The lawsuit of the century is gearing up. Although hearings are scheduled to start in mid-October, thick legal briefs have already been filed with the Delaware Court of Chancery (civil court) in Twitter’s lawsuit against Elon Musk. The court will decide whether Musk is obligated to buy Twitter for $44 billion as stipulated in their merger agreement. Musk now wants to back out of the agreement, claiming Twitter failed to provide sufficient information and breached its agreement by firing top managers and laying off workers.
The world’s richest man may be unsure about winning the lawsuit, since he just sold $7 billion of his Tesla shares in case he is forced to buy Twitter or pay the $1 billion breakup fee. Musk was asked at Tesla’s recent shareholder meeting whether he would be spending most of his time at Twitter or the electric auto company. “I think Tesla, you know, would continue to do very well even if I was kidnapped by aliens, or went back to my home planet,” the Tesla CEO said, eliciting laughter and applause. “To be frank, I don’t have an easy answer,” he added.
The legal briefs filed by both parties indicate that Musk may have jumped into the deal without doing the usual homework and signed a contract that left him few escape clauses. Twitter’s case has few cracks and seems to have a good chance of winning. Musk’s legal team is surely searching for any weaknesses it can exploit and will undoubtedly mount a vigorous defense. And Musk is adept at pulling rabbits out of hats.
A speedy trial
It’s going to be a speedy trial. Chancellor Kathaleen McCormick, the head judge of Delaware’s Court of Chancery will hear the case. Many corporations choose to incorporate in the small US state of Delaware because of the corporate tax benefits and up-to-date body of corporate law. Delaware’s special commercial court, the Court of Chancery, has expert judges who can rule on corporate law disputes without juries. There are more large companies domiciled in Delaware than in the other 49 US states combined, as a long-time Delaware resident, President Joe Biden, regularly reminds us.
The Delaware Court of Chancery was established in 1792, shortly after US independence, and over the last two centuries has become the preferred arbiter of major US corporate disputes. It has settled business quarrels pitting companies against disgruntled shareholders, or parties to troubled mergers and acquisitions, such as RJ Reynolds and Nabisco, Time and Warner, HP and Compaq, and LVMH and Tiffany. But none of these high-profile cases can compare to the public battle between the eccentric, richest man in the world and the popular social network with $44 billion at stake.
McCormick scheduled the start of the trial for the week of October 17-21, marking the first defeat for Musk, who wanted a delay to February 2023. The judge has established an accelerated schedule for discovery, subpoenas, depositions, expert requests, witness lists, and pretrial hearings. The two sides have kicked into gear. Musk has already requested transaction-related documentation from Twitter’s bankers, JP Morgan Chase and Goldman Sachs. Meanwhile, Twitter has subpoenaed Musk associates, friends, and allies, including Oracle co-founder and executive chairman Larry Ellison, who is also a Tesla advisor; PayPal co-founder Jason Calacanis, an investor in Uber and Robinhood, and a partner in Musk’s Twitter deal; and PayPal co-founder David Sacks, who replied with a digital middle finger.
Legal strategies revealed
The complaint, counterclaim and reply to the counterclaim filed with the Delaware court clearly reveal the direction of each party’s pre-trial strategy. Twitter’s lawsuit begins forcefully: “In April 2022, Elon Musk entered into a binding merger agreement with Twitter, promising to use his best efforts to get the deal done. Now, less than three months later, Musk refuses to honor his obligations to Twitter and its stockholders because the deal he signed no longer serves his personal interests. Having mounted a public spectacle to put Twitter in play, and having proposed and then signed a seller-friendly merger agreement, Musk apparently believes that he – unlike every other party subject to Delaware contract law – is free to change his mind, trash the company, disrupt its operations, destroy stockholder value, and walk away.”
Twitter says that Musk made a “take it or leave it” offer, but did not make it conditional upon the results of a due diligence process or upon the financing of the transaction. The company argues that Musk now wants to renege on the deal because Twitter’s stock price has fallen. “Musk’s exit strategy is a model of hypocrisy,” says the Twitter complaint, because after saying he wanted to buy the company to get rid of spam bots and fake accounts, he now points to fake accounts as the reasons for backing out of the deal.
Twitter also claims that Musk’s strategy is a model of bad faith. “While pretending to exercise the narrow right he has under the merger agreement to information for ‘consummation of the transaction,’ Musk has been working furiously – albeit fruitlessly – to try to show that the company he promised to buy and not disparage has made material misrepresentations about its business to regulators and investors.
