The legal lessons from Elon Musk’s turnaround in buying Twitter:
Musk signed the merger agreement before his advisors conducted due diligence.
M&A Process and Due Diligence
Generally, a purchaser in a merger & acquisition (M&A) deal would first enter into a non-binding letter of intent (LOI) to indicate interest in buying the company on certain terms, and agree to confidentiality as it undertakes due diligence (Due D) on the company.
During Due D, the purchaser’s legal, financial and other professional advisors would review material information and documents regarding the company. Including its finances, operations, intellectual property, and consider legal and other risks.
If the purchaser is satisfied thereafter that it is willing to proceed with the deal, it will then negotiate and enter the binding agreement. The Due D process helps the purchaser negotiate the price (usually lower than initially estimated to take into account the risks uncovered in Due D) and terms.
The agreement would include representations and warranties by the company and the seller/vendor regarding such risks, information and documents which were uncovered during Due D.
Musk’s Legal Arguments
In this case, Musk did not do that. He had relied on public information (public regulatory filings by Twitter) and not Due D to enter into the merger agreement. So, he cannot claim that Twitter made false misrepresentations to him through private information. He would have had to argue that he was misled by Twitter based on public information and that this was intentionally fraudulent on the part of Twitter.
Musk’s legal team therefore did not actually plead misrepresentation. Rather, they pleaded that Twitter breached the agreement by failing to provide information to make an independent assessment on the number of fake / spam accounts on Twitter. Further, they did this because they knew they were not likely to succeed on a “material adverse effect” (MAE) claim to avoid closing/completion. An MAE clause entitles a purchaser to terminate the deal if the company suffers a MAE before completion.
However, Musk’s breach of contract claim to get out of the merger agreement entirely is likely not going to succeed. Generally, a breach of such a term, even if proved, would not entitle the buyer to get out of the deal. At most, it can claim damages for loss or breach of warranty.
Twitter would be entitled to seek specific performance of the contract under the terms of the agreement. And that is what they sought in the legal proceeding. The management probably stuck to their guns because they were advised on the legal prospects of their case. And the decision, taking into account shareholders’ interests, would be eminently justifiable given the purchase price and the market price discrepancy after Musk entered into the agreement. In any case, if Twitter did not rigorously fight the case, it would cast a shadow forever thereafter on its reputation and veracity regarding its fake/spam accounts.
Lessons
Briefly, here are some legal lessons from the saga:
1. Listen to your lawyers before you sign any document which could turn out to be a binding agreement.
2. Conduct due diligence before entering into any binding document for a merger and/or acquisition.
3. Musk’s attempt to get out of the deal on a purported legal basis was a gamble. Not necessarily a poor choice. Considering the costs and benefits as well as prospects in any given case, such a gamble could work. In this case, it failed.
4. Twitter rightly started legal action promptly to pressure Musk to proceed with the deal. It worked. Legal action isn’t always about aiming to go to trial. It’s one tool and option among many to achieve a certain practical outcome. An alternative outcome could have been a settlement of the suit with the deal terminated, and the settlement could have resulted nonetheless in a handsome sum in pocket for Twitter.
5. Good lawyers will identify the obvious legal arguments. Great lawyers come up with interesting and complex legal arguments which at least won’t get dismissed at the outset. But the best legal arguments don’t necessarily achieve the desired outcomes. At the end of the day, the facts of the case predominantly determine the outcome.