell is an interesting thing and trying to figure out, Why are they doing this? But the point is, in a contract like this, you’re picking a moment in time. You’re saying these are you guys are coming in with whatever assumptions you have about what’s true so that we can wrap this deal, but we have to pick a moment in time. So this is the moment in time. Whatever your assumptions are, let’s nail those down and put them into this agreement so that we can do the very heavy lifting of moving this boat, turning this boat and making this transaction happen. So there was a moment in time that they said, this is the day, these are the assumptions, let’s go make this happen. And now we’re at this point where, Did things change in a way that matters to the contract? And so we’re going to dig into that by starting with Section 6.4. 6.4 talks about access to information that the company here, Twitter, will reveal to Elon Musk and his people, information that they’ll afford to the representatives, officers, directors, employees, agents, etc., apparent reasonable access in a manner not disruptive in any material respect, some of the details of the business. So there’s got to be an exchange of information for this deal to happen. What do you think about Section 6.4 and what it’s trying to do?
James Raanan So as I go down to Section 6.4, I think part of the backdrop to this, why this is a relevant question, is because in the back and forth between Musk and Twitter, he’s asking for this information on the Twitter spam accounts and how they came to that number and and how that’s calculated. And you may have seen in the media, that Musk is quoted or they say that Musk waived due diligence. So what that really means is that he entered into this agreement pretty much based on the public filings of Twitter and didn’t do his own independent due diligence. And so the type of information that he is asking for at this point is more typical of the type of information that you would have asked for before you signed an agreement, typical information that you would ask for in a due diligence review. And so the contractual question is, Does he have the right to receive that information? And there’s—yeah, and there’s an interesting back and forth. So what I think his lawyers are trying to hang their hat on is this provision, Section 6.4, where it specifically says that he has to furnish promptly to the representatives all information concerning the business, etc., etc., as may reasonably be requested in writing in each case for any reasonable business purpose related to the consummation of the transactions contemplated by this agreement. So the whole question really is, Does the provision of information about these spam accounts, is that reasonably related to consummating the transactions under this agreement? Now, the lawyers for Twitter may say, you know, that’s nothing to do with it, that’s a phishing exercise, and if you would have wanted that information, you could have asked for that beforehand. But it’s quite hard to take that position. And I think Musk’s lawyers would probably argue that, No, we need this because we need to be able to persuade our bankers to put up the money. And everybody has to be comfortable that the spam count that you say is the spam count is the spam count or near enough to that, and that’s why it’s relevant. But it’s not a no-brainer, but it looks as though for the time being, Twitter has chosen to provide this information. And it’s an interesting piece of gamesmanship. Sometimes when you find yourself not exactly in the you know, in the four corners of the contract, you’d come with a, you know, what I would say is quite a little bit of gamesmanship to ask us something which is hard for Twitter not to give, because if they don’t give it, it looks as though they’re hiding something. And obviously as a public company, that has its own ramifications.
Mike Whelan Right. And you made the point before that Twitter has had a public statement about the number of spam accounts and that it seems like that might not be accurate. Tell me about the 10-K in this representation of how many spam accounts there have been.
James Raanan So Twitter, you know, I’m not an expert on Twitter, but from what I’ve seen over the many years, they have made a reference in their public filings to spam accounts. They reference the number 5%, and they indicate in there how difficult it is to really calculate that number. And they caution the public reading the document that these are estimates and that, you know, they can’t be relied on. But the number is important because if it’s significantly more than the key metric which drives Twitter, which is what they refer to as, I think, mDAU, which is monetizable daily users, is smaller than maybe what they’ve been representing. And I think that’s where—I’m guessing that’s where maybe Musk is going with this. But from a contractual legal perspective, this all goes down to, is the–if the information which is provided to Musk turns out to prove Musk’s theory, let’s say, that the spam count is significantly more, then is that grounds for him to be able to terminate this contract, to be able to exit the contract, to be able to prove there’s a material adverse effect? And that’s where I think we’ll see in the coming clauses where that turns out to be relevant. And the fact that the information was previously known in public, is that—once you know something or should have known something, is that something you can rely on as a breach of a representation. I think we’ll see that in some of the next clauses.
