On July 12, 2022, Twitter, Inc. sued Elon Musk and certain of his special purpose entity affiliates in the Delaware Court of Chancery, seeking specific performance to force Mr. Musk to close on his agreement to purchase Twitter. Twitter, Inc. v. Musk, C.A. No. 2022-0613 (Del. Ch.). The case, assigned to Chancellor Kathleen McCormick, has received and likely will continue to receive widespread media attention because it is one of the largest broken deals (if not the largest) to be litigated before the Delaware Court of Chancery, and because of Mr. Musk’s colorful involvement. But Chancellor McCormick’s decisions in the course of the case may also have significant implications concerning transaction agreement language and provide guidance to practitioners going forward.

Factual Background

Twitter owns and operates a social media platform. Mr. Musk is the CEO and a significant shareholder of several public and private companies, including Tesla, Inc. and SpaceX, and is among the wealthiest people in the world. He is also one of the most followed users on Twitter, which he prolifically employs. In early 2022, Mr. Musk publicly and privately suggested he might start a competitor to Twitter. Then, on April 4, 2022, Mr. Musk publicly disclosed for the first time that he had accumulated 9.1% of Twitter stock, thus becoming its largest single shareholder. After Twitter’s efforts to have Mr. Musk join Twitter’s board of directors failed, on April 14, Mr. Musk announced that he made an offer to Twitter’s board of directors to buy all outstanding Twitter stock for $54.20 per share, a 38% premium to Twitter’s last traded price and valuing Twitter at approximately $44 billion. In response to his unsolicited offer and to thwart a potential tender offer by Mr. Musk, Twitter’s board swiftly implemented a shareholder rights plan (commonly known as a “poison pill”). On April 21, Mr. Musk publicly disclosed that he had firmed up his offer by no longer making it contingent on financing or subject to due diligence, and that he was exploring whether to commence a tender offer. 

On April 25, after an expedited 24-hour negotiation, Twitter executed a merger agreement with Mr. Musk providing for the proposed ~$44 billion purchase price. 

Shortly following the signing of the merger agreement, the stock market experienced heightened volatility. On May 13, Mr. Musk tweeted that the deal was “temporarily on hold” until Twitter would provide details supporting statements in its securities filings estimating that less than 5% of Twitter accounts are fake, but hours later clarified that he was still committed to the deal. Over the next several days, Mr. Musk made a series of tweets concerning the veracity of Twitter’s fake account estimate. On June 6, Mr. Musk sent a letter to Twitter through his counsel claiming that Twitter was in material breach of its information sharing obligations under Section 6.4 of the agreement. On July 8, Mr. Musk’s counsel followed up with another letter, this time purporting to terminate the agreement. The letter principally argued that:

1. Twitter had failed to comply with Section 6.4 of the agreement, which required it to provide information for “any reasonable business purpose related to the consummation of the transactions,” by not responding fully to Musk’s information requests relating to fake accounts.
2. Twitter had failed to comply with Section 6.11 of the agreement because it had not provided Mr. Musk working copies of its financial model and its financial advisor’s valuation model, which he had requested to help secure debt financing.
3. Twitter’s representations in its securities filings concerning its estimate of fake accounts are false or misleading, and the related breach of Twitter’s representations under Section 4.6(a) of the agreement may have caused or is likely to result in a material adverse effect (MAE), thus resulting in a failure to meet the “bringdown” closing condition under Section 7.2(b)(i) of the agreement.
4. Twitter violated the ordinary course covenant under Section 6.1 by firing senior employees without Mr. Musk’s consent, laying off a significant percentage of its talent acquisition team and instituting a hiring freeze.

Twitter responded by filing suit on July 14 for specific performance of Mr. Musk’s obligations under the agreement and moving to expedite in order for the court to reach a decision before the Oct. 24, 2022 “drop-dead date” stipulated by the agreement, seeking a mid-September trial date from the court. Mr. Musk opposed an expedited trial and proposed instead a Feb. 13, 2023 trial.  He argued that the outside date for debt financing is April 25, 2023, the drop-dead date is automatically stayed under Section 9.9(c) pending litigation, and the case will require complex discovery concerning Twitter’s user metrics. On July 19, Chancellor McCormick held a hearing on Twitter’s motion to expedite. Citing the “cloud of uncertainty” cast over Twitter, Chancellor McCormick granted expedited proceedings and instructed the parties to prepare for a five-day trial in October 2022.