Three reasons to axe the deal
The Twitter lawsuit indicates that Musk’s notice to Twitter alleged three grounds for terminating the agreement. First, there was a “purported breach of information-sharing and cooperation covenants” by Twitter. Second, Twitter supposedly made “materially inaccurate representations” in the merger agreement that allegedly are “reasonably likely to result in” a material adverse effect. Third, Twitter purportedly failed to comply with “the ordinary course covenant by terminating certain employees, slowing hiring, and failing to retain key personnel.” After laying out Musk’s alleged motives for terminating the agreement, the Twitter brief proceeds to refute them one by one.
The lawsuit is an inside look at how the merger negotiations unfolded. After buying more than 9% of the company’s stock on the open market, Musk told Twitter CEO Parag Agrawal that he was thinking about either joining Twitter’s board, buying the company or starting a competing company. Musk accepted the board seat offered by Twitter in April, but changed his mind a few days later and said he wanted to buy the company. He submitted an offer that was initially conditioned upon financing and due diligence, but then withdrew those conditions. Musk’s lawyers presented a seller-friendly draft agreement to close the deal as soon as possible. Twitter’s lawyers won a few more concessions, including the right to hire or fire employees until the deal closed without Musk’s consent.
In the merger agreement, Musk stated that he was satisfied with the results of his own investigation, review and analysis of Twitter’s business operations. The social network promised to provide Musk with information that would facilitate closing the transaction, and Musk pledged not to publicly disparage the company or its executives.
Twitter argues that Musk decided to back out after realizing that his offer of $54.20 per share was too high, especially after the stock market dropped sharply. “Musk wanted an escape,” says the Twitter brief. “But the merger agreement left him little room. With no financing contingency or diligence condition, the agreement gave Musk no out absent a Company Material Adverse Effect or a material covenant breach by Twitter. Musk had to try to conjure one of those.”
Fake user accounts
Although the Twitter sale agreement never mentions fake user accounts, Musk repeatedly stated he wanted to buy the company to purge them from the platform. Yet Musk made his offer without seeking any representation from Twitter regarding its estimates of spam or false accounts. He even sweetened his offer to the Twitter board by expressly withdrawing his prior diligence condition.
In early information-gathering meetings, Musk was interested in how Twitter counted its users, especially the monetizable daily active users (mDAU). Twitter believes that the best way to measure its success is to count the mDAU – users who log in and access Twitter on any given day through Twitter.com or Twitter applications that are able to show ads. Musk was not convinced by the explanations, and on May 13, without formally notifying Twitter, he tweeted that the agreement was “temporarily on hold” until he understood how they determined that fewer than 5% of the mDAU were fake accounts. Two hours later, after speaking with Twitter executives, Musk tweeted that he remained “committed” to the agreement.
Still committed to acquisition— Elon Musk (@elonmusk) May 13, 2022
The commitment was short-lived, as less than a week later, Musk responded to Twitter’s technical explanation of the fake account calculation issue by tweeting a smiling poop emoji, a message for the ages.
💩— Elon Musk (@elonmusk) May 16, 2022
Twitter says it never withheld information from Musk and provided a torrent of data – almost 54 terabytes worth – but it was not enough for Musk who sent a letter in mid-June that Twitter described as “… an alternative reality in which Twitter had failed to cooperate in supplying Musk with information,” according to the Twitter complaint. The letter contained a litigation-style discovery demand for information Musk asserted was needed to investigate its active user base. Twitter began to suspect that Musk was seeking a pretext to break the agreement and refused to respond to some of those requests.
In a June 30 meeting, Musk acknowledged he had not read the detailed summary of Twitter’s sampling process provided back in May. Twitter offered to meet again and review the detailed sampling methodology sampling process, but that meeting never occurred despite multiple attempts by Twitter.
Lastly, regarding workforce layoffs, Twitter claims that it reserved that right and notes that Musk wanted the company to be more aggressive in cutting costs and headcount. With respect to employee attrition, Twitter maintains that employees have every right to voluntarily leave the company, and says that Musk refused to approve employee retention plans.
The counterclaim brief acknowledges that Musk waived the normal due diligence process and instead followed the adage “trust but verify.” When he went to verify, Musk concluded that Twitter had been misleading the market for years and had been filing false information with the US Securities and Exchange Commission (SEC). The counterclaim states that the SEC disclosures “… contain numerous, material misrepresentations or omissions that distort Twitter’s value and caused the Musk Parties to agree to acquire the company at an inflated price.”