Mike Whelan Yeah, and that brings us to an interesting shift in the argument that is rooted back in the contract. I would point out that a company called SparkToro has done an analysis and the way they did it, which may not be agreed to by Twitter and Elon Musk, but the way they did it, they’re estimating about 20% of the accounts on Twitter are spam accounts. But the question is, Who cares? Right? Even if that’s true, Who cares? Initially, Elon Musk and his lawyers, their argument was, okay, you guys didn’t give us material information, and the document is saying, you know, it’s okay, like, that didn’t change anything. But they recently had a shift that is rooted in a definition that you wanted to highlight: company material adverse effect. This is back in the definitions and it says any change, event, effect, or circumstance which has resulted in or would reasonably be expected to result in material adverse effect on the business, financial condition, etc. Talk to us about this definition and how Musk and his lawyers are now using this definition to try to get out of this deal.
James Raanan Yes, so I think, and I might be wrong, but if this deal ends up in the Delaware Chancery Court, then I think that the interpretation of this clause is going to be very significant. And I think that the argument, if you were looking to exit the agreement, would be that the spam count—let’s assume it’s 20% or higher—is an effect or a circumstance which either constitutes a material adverse effect—we’ll look at what that means—or is otherwise a breach of a different representation. And the reason why that is important is because contracts like this, and essentially any purchase agreement, will have what’s called conditions to closing, meaning those conditions have to be fulfilled in order for the parties to be obligated to close the deal. In this case, in order for the buyer to be obligated to close the deal, there cannot be any material adverse effect. If there is a material adverse effect, then the buyer does not have to proceed with the deal. And so that’s why this definition is so important. And so this provision is very typical. I would argue, and I think it’s been argued in, you know, in case law, including in the fairly recent Akorn case, that this clause is very much forward-looking. So when you read this clause, you look at the words in the…I think it’s in the…where is it now…in the second sentence, any change, event, effect, or circumstances which would be reasonably expected to result in a material adverse effect. It really seems to be talking about something which is future-looking and happened sort of going forward rather than something that maybe happened in the past. So they have this initial introduction to the clause and then they then have a number of provisos. So they say, a material adverse effect is something which is going to have a material adverse effect, a material effect on the conditions of the business. And then they go on to say, but doesn’t include the following, and they list a whole number of exceptions. The purpose of these exceptions is to shift risk. So you could think of it very simply in the following way: In a material adverse effect clause, there is the business risk, meaning that the risk that something might happen inherently to the business, you may lose the customer or there may be faults in your product. Demand may drop off, supply problems may happen. Those are inherent to the business. And then there are events which are out of your control. For example, it lists here, COVID, changes in law, cyberattacks, general market changes. And those are risks which a seller typically can’t mitigate, right? Those are the things that happen. And so all of the—all of these exceptions seek to shift the risk back to the seller, whereas this—sorry away from the seller back to the buyer, because the seller can’t be responsible for them. And so, you know, in our particular case, what Musk would seek to argue would be that the increase in spam accounts or the false number of spam accounts is a material adverse effect because it affects the business as a whole. What I think the other side might argue is a couple of different things. First of all, if this was so important to you and this is something you should have known about, then you should have—you’re a sophisticated person, you should have put this into one of the exceptions to this agreement. And furthermore, this clause refers to affecting the business when taken as a whole. And it’s not clear to us the spam accounts really make a big difference. I mean, if you look at the recast numbers that Twitter did, when it recast the difference of this, you know, this mDAU, I mentioned the monetizable, daily active users was a difference of 214 million to 216 million. So it wasn’t necessarily a massive difference and it’s difficult to see how it translates into the bottom line. So it’s going to be very interesting to see kind of how this argument plays out around this clause.
