The Industry

There’s a New, Chaotic Possibility in the Elon Musk–Twitter Trial

A lot is riding on what the finance guys do next.

This illustration photo taken on July 8, 2022 shows Elon Musk's Twitter page displayed on the screen of a smartphone with Twitter logo in the background in Los Angeles. - Elon Musk pulled the plug on his deal to buy Twitter on July 8, 2022, accusing the company of "misleading" statements about the number of fake accounts, a regulatory filing showed. (Photo by Chris DELMAS / AFP) (Photo by CHRIS DELMAS/AFP via Getty Images)
Entropy birds. CHRIS DELMAS/Getty Images

Elon Musk’s attempt to not buy Twitter is now in Delaware court, after the billionaire attempted to back out of his $54.20-per-share purchase and the social media company sued to make him pay up. The trial will take place in October, earlier than Musk wanted. He’s been rummaging for months for a suitable reason not to buy a company that has lost much of its market value since he signed a deal to buy it in April at a $44 billion valuation.

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Without much time remaining to assemble a passable excuse,  it appears likely that Musk will go to trial with roughly three paths out of buying Twitter. The first two—a nominal concern with fake accounts and another one with Twitter’s compliance with his information requests on the subject—are more than likely bullshit. There are a lot of reasons to believe that Delaware’s chancery court, which will hear this case and sets much of American corporate law, is not going to bite on either of them.

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But Musk has a third potential path, which has come into sharper focus in the last few days. This one revolves around the banks and investors who agreed to spend around $20 billion as part of his purchase effort, including Morgan Stanley and the venture capital firm Andreesen Horowitz. One hypothetical world in which Musk does not have to buy Twitter is one in which those backers pull away their money and Musk no longer has the cash to go through with the deal. Of course, he’d love that. Twitter’s lawyers are attuned enough to the threat that they just sent dozens of subpoenas to these organizations in an effort to make sure they can’t squirrel out of a deal that Twitter’s board of directors is desperate to complete.

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But it’s not nearly as simple as Musk or his financiers snapping their fingers and making the entire deal go away. To sort through this wild card in Twitter v. Musk, I talked on Thursday with Eric Talley, a professor at Columbia Law School whose focuses include corporate law, governance, and finance. Our conversation has been  lightly edited for clarity.

Alex Kirshner: Elon Musk and his lawyers seem to have three potential routes out of him buying Twitter. There is the bot thing. There is the idea that Twitter has not complied well enough with his information requests. And third is the issue of his financing. Are there any other routes that you can see that he might try to use in Delaware to get out of the deal?

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Eric Talley: No, I think you got the main ones. The thing that’s distinct about this one is that it actually doesn’t let him get out of the deal. What it does is it limits the remedy that Twitter can get against him if there’s a bonafide financing failure. The other two could allow him to just walk away.

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But this one says, “No, you’re still going to be in breach of contract. There isn’t explicitly a financing condition to close this thing. So even if you don’t get financing, you could still close the deal, and that’s the reason you breach the contract. You could still breach it, but the remedy in that instance would—at least per the terms of the contract—appear to be limited to money damages.”

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And then, in turn, that looks like it is probably capped at $1 billion.

That’s the $1 billion “breakup fee” that gets talked about a lot. And if the banks were to walk, the idea is that Musk is still in breach of his contract, but instead of having to buy Twitter for $54.20 per share and $44 billion or so in total, he would just have to pay this fee. Is that correct?

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That’s correct. Now the key thing is that if the banks walk away, in order for this to operate as I think he wants it to, the bank’s decision to walk away can’t be a coached decision. It can’t be essentially a byproduct of self-sabotage. It’s a deft thing to try to play this card, particularly when he’s been really clear and publicly signaling how he has gotten cold feet about the deal.

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Do you think that’s what Twitter is looking for in this batch of subpoenas to Musk’s investors in the deal? Some indication that he is basically ordering them to sabotage him?

Yeah, I think there’s probably three things that they’re looking for. So one is: Is there a smoking gun of communication that Musk or Team Musk has made to these lenders or the lenders have made amongst themselves, saying, “Hey, we just talked to Elon’s camp, and they really want to pull the plug”? So, a smoking gun that suggests that not only was he not using his best efforts to get financing, which he’s required to do, but he was actively trying to sabotage the deal. So I think that is probably item one on their shopping list when they try to do this. Another item, which is related to it, but it just works in the opposite direction, is the lack of communication among lenders about their concern about bots. That if lenders hadn’t really been voicing internal concerns about the bot issue, then that dog that’s not barking could actually serve as evidence that, yeah, this is all artificially constructed by Mr. Musk. That can actually be effective as well—not for what it says, but for what it doesn’t say.

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And then I think a third part is that the major lenders probably did their own Twitter valuation analyses here and their own risk exposure analysis. And so that would also be probative evidence, presumably, of banks: “You’re claiming that you’re worried about the financeability of this deal, but take a look at your own valuation assessments on Twitter and the stress testing that you did on it, and it doesn’t look like there’s any reason to be worried about that.”

If I were to line up the biggest clusters of what I suspect the Twitter attorneys are after, it would be in those three camps.