On the controversy over fake and spam accounts, the counterclaim states, “Twitter was miscounting the number of false and spam accounts on its platform, as part of its scheme to mislead investors about the company’s prospects by focusing on its purported hundreds of millions of mDAU.” It also claims that although Twitter has repeatedly touted mDAU as a “key metric” for revenue growth, mDAU is not as closely tied to revenue as Twitter leads the public to believe, because many accounts are barely active and to say they are monetizable is misleading.
The counterclaim brief proceeds to make a legally irrelevant point, proclaiming that “Musk is an avid Twitter user who believes in free speech and open debate, and he appreciates Twitter’s role as the world’s town hall.” But he rejects aggressive content moderation and suspension of accounts that propagate misinformation. To Musk, and many others, eliminating free speech is a cure worse than the disease.
By buying Twitter, Musk believed he could kill two birds with one stone. By requiring effective verification of all users, he could eliminate what was supposed to be a less-than-5% false or spam account problem. Then he could better engage the over 220 million mDAU that Twitter represented were real, monetizable users and enhance subscription revenue.
The counterclaim is contradictory in places. It says that “… Twitter frantically [closed] the gates on information in a desperate bid to prevent the Musk Parties from uncovering its fraud.” Yet it then relies on that same Twitter-supplied information and data to conclude that at least 10% of the mDAU are fake. The brief often slips into lyrical critiques of the company’s management and its business model. “As a long bull market was coming to a close, and the tide was going out, Twitter knew that providing the Musk Parties the information they were requesting would reveal that Twitter had been swimming naked.” Musk believes Twitter was in a hurry to close the deal because its fraud would be discovered during the presentation of second quarter results at the analyst conference, which was ultimately cancelled because of the merger agreement. It’s clear to everyone, however, that Musk was driving the timeline.
The counterclaim alleges that Twitter stonewalled and chose not to disclose its mDAU calculation methodology. Instead, it engaged in “an unending game of cat-and-mouse, with Twitter obfuscating the truth at every turn” and parroted “the mantra that its process was robust” without ever explaining it.
Compensatory damages sought
Somewhat desperately, Musk’s lawyers also argue that Twitter made significant changes to its business without obtaining the consent required by the merger agreement when it “disobeyed orders from and initiated risky litigation against the Indian government – thereby placing Twitter’s third largest market at risk.” This is a new argument that was not mentioned in the merger agreement termination notice.
Ultimately, Musk is accusing Twitter of fraud, violation of securities laws and breach of contract. He is asking for termination of the merger agreement and is seeking “an award of compensatory damages in an amount to be proven at trial.” The counterclaim asserts that Twitter has not suffered losses and is not entitled “to recover losses suffered by third parties, including, among others, its shareholders.” And it reiterates that “the merger agreement was fraudulently induced.”
Twitter’s ironic reply to the counterclaim
Twitter’s reply to Musk’s counterclaim begins by wryly observing, “According to Musk, he – the billionaire founder of multiple companies, advised by Wall Street bankers and lawyers – was hoodwinked by Twitter into signing a $44 billion merger agreement.” The response goes on to say, “… the Counterclaims are factually inaccurate, legally insufficient, and commercially irrelevant.” The merger agreement does not contain a single reference to fake or spam accounts, insists Twitter, and charges Musk with selectively wielding confidential data provided by Twitter to allege a breach. “Yet Musk simultaneously and incoherently asserts that Twitter breached the merger agreement by stonewalling his information requests.”
Twitter claims that Musk’s calculation of 10% fake accounts didn’t measure the same thing as Twitter or even use the same data, and was done using a generic web tool that designated his own Twitter account a likely “bot.” Musk has more than 100 million followers and has tweeted more than 18,000 times.
“The Musk Parties have spent months trying to invent a spam disclosure problem and have found nothing. Their complaints about the mDAU metric were not even among their reasons for termination – they are a newly invented litigating position.” Twitter makes the same claim about its litigation with the Indian government, saying it’s nothing new or exceptional, and was not mentioned in Musk’s termination notice.
Some surprises are surely in store, but as things stand now, Musk’s legal position looks difficult. Judge McCormick is known for her enforcement of transaction agreements. If that happens, Musk’s last hope is the unlikely possibility that Twitter shareholders will vote against the merger in their annual meeting. Musk can also try to negotiate an out-of-court settlement with Twitter. If not, it will all play out in court.
The second half of October looks tough for Musk. The week after the Twitter trial begins, he faces another lawsuit in the Delaware Court of Chancery from Tesla shareholders seeking to void the CEO’s record-breaking $56 billion pay package, alleging corporate waste and unjust enrichment.