The justification Elon Musk provided for terminating his Twitter acquisition is the kind of argument that almost never succeeds in court. In fact, the relevant court has only ever accepted it once before.
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After weeks of hand-wringing and second-guessing Twitter about the share of the platform’s users who are real, Musk announced on Friday that he intends to pull out of his $44 billion purchase. Twitter’s board chairman quickly responded that the company has no plans to let that happen, setting up a showdown in the Delaware Court of Chancery.
Musk’s main argument, though he has others, is that Twitter misled him by claiming only 5% of its active users are spam bots. Further, his justification for backing out of the deal is that the alleged misrepresentation could cause a “material adverse effect” on the company.
Successfully defending that stance, though, is going to be a heavy lift.
Only one court case in the history of the Chancery court has succeeded in arguing a deal should be broken because of material adverse effect.
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Healthcare group Fresenius Kabi successfully ended its plan to purchase generic drugmaker Akorn in 2018.
In that case, Fresenius had agreed to buy Akorn, but shortly after the agreement was inked, the company’s business “fell off a cliff.”
Akorn blamed its poor performance on unexpected competition and the loss of a major contract, but whistleblowers then came to Fresenius about claims that Akorn was failing to comply with regulatory requirements.
After a five-day trial, the Delaware Court of Chancery ruled that Fresenius’s push to end the deal was valid because Akorn’s financial performance after the deal was signed constituted a general material adverse effect, according to the National Law Review. The court also said that Akorn’s representations of its regulatory compliance would have been expected to result in a material adverse effect.
Despite Fresenius’s one-time success, Musk’s ability to argue successfully that Twitter misrepresented the number of fake users on its platform and that misrepresentation caused a material adverse reaction is unlikely, experts say.
“If it goes to court, Musk has the burden to prove more likely than not, that the spam account numbers not only were false, but they were so false that it will have significant effect on Twitter’s earnings going forward,” Ann Lipton, associate dean for faculty research at Tulane Law School, told Reuters.
The claim that Twitter misrepresented its spam bot numbers, though, is not the only complaint that Musk’s lawyers brought forward about Twitter.
Musk’s lawyers are also arguing that the social media giant breached the terms of the deal by failing to provide the billionaire with enough information about the spam bots. For this line of argument to succeed, Musk’s team wouldn’t need to show a material adverse effect. Rather, it would need to prove that Twitter broke the covenant between the two parties.
The merger agreement states that Twitter “shall (and shall cause each of its Subsidiaries to) furnish promptly to such Representatives all information concerning the business, properties and personnel of the Company and its Subsidiaries as may reasonably be requested in writing, in each case, for any reasonable business purpose related to the consummation of the transactions contemplated by this Agreement.”
Musk will try to argue that Twitter didn’t provide a sufficient amount of information after it was requested, although the argument becomes more complicated considering the open-ended word “reasonably” is in the agreement in reference to what information must be provided.
Additionally, the agreement states that from the time of signing until the deal is closed, Twitter must “use its commercially reasonable efforts to conduct the business of the Company and its Subsidiaries in the ordinary course of business.”
Musk’s lawyers also claim Twitter hasn’t been operating ordinarily since the deal was signed, noting that the company fired two high-ranking employees — its revenue product lead and the general manager of consumer products. The company also announced this month that it is laying off a third of its talent acquisition team. Musk’s legal team additionally noted that three other executives have resigned since the merger agreement was signed.
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The best result Musk can get from his attempt to back out would be a $1 billion fine. In order to do so, one of his arguments must be accepted by the court. The court could also force Musk to follow through on the purchase, or the two parties could settle outside of court.