Summary of Claims

Ordinarily, it is the seller who has to overcome numerous obstacles to obtain specific performance. Deals are often terminated shortly before the drop-dead date, leaving little time for the seller to enforce a specific performance remedy. Such deals, particularly private equity deals, are often contingent on the availability of debt financing, creating another obstacle to specific performance should that financing cease to be available. And while the buyer may have a number of arguments for why termination is warranted, only one of them need be meritorious to defeat the seller’s arguments for specific performance.

There are a number of aspects of the Twitter deal, however, that bear on whether Mr. Musk can successfully terminate the agreement and defeat Twitter’s specific performance demand. As is common in merger agreements, a party cannot terminate the Twitter merger agreement if it, itself, is in material breach of it. Here, Twitter alleges conduct by Mr. Musk that potentially raises this issue. Mr. Musk is a party to the agreement, and Section 8.1(d)(i) specifically requires that he not be in material breach for buyer to terminate. For Mr. Musk to win at trial, the court likely will have to find not only that there has been an MAE or that Twitter materially breached a covenant but also that Mr. Musk did not himself materially breach the agreement.

Turning to Mr. Musk’s legal arguments for terminating the agreement, first, Mr. Musk argues that Twitter failed to comply with its obligations under Sections 6.4 and 6.11 of the agreement to provide certain information to which he is entitled. Section 6.4 gives buyer the right to request information “as may be reasonably requested … for any reasonable business purpose related to the consummation of the transactions,” except when such disclosure “in the reasonable judgment of the Company” would cause it “significant competitive harm” if the transaction is not consummated. Mr. Musk requested information under Section 6.4 related to fake accounts on Twitter on multiple occasions following the execution of the agreement. However, he and Twitter are in complete disagreement with respect to the nature and adequacy of information exchanged and requests still outstanding, and discovery and the trial will determine the reasonableness of the requests and whether Twitter adequately complied with them, as it claims. Importantly, Twitter appears to argue it was entitled to not comply with certain of Mr. Musk’s requests because either they were well outside the scope of “relat[ing] to the consummation of the transactions” or there was risk of “significant competitive harm,” particularly given its allegations that Mr. Musk had previously expressed interest in launching a competitor platform to Twitter, and in light of what it claims to be repeated violations of his confidentiality undertakings via disparaging Tweets by Mr. Musk.

Second, Mr. Musk argues that Twitter breached the debt financing cooperation covenants under Section 6.11 by failing to use “commercially reasonable best efforts” to “provide any reasonable cooperation” requested by him, specifically with respect to his request for Twitter’s working financial model and the working valuation model used by its financial advisor. Twitter characterizes the request as “extremely unusual” for financing processes of this type and irrelevant to securing the financing contemplated by Mr. Musk’s financing commitments. Among other things, Twitter also points to “ringfencing” type language in such provision, whereby Twitter’s undertakings under Section 6.11 are its “sole obligation ... with respect to cooperation in connection with the arrangement of any financing,” thus precluding a conflation of its general information-related covenants under Section 6.4 and such provision. Twitter also highlights that, by its terms, it may be considered to have breached Section 6.11 only if a failure by Mr. Musk to obtain the committed debt financing is “due solely to a deliberate action or omission taken or omitted to be taken by the Company in material breach of its obligations.” 

Third, Mr. Musk alleges that Twitter violated its representation in Section 4.6 that its 2022 securities filings did not include any “untrue statement of a material fact” because its estimate that less than 5% of the accounts on its platform are fake is false and misleading. Mr. Musk also points to Twitter’s restatement in its Q1 2022 10-Q of its previously reported monetizable daily active user (mDAU) estimates for recent quarters as evidence that the metric is material and Twitter’s “estimates” are meant to be precise. But, for the “bringdown” closing condition under Section 7.2(b)(i) not to be met (and for the related termination right to be triggered), a failure of such representations to be true would need to result in an MAE. Thus, Mr. Musk alleges that the purportedly false representation “may have also caused, or is reasonably likely to result in, a Company Material Adverse Effect.” He also alleges that he “is considering whether the company’s declining business prospects and financial outlook constitute” an MAE and are also a basis for termination. Twitter, in turn, maintains that it did not represent that less than 5% of its accounts were false, but only that the company estimated that amount based on the procedures the company employs.