Mike Whelan Yeah. And their argument now, which is fascinating and sort of implausible, which is what makes it so interesting, but it’s a colorable claim, as we say. The argument now is that they can’t get financing. Originally, Musk was trying to—was pulling money from three sources, from his own money, from debt against his interest in Tesla, and from debt with the assumption that Twitter’s, you know, financial gains are going to pay back that debt in the future. Apparently now, post the stock market is sort of dropping quite a bit, that second source of money is not as available. It’s hard for him to go get debt on Tesla stock. And so now he’s freaking out a little bit. But the argument that he’s making on that third source of money is that he can’t get the debt against Twitter’s future revenue because these—there are just too many spam accounts. Nobody knows if that’s true at this point. Nobody you know, obviously, that would come out in court, but that’s the argument that’s happening right now is that he can’t financially make the deal happen because Twitter didn’t reveal some information that was necessary to make the transaction work. I’m looking down at 7.2 and the conditions to the obligations, and it talks about some of this, these breach of representations in (b): did Twitter—in saying we have X number of spam accounts in their 10-K, but actually they have Y number, and they just didn’t do the legwork to get the right number—did that undermine Musk’s ability to even finish this transaction? What do you think about Section 7.2?
James Raanan Right. So I think 7.2 is really a key section. And when we look at Section 7.2, (b)(i), where it says: each of the representations and warranties of the Company contained in this Agreement—and it excludes a couple of representations which typically refer to capitalization and other things—without giving effect to any materiality or company material adverse effect qualifications therein shall be true and correct as of the closing date. But then it goes on—there’s a line just before the word “and” the Roman two—except for such failures to be true and correct as would not have a Material Adverse Effect. So this seems to say that even if there would be a breach of a representation, if that breach or that lack of truth would not have a Company Material Adverse Effect, then maybe, as I’m reading it, it wouldn’t necessarily be a a breach which would rise to the level of something which would stop this closing condition from going through. Now to your question, there is a provision in the agreement in the representation section—and in a second I will find that—which relates to the SCC filings.
Mike Whelan Yeah. And I would point out that they initially did say that the reason that this contract shouldn’t hold was because there’s 20% instead of 5%. But that argument just didn’t work. I mean, it just—in the public eye, you know, as they were putting it out into the world, everybody was saying, Dude, did you read this contract? That’s not enough. Now they’re at this argument of, It’s making it impossible for us to get a loan, which is different, right? That’s taking it to the next level, to your point about the adverse effect. But yeah, sorry, back to the representations.
James Raanan Right. So absolutely, 100%. And I think if you look in the Representations section, 4.6—which is the Company SCC Documents—you look at Section 4.6 (a), where it says, Since January 1st, 2022, the company has filed FCC documents, blah, blah, blah as of their respective dates, etc., etc., the Company SCC documents complied in all material respects with requirements of the Securities Act and the Exchange Act. So he may—this is all speculation and is fun to do—but if he is able to prove that the erroneous statement, the suspected or alleged erroneous statement of accounts, is so significant, that it’s something that really—is something that they knew about, is something that should have been—something material that should have been disclosed in Twitter’s SEC documents, then he may have a shot at trying to allege that there’s been a breach of this particular provision. And, you know, again, this is, you know, maybe what the person drafting this time was not thinking about. Obviously, this is a standard clause that you see in all of these agreements. But that may be a route that they’re going down. And in and of itself, if he is able to prove that, then Twitter may have a problem. And that sort of gamesmanship, you know, maybe causes to bring them to the table in a way to avoid something like this. But that might be one area where you would try and take a crack at a breach in one of these representations.
Mike Whelan Well, and before we get to the performance that’s needed by each party, if this is successful, you know, if either the contract does exist or does not after scrutiny from the judge, where is this idea of the waiver of due diligence coming from? I’ve seen this in the media to your point of saying, okay, there was no way for Elon Musk to know X, Y, Z, because he waived due diligence. He could not go find this out because he said, don’t worry about it. I know what I need to know. I’m just going to buy this thing. Where is that coming from? This idea of the waiver of due diligence?