There has been some analysis done that shows that because of the change in credit markets since the time this deal was signed in April, the banks have their own financial reason to walk away: They would avoid losses. It also seems like if the banks are interested in keeping the richest guy in the world as a client, helping him tank the deal might be good for that relationship, if they wanted to be involved in a SpaceX IPO or something like that, or future business with Tesla. What are their incentives here? And do those incentives create the possibility for some gray area in what’s an acceptable reason for the banks to walk away and what is not?

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Yeah, I think there’s definitely some gray area that gets created in these situations. The Delaware courts have had to deal with prior instances  where a clearly remorseful buyer points to something that didn’t happen: Maybe it was people that the buyer was working with who were supposed to do something, and then they refused to do it, whether it’s extending credit, whether it’s issuing a solvency certificate, whether it is issuing a tax opinion about the tax status of the deal. The case law is littered with examples of people saying, “Oh my gosh, too bad we can’t go through with this transaction because we didn’t get X.” In this case, it might be financing. And so if read fairly, I think the contract basically says if there’s an independent reason why financing fails, then that can be a reason for the lenders to end up pulling the plug.

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But it better be pretty darn clear that it’s an independent reason, and it better be pretty darn clear not only that Elon Musk didn’t deliberately coach them into it, but that he didn’t sit idly by while they were getting cold feet and didn’t try to get them back on board, because his best-efforts duty applies to obtaining financing. So I’ve always thought personally that the financing angle was probably going to be the strongest card Musk could play, but it’s a delicate card to play as well, because there are a bunch of ways that things could end up going sideways.

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The other thing that’s worth noting is that if you take a look at the financing and what’s been disclosed thus far, there’s a bunch of stuff that hasn’t been disclosed. Shortly, we may actually see some attachments with some other terms of the financing agreements that people are going to want to go through. But the stuff that’s been disclosed on SEC filings thus far is pretty thin in terms of adding on any extra conditions that weren’t already in the merger agreement. And so, if the financiers were to say, “Oh my gosh, credit markets. Look what’s happened to them. That constitutes a material adverse effect, and we get to walk away.” Well, from what I can tell, from the disclosures thus far—and this is good practice as well—they pretty much echo whatever the definition of “material adverse effect” is in the merger agreement.

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And that basically says that we’re not talking about the movement of markets or the credit markets, equity markets, or whatever. That can’t be a material adverse effect.

The market movement wouldn’t be a material adverse effect—that is, something that so drastically changes Twitter’s business situation that it voids the deal—for Elon, or for the banks? 

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Well, for either, if the financing contracts basically say, “We are going to echo whatever the definition is in the definitive merger agreement of a material adverse effect, which it looks like they do.” It’s a little cryptic, and [all we have from the contract] is general. But if that’s what it looks like, then their ability to walk away is only as big as Musk’s ability to walk away under a material adverse effect. And an MAE, the way that it’s defined in the merger agreement, basically excludes things like market swings as being an MAE. So one could imagine that a fairly significant market swing could be so large that in principle, someone that the lender, or the agent for the lenders, would not be willing to issue a solvency certificate.

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One of the key concrete conditions to closing besides just “oh, they got that paperwork done” and so forth is there’s got to be this solvency certificate that gets issued. And that is essentially under the lender’s control to do that. And so the most concrete way that one could imagine the lenders trying to walk away is saying, “Oh, check it out. We cannot get a solvency certificate given the nature of how markets have moved. They’ve been so extreme that given where Twitter is now, the nature, the level of financing on this deal and the market value of Twitter stock, this agent is no longer willing to attest to the solvency of the post-closing entity” That’s been tried before, if you go back about 13, 14 years to the Hexion versus Huntsman case. And in that case, the Delaware judge concluded that it was ginned up, that it was coached.

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And then that creates this problem, because if financing fails either because banks just say we’ve got cold feet and they’re pointing to a solvency certificate, and it looks like that’s just been ginned up with the explicit or implicit encouragement of Musk, then it doesn’t matter whether his financing has failed. The court likely would say, “Yeah, we understand that, but you’re not going to be able to benefit from your own self-sabotage. So we’re going to construe the agreement to say you got to close anyway. Sorry your financing failed, sorry you sabotaged it, but you’ve got to close anyway.”

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Consider a chaos scenario, then. On the one hand, there’s either a smoking gun that Musk is trying to tank his financing so he can avoid buying Twitter, or there is just so much silence that it’s clear that he’s not trying to secure his financing. But on the other hand, the banks also make a good case that the market has swung so wildly that this new Twitter can’t be solvent, so they cannot finance it. What happens then? 

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That definitely is what happens when matter hits antimatter. I want to watch from a distance, because I think it’ll be pretty interesting to see how it shakes down.

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There’s an interesting echo-chamber aspect to this as well, though, because if the lenders come forward and say, “Oh, we can’t attest this company would be solvent,” that probably is going to be in some way based on their assessment of Twitter’s market value. But if people are thinking, “Eh, they’ve only got a sketchy chance at winning,” then Twitter’s market value might start creeping up pretty close to $54.20. There’s almost a sense in which if it does that, it becomes even harder to assert the problems with solvency, which then reinforces the $54.20 price.

On the other hand, if people thought that they were going to be successful, then that stock price would probably creep down from where it is right now. And then it becomes easier for them to make that court case in which the stock price would creep down even further. There’s definitely some interesting echo chambers, vicious circularity, about how this might play out, which I think in some ways just is an accelerant on the collision between matter and antimatter.

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