Based on Delaware case law to date, Mr. Musk faces an uphill battle to prove the existence of an MAE. The only case in which the Delaware Court of Chancery has found an MAE is Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d 198 A.3d 724 (Del. 2018) (finding MAE based on a long-term collapse in value and financial metrics of a seller resulting from seller’s violations of FDA regulations). Despite several attempts by buyers to extract themselves from signed M&A transactions at the onset of COVID-19, no buyer successfully persuaded a court that it had met the burden of proving an MAE because of the pandemic or its immediate financial consequences. As discussed in a prior alert, the Court of Chancery recently reaffirmed that a buyer must prove that an MAE is, regardless of its magnitude, “durationally-significant.” 

The agreement at hand also contains numerous carve-outs to the definition of MAE, as is fairly typical. For example, the MAE definition carves out “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’).” Mr. Musk could therefore rely only on Twitter’s ‘Risk Factors’ or ‘Forward-Looking Statements’ securities disclosures for his breach claim. With respect to the Risk Factors section of its most recent annual report, Twitter stated that its “estimate” of false or spam accounts was “fewer than 5%,” but qualified that the “estimation of false or spam accounts may not accurately represent the actual number of such accounts, and the actual number of false or spam accounts could be higher than we have currently estimated.” Turning to Mr. Musk’s allegation that Twitter’s revised financial projections may constitute an MAE, the MAE clause carves out, among other things, conditions “generally affecting any of the industries or markets” that Twitter operates in; “general economic, regulatory or political conditions … in the financial, credit or securities markets”; and “any failure by [Twitter] to meet internal, analysts’ or other earnings estimates or financial projections or forecasts for any period.” Mr. Musk will have to prove that any changes in Twitter’s “business prospects and financial outlook” do not “relate to or result from” conditions affecting other participants in its industry, macroeconomic conditions or simply a failure to meet financial projections or forecasts.

Finally, Mr. Musk alleges that Twitter breached the ordinary course covenant in Section 6.1 by firing certain high-level employees, laying off a third of its talent acquisition team and instituting a hiring freeze. While a Delaware court found in AB Stable VIII LLC that certain pandemic-related changes to business operations breached an ordinary course covenant and justified termination of a sale agreement, the formulation of the ordinary course covenant in the Twitter agreement is arguably more seller friendly. The ordinary course covenant in AB Stable required the seller to operate “consistent with past practice.” No such language exists in Section 6.1 here. Moreover, Section 6.1 merely requires Twitter to “use its commercially reasonable efforts to conduct the business … in the ordinary course of business.” To establish a material breach, Mr. Musk will have to argue that the employment-related measures taken (or not taken) by Twitter fell outside of Twitter’s ordinary course operations in a material manner and that Twitter’s related efforts fell short of being commercially reasonable.

But even if the court finds that Twitter breached any one of these provisions, Mr. Musk will still have to defend against Twitter’s claim that he is in material breach of the agreement. Twitter previews several potential arguments for why it believes that Mr. Musk is in material breach of the agreement. It alleges that Mr. Musk violated Section 6.4 by disclosing confidential information, Section 6.8’s requirement that he not issue Tweets about the deal that “disparage” Twitter, Section 6.1’s requirement that he not unreasonably withhold consent to operational changes, and Section 6.10’s requirement that he take “all actions … necessary, proper or advisable to … obtain and consummate the financing.”

Twitter’s ability to obtain specific performance of Mr. Musk’s obligation to close and fund the purchase price depends on conditions not completely within its control. Notably, even if the court were to determine that Mr. Musk did not properly terminate the agreement, if the bank financing were to fall apart, specific performance would no longer be available. Though Section 6.10(f) disclaims that financing is a condition to closing, Section 9.9(b) conditions the availability of specific performance as a remedy on the availability of such committed (or alternative) debt financing. Mr. Musk’s general financing-related covenants under Section 6.10(a) require him to take “all actions … to … obtain and consummate financing” for the deal (which Twitter characterizes as a “hell-or-high-water” clause), but in the event the originally committed financing ceases to be available, Section 6.10(c) merely requires Mr. Musk to use “reasonable best efforts” to obtain alternative financing that is “not less favorable” to buyer than the original financing. Therefore, even though the agreement expressly disclaims that financing is a condition to closing, the continued availability of the debt financing could prove pivotal to whether a consummation of the ~$44 billion transaction can be ordered or if Twitter will need to content itself with the receipt of monetary damages (which are capped at $1 billion under the agreement). That said, Chancellor McCormick recently applied the prevention doctrine in Snow Phipps Group, LLC v. KCake Acquisition, Inc. to enforce specific performance after financing became unavailable because of buyer’s deliberate conduct, holding that “it is not necessary that there be a specific malevolent intent” or that buyer “actively scuttle the debt financing” for the prevention doctrine to apply. Should debt financing become unavailable but evidence emerges that Mr. Musk was responsible for that unavailability, Chancellor McCormick could apply the same principle here.