James Raanan Well, I think it’s…you know, there’s no there’s nowhere in here which has in big capital letters, I have waived due diligence. I haven’t found him saying that. But I think people are intuiting that as a result of the, you know, the back and forth between them, and the speed at which he went from the position he was in to closing—to signing this deal, right? You can imagine it’s such a significant deal. There are so many moving parts, yet they concluded it in lightning speed. But I think in section 5.11, there is some language, which I’m not sure whether it—I mean, some of it is standard, but some of it is little bit more than the standard—where he says—and in many of these representations you find on the purchaser’s side, it really is so the purchaser satisfies the obligation that it’s right an accredited investor and so forth—but if you look maybe several lines down, the sentence that begins, Each repair and acquisition sub has conducted to its satisfaction its own independent investigation, review and analysis of the business results of operations, prospects, conditions, or assets of the company and its subsidiaries. So that’s not so unusual. You do see that in many agreements. But then it goes on and on and on, and they go on to say, Pairing an acquisition sub hereby acknowledged that notwithstanding anything contained in this agreement to the contrary, neither the company nor any of his subsidiary nor any other person makes or has made or is making any express or implied representation or warranty with respect to the company or any of its subsidiaries or their respective business or operations in each case, other than those expressly given solely by the company in Article IV. And it continues in a similar vein to say that the purchaser is not relying on anything which hasn’t been expressly said here. So in one sense, this is a fairly standard clause, but when you add this together with the context and the fact that there is no closing condition for him having the right to do due diligence, I think that’s how they get to the waiver of due diligence, because if he would have wanted due diligence to be a condition to closing, then it would have been a condition to closing. And I think that’s what they’re getting at between these different clauses.
Mike Whelan So let’s just say one way or another—I mean, clearly Elon Musk has buyer’s remorse. Let’s say one way or another, they’re able to, they’re trying to find a way out of this contract and they do it. The question is, what happens? What happens with this agreement that has been in the air for months now? Down in 8.3 (b), it talks about a termination fee, and that parent termination fee was defined up in the definitions section at $1 billion. So look at 8.3 (b) and tell me, can he just do this? If they decide to get out of this, is he just paying a billion dollars and moving on with his life?
James Raanan Yeah. So I think it’s interesting. I’m just going down to the clause now, so bear with me a second. You know, the easy, sort of easy commentary in a way is to say, yeah, you know, if he pulls out of this agreement, he has to pay a billion dollars. And that sounds like a lot of money, but it’s not a lot of money when you’re on the hook for $44 billion. And so I think the answer to your question is, yes, and maybe more. Or yes…or if he does not have valid grounds for terminating the agreement and doesn’t close or doesn’t terminate the agreement or wrongfully terminates the agreement, then one of two things can happen. Either I believe, you know, under the section 8.3 (b), Twitter could seek to receive payment of the termination fee of the billion dollars, or as maybe more of a risk is that they will seek to enforce the agreement and enforce something which is called specific performance. And, you know, if we—I may be jumping the gun a little bit—but if we kind of scroll down to Section 9.9 (b). What this does is say, Notwithstanding anything to the contrary, including the availability of the parent termination fee or other monetary damages, remedy or award, it is hereby acknowledged and agreed that the company shall be entitled to specific performance or equitable remedy to enforce parent and acquisition sub’s obligation to cause the equity investor to fund the equity financing, etc., etc., and to consummate the closing if and so for long as it goes on. And what this means is that Twitter may have a choice, which is either to try and collect the billion dollars or to go to the court and ask the court to enforce this agreement to be consummated and for the whole consideration to be paid over. And I think that is the, you know, if I’m on the side of the buyer and I want to get out of the contract, that would be my biggest concern. And that’s why many times and I’m sure it was deliberate here, you know, this is not—it was deliberate and it would have been known by both sides—very often in contracts like these, you would see a provision that would say that the termination fee or damages is the exclusive remedy and the specific performance is not, and that would exclude specific performance. But because specific performance is specifically enumerated as a remedy very specifically, that seems like something the parties thought might actually happen, or at least the seller did. And I think that’s the big risk that Musk finds himself in Delaware Chancery Court with a judge who is all about the freedom of contract and will look at this very carefully. We’ll see two sophisticated, very sophisticated parties and may not be overly persuaded that questions the buyer could have asked before the deal was closed are now being asked. And I think that, you know, I’m not a prophet, but I think that might be how this begins to play out.
