Page 12 - Delaware Lawyer - Fall 2022

FEATURE | TWITTER V. MUSK
Contract Claims
As discussed above, Musk would be permitted to escape the deal if he could show Twitter had suffered an MAE whether due to misrepresentations in the agreement itself, or for other reasons. The key misrepresentations he seized upon, and that attracted most of the media at- tention, were Twitter’s statements regard- ing its “monetizable daily active users,” or mDAU, which translated to a rough estimate of the number of real humans — rather than bots or spam – regularly using the platform who could respond to advertisements. After the whistleblower’s allegations that Twitter was violating the terms of a Federal Trade Commission set- tlement, had shaky claims to its intellectual property, and was vulnerable to sundry other data security flaws, Musk amended his counterclaims to include these allega- tions too, accusing Twitter of misrepre- senting additional aspects of its business.
A key problem for Musk — and one that would continually haunt his contract claims — was that he made little to no at- tempt to connect any of these purported flaws to Delaware’s standard for an MAE, namely, “an adverse change in the target’s business that is consequential to the com- pany’s long-term earnings power over a commercially reasonable period.”5 The contract would not allow an easy escape for inaccurate representations or other shortcomings of any less severity.
Musk additionally argued that Twit- ter breached its own covenant to supply information for any “reasonable business purpose related to the consummation” of the merger by denying him access to in- formation about Twitter’s spam detection and mDAU figures. While superficially an interesting claim, it soon became clear the information he sought seemed less related to consummating the deal than seeking a basis for rescinding it. Moreover, Twitter’s information-sharing obligation expressly permitted it to withhold information if disclosure could “cause significant com- petitive harm” to the company — a risk
that seemed more pressing as Musk began tweeting proposals to start a competing so- cial media platform if the Twitter deal was not consummated.
Finally, Musk claimed that by freezing its hiring and conducting layoffs, Twitter breached its obligation to operate in the ordinary course of business between sign- ing and closing. But that covenant only represented that Twitter use “commercial- ly reasonable efforts to conduct the busi- ness ... in the ordinary course,” a phrase that Delaware has interpreted to mean in accordance with peer companies.6 Because layoffs and hiring freezes were widespread in the tech sector at the time, this argu- ment, too, seemed sketchy at best.
Common-Law Fraud Claims
As an alternative basis for rescinding the contract, Musk argued that he had been defrauded, and he focused on the same “misrepresentations” that formed the basis of his contract claims — namely, false user counts, misrepresentations re- garding legal compliance, data privacy, security and similar matters. Musk faced obstacles here as well: for a fraud claim, Musk would not only need to prove scien- ter on the part of Twitter’s management — for which he offered no evidence — but he would also need to establish that he relied on the purported misstatements. To outsiders, however, it seemed appar- ent that Musk had not relied on anything, diving into the deal on an apparent whim, repeatedly declaring (again via tweets) that one of his major contributions to Twitter would be to fix its “bot prob- lem.” Moreover, an important provision of the merger agreement specified that Twitter was not making any representa- tions that were not expressly included in enumerated representations and war- ranties.7 Finally, Twitter’s own disclosure about its spam-fighting efforts seemed so heavily lawyered and caveated that it would be odd for any reasonable person to rely on them without also impounding an enormous margin for error.8 To most outside observers, then, Mr. Musk’s fraud
claims seemed even more dicey than his contractual defenses.
Texas Securities Act Claims
States have “blue sky” laws that regu- late the sale of securities within their terri- tory. These are typically used to police local frauds perpetrated against retail investors, such as affinity frauds that target retirees. Like the federal Securities Act, many blue sky laws provide a rescission remedy when securities are sold on the basis of misstate- ments, even if the misstatements were negligent rather than intentional, and even if there has been no showing that the in- vestor relied on them. Because these are mandatory laws, they cannot be evaded by contract: the law that controls is that of the jurisdiction with the materially greatest interest in the transaction, regardless of any agreements to the contrary.9 Texas has its own blue sky law,10 which is apparently why Musk invoked it in his battle with Twitter. If he could convince a court that Texas law applied by default, and had a materi- ally greater interest in the dispute, it would trump the selection of Delaware law in the merger agreement, and he might have been able to rescind the contract based on false statements alone, notwithstanding the lack of a material adverse effect, a lack of reliance, and a lack of intent by Twitter.
This was the least developed argument before settlement. But had the case pro- gressed in this direction, Twitter surely would have argued that there were no false statements on which to base a rescission remedy, and it may have argued that Tex- as’s law should not cover merger transac- tions involving public companies. But the most significant (and we believe decisive) response would have been about Delaware itself. Delaware is famously protective of its status as the nation’s producer and arbi- ter of corporate law. If Musk were able to sidestep a heavily negotiated merger agree- ment merely by invoking his presence in Texas during part of the negotiations,11 it would severely undermine Delaware’s dominance as a clear and predictable lode- star for merger agreement disputes (not
10 DELAWARE LAWYER FALL 2022