Preliminary Takeaways

The litigation is still in its early stages, and we will continue to closely monitor it for new developments and insights. However, even as it stands, the Twitter v. Musk saga offers some preliminary guidance for practitioners, including:

• As became apparent in many of the busted deal lawsuits arising from COVID-19, allegations of covenant breaches by the seller are, and will likely continue to be, front and center when seeking to terminate acquisition agreements on the buy side. Unlike the much-harder-to-prove MAE standard, establishing a merely “material” breach of the various seller undertakings between signing and closing is generally more attainable, and sellers should pay special attention to any weaknesses or “hair triggers” across the many pertinent provisions. In particular, “materiality,” “commercially reasonable efforts” or similar qualifiers will be important in mitigating some of the risk for breach on the sell side. Interim operating covenants will continue to be tightly negotiated as to balance the seller’s need for operational flexibility and avoid any “foot faults,” on the one hand, with buyer’s demand for protection against value-impacting deviations from ordinary course, on the other hand. And practitioners will want to give thought to the appropriate standard and scope of the “access to information” covenants in order to potentially avoid the dispute at hand and clearly define the degree, frequency, purpose and boundaries of information sharing with which sellers are expected to comply. Mr. Musk’s allegations also reaffirm the importance of keeping an organized paper trail demonstrating the seller’s responses to and compliance with buyer’s requests under the various covenants during the executory period.
• Typically, in order to terminate a transaction agreement, the terminating party cannot itself be in material breach of the agreement. Practitioners representing buyers who are contemplating a potential termination should be careful to make sure that their clients comply in good faith with their own contractual covenants. The abovementioned considerations in negotiating covenants that are less prone to breach will therefore be equally important on the buy side.
• Musk’s rush to litigation may not create a helpful record. Less than three weeks after the agreement was executed, Mr. Musk first publicly suggested that the deal might not close at all, and he purported to terminate the agreement less than three months after its execution and less than two months after he first requested the information he alleges Twitter had not provided. According to Twitter, Mr. Musk also involved litigation counsel at an early stage, which Delaware courts have noted unfavorably in cases of “buyer’s remorse.” Practitioners should closely coordinate with their clients regarding content and timing of any (private or public) communications with their counterparties, taking into account potential implications for eventual litigation.
• While the termination fee/damages cap construct in the merger agreement at hand is fairly common for leveraged buyout transactions, these provisions may not always sufficiently disincentivize a buyer from seeking to terminate an agreement in the manner purportedly done by Mr. Musk. Because the agreement caps money damages (including in the event of knowing and intentional breach) at an agreed amount (here, $1 billion, or roughly 2.2% of the purchase price), an “efficient breach” could still be an appealing route, especially since Mr. Musk’s likely perceived worst-case scenario is compliance with an agreement he was eager to enter into just a few months ago (albeit under different market conditions). In the interim, the uncertainty of the deal (including the risk of the debt financing collapsing and de facto elimination of specific performance as a remedy) may cause Twitter to agree to a reduction in the deal price, granting Mr. Musk a financial win even if he does not prevail on the law. Practitioners should consider the risk that a particular counterparty might seek to avoid the obligation to close if the market declines, and whether the acquisition agreement includes appropriate deterrents (e.g., the availability of uncapped benefit of the bargain damages for willful breach) to prevent such litigation strategy.
• Due diligence matters. Today’s M&A transactions often move at lightning speed, making it challenging to complete a fulsome due diligence process ahead of signing. As is the case here, buyers typically disclaim any reliance on representations and warranties outside of those specifically negotiated within the “four corners” of the acquisition agreement and thus effectively waive any further due diligence. As a result, a buyer’s principal escape hatch in response to adverse post-signing diligence discoveries or breaches of representations is proving the occurrence of an MAE — as discussed above, a very high burden. This case serves as a good reminder of the challenges faced on the buy side in balancing demanding deal timelines and a generally seller-favorable risk allocation paradigm, on the one hand, with the need for satisfactory conclusion of essential due diligence, on the other hand. Practitioners should ensure that their buy-side clients are aware of the risks assumed in entering into agreements with a confined set of representations and limited recourse with respect to adverse post-signing findings. Buyers should aim to address any critical valuation assumptions through sufficient pre-signing due diligence or specific contractual protections in the acquisition agreement.

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