Hey, Musk changed his mind. Twitter's suit going nowhere.
Twitter’s Lawsuit Against Elon Musk Looks Like a Loser
The company probably can’t prove damages, and its shareholders weren’t a party to the agreement.
By J.B. Heaton and M. Todd Henderson, WSJ
July 13, 2022 8:42 am ET
Twitter has sued Elon Musk, seeking to compel him to buy the company for $54.20 a share. Many observers think the company will prevail, or that Mr. Musk is likely at least to pay the $1 billion breakup fee. They’re wrong. He is likely to walk away largely unscathed, a belief reflected in Twitter’s stock price. This case will be a good lesson on the limits of boilerplate merger agreements and the difference between a corporation and its shareholders.
The merger agreement in this case could be read in a way that permits a court to order Mr. Musk to buy Twitter—he and two entities he controls agreed they would “not oppose” such an order—through a remedy known as “specific performance.” Although litigation is always uncertain, it is hard to imagine a court would force the purchase of a $44 billion corporation.
Specific performance is used fleetingly, and for good reason. It is the ultimate act of coercion, and it makes sense only when there is no alternative. If one agrees to sell Hearst Castle, but tries to back out when a higher bid emerges, a court may specifically enforce the contract. There is only one Hearst Castle, and no other remedy can make the jilted buyer whole.
But where alternatives exist, other remedies usually make more sense. Imagine the contract was to paint Hearst Castle, and the painter walked away. A court would be reluctant to force the painter to do the job. No one wants to have his house painted by someone under court order. A coerced painter might skimp on quality, which could require the court to get involved again.
For this reason, Delaware courts have rarely ordered specific performance in merger agreements. If Mr. Musk doesn’t want to buy Twitter, it doesn’t make much sense for a court to make him do so. Twitter might be worse off under his ownership at this point, a fate Twitter’s board is legally obligated to try to avoid. There are also other potential buyers for Twitter.
What happens if the court orders specific performance and Mr. Musk refuses? The only means the court has to compel him to line up financing and affix his signature to a deal is by holding him in contempt if he refuses. But it isn’t Mr. Musk that promised to buy Twitter, but two entities under his control. The court could hold them in criminal contempt, but as Lord Thurlow observed, “corporations have neither bodies to be punished, nor souls to be condemned.” Mr. Musk promised to “cause” these entities to consummate the deal, but a court is unlikely to jail him if he shirks or refuses. Mr. Musk could play a high-stakes game of chicken that ultimately reveals that courts are extremely limited in cases like this if the parties don’t want to play along.
Damages are easier to enforce. The court could order the painter who walked away to pay the difference between the price agreed and the price of hiring a replacement. In the case of Twitter, however, this remedy seems unavailing. It isn’t clear how Twitter is made worse off by Mr. Musk’s walking away. Twitter shareholders are surely worse off because the merger agreement would have cashed them out at $54.20 a share. But the shareholders aren’t party to the agreement. Only Twitter Inc. is a party, and it is a separate and distinct legal entity. Twitter would have to prove harm, such as lost profits, and that’s an uphill battle.
Twitter could have raised the stakes for Mr. Musk by including a requirement that he pay damages to its shareholders if he walked away. In that case, the shareholders could have sued for the difference between the amount Mr. Musk agreed to pay and the price any other suitor would pay—like the homeowner finding another painter. But the merger agreement doesn’t give shareholders this remedy.
The issue of the $1 billion breakup fee remains. Courts will be much more likely to make Musk pay to walk away than force him to walk down the aisle. But it isn’t clear he will have to pay that much. Breakup fees are supposed to reflect damages caused by a breach of contract. They aren’t supposed to act as a penalty. Given that Twitter isn’t obviously worse off by $1 billion—if at all—a court might balk at imposing such a high fee.
This case highlights an important risk to shareholders in mergers and acquisitions: The corporation that negotiates the deal may not have much of a case against a breaching counterparty because the corporation, unlike its shareholders, usually isn’t harmed when the counterparty walks away. The easy fix is to give shareholders the right to sue for their losses. But either Mr. Musk’s lawyers were too smart for that or Twitter’s weren’t smart enough.
Mr. Heaton is managing member of an investment research firm. Mr. Henderson is a law professor at the University of Chicago. They are co-founders of Heaton Henderson LLC, a corporate governance consultancy.