Mike Whelan Yeah. And stepping back to sort of the big picture, there is an interesting question about why Twitter is doing this. They knew at the time that Elon Musk is—we’ll use mercurial as the nicest word for his temperament. They knew that he was shifty and knew that things might change and that they trusted him for whatever reason, to take their baby to move on with this baby. The idea has been that probably they were just looking to maximize the share price. And so they picked a moment in time and said, we’re at a pretty good share price now. Let’s have everything based on now. To me that says, you know, getting to the purpose of contract, that says that at this moment in time, at some moment in time, there were some expectations and some assumptions. They were the spirit of the deal. And we all know in contracts that that could be undermined over time. Maybe the only thing about the spirit of the deal that has changed is that Elon Musk has changed his mind. He’s just not as interested in it. In reality, we’re looking at all these other things to find some other thing that has changed. But clearly something has changed in his mind, and there’s some buyer’s remorse. When I’m drafting contracts, when I’m trying to put these things together and serve the purpose of the contract. Are there better ways to try to protect the intentions of the party so that they stick? Is there some variable way to say, okay, we know that we’re arbitrarily picking this moment in time, let’s have some more flexibility about what happens. Is this change in share price? Is this more like—I mean, this wasn’t force majeure, this wasn’t COVID. But you might argue that this was finally the stock market collapse because all the money the government was putting in because of COVID stopped. Right. And so now we are facing this inflationary pressure so, point is, something has changed, whatever the intentions of the parties were, they’ve now changed. How do you deal with that in contract in a way that doesn’t just, you know, undermine the purpose of the deal, but also undermines the future state that both of these parties saw after this transaction, that seems to have changed.
James Raanan Yes, it’s a great question. From a practitioner’s point of view, it’s very rare to see the circumstances of a contract play out so publicly and so quickly after the contract has been signed. I think the—and actually, I don’t have a good answer for you in this particular case because it’s a very public, high stakes contract. And I look at it from the eyes of the board of Twitter and the lawyers of Twitter needed to make sure that there was a lot of certainty that this deal would go ahead. And so, you know, the almost kind of the contrary, what you’re saying, there are some times when you need to be pretty inflexible. And if somebody is going to come and put a big chip down on the table like that in a very public way, with all of the ramifications of it being a public company, then actually you can’t allow for wiggle room. And why should you? Because essentially what’s happening is…it’s you know, everybody has an agenda. I’m not saying whether that’s right or wrong, but it is a fact that everybody has their own selfish agenda. And the role of, you know, in this case, Twitter’s lawyers was to give as much certainty as possible. And I think if anything, it’s the hubris sometimes of not doing due diligence, right. If that’s important to you, or if it’s important to your client, then sometimes you need to be unpopular and, you know, you need to put in that extra caveat into that material adverse effect clause or even identify it as something that is specifically important, that if there’s a material change in that metric, then that would be a be constituted in its own right, a material adverse effect. So I think it’s a question of discussing with your client, what are the most important drivers of value in a particular transaction? Then trying to determine whether any change in those drivers before the transaction is closed would cause you to want to reject the transaction and how much they would be, and then deciding whether that covered or not. And it might be that you go through all of that discussion and you come to the conclusion, you know what, I’m going to—my client’s going to roll the dice. But I think the sort of the important practitioner question is actually to have the conversation and to to understand that. Now, we can’t play the Monday morning quarterback here because, you know, who knows whether that conversation happened and what the result of that conversation was. So I don’t blame anybody here. It sounds—you can kind of just imagine here the conference—the Zooms on this deal and, you know, and how quick they were and how stressful they were.
Mike Whelan Yeah. And maybe the lesson here is, no matter how ironclad your drafting is, client’s gonna client. You know, sometimes these are just human beings, and they just do things and you’re trying to do your best. But to your point, there are a lot of people relying on where this contract goes. There are careers on the line. There are shareholders, there’s just a lot on the line. And so maybe that inflexibility is actually important. So I appreciate that perspective. James, we are grateful. We’re sure that the drama will continue. We know that a deal like this is going to provide future fun, but I appreciate you giving us the state of things for today. James, for people who want to learn more about your practice and get in touch with you to talk—I mean, there’s always going to be drama, James. We’re always going to want to talk to you about it—what’s the best way to reach out to you?
James Raanan The best way to reach out to me, google my name on LinkedIn. I have the benefit of a very unusual name. There is only, I think, one in the world. So go on LinkedIn and you’ll find me.
Mike Whelan Great. We’ll have a link to that, as well as a link to these documents that we’ve talked about. And if you want to be a guest on The Contract Teardown Show, all you have to do is email us. We are at community at law insider dot com. We look forward to having you and to talking to you all next time. Thanks, James. Have a good day.
James Raanan Thanks a lot. Bye.