RICCI HACKNER: Would Elon Musk have won case based on material adverse change?

Nothing has been more gripping for merger & acquisition (M&A) attorneys then when celebrity entrepreneur Elon Musk agreed to buy Twitter for $44bn in April. The drama that has unfolded has been more exciting than any Kardashian on-off relationship.

In summary, Musk planned to walk away from the takeover; then Twitter sued Musk in Delaware in an effort to compel him to complete the deal, which was scheduled for October 17.

Musk counter-sued, with a suit that would be heard during the same trial, and argued, among other things, that the company had suffered a material adverse change, or substantial reduction in its value that rendered the deal invalid.

Ultimately Musk agreed to complete the deal, putting an end to the legal process.

The acquisition was interesting for a number of reasons from a corporate perspective, one of which was whether the closing condition in the agreement that excused Musk from having to complete the deal if a material adverse change occurred and ensued, would have got him off the hook if the case proceeded to court.

Musk’s argument centred on the number of spam accounts or bots on Twitter’s platform, which he claims is underplayed by the company, and was expanded to include revelations about information security at the company from a whistle-blower.

In our fantasy court scenario, it would have been exciting to see how this would have been argued, and what the Delaware courts would have decided. There is a dearth of case law on material adverse change in SA, which is why what transpires in the Delaware courts are always of interest to us.

The material adverse change defence’s prospect of success seemed dubious at best. Let’s consider a few of the glaring inadequacies of the clause:

First, the definition of what constituted a material adverse change in the agreement omitted any reference to Twitter's “prospects”. It is common for material adverse change definitions to include references to the target’s “prospects”. However, targets generally will be reluctant to agree to include prospects, because its inclusion reduces deal certainty.

Then, an effect must be “durationally significant” to constitute a material adverse change, unless there are clear contractual provisions to the contrary. This means Musk would have had to convince the court that the bot issue would be a long-term problem.

Lastly, material adverse change clauses should set out specific, objective tests for what events will constitute a material adverse change. The bot issue was not specified in the agreement and should have been included in the definition if it was always a concern for Musk. Consequently, its likely Musk would have been obliged to prove a material adverse effect on Twitter's Ebitda.

It is an extremely heavy burden to establish the existence of a material adverse change in the Delaware courts. One of the very few instances was, for example, in 2018 when the Delaware courts allowed German healthcare group Fresenius Kabi to terminate its $4bn merger agreement to buy generic drugmaker Akorn as a result of a material adverse change.

A key takeaway from this judgment is that the court not only examines the deterioration of the target but also how the acquirer acts in the process of first trying to close and then terminate the deal (Musk’s actions could arguably have acted against him in this regard).

It is unlikely that the court would have allowed Musk to walk away from the deal, which is why we assume he decided to stick with it. It seems to have been his least-bad option. In April the Twitter board was lambasted for accepting a price that was too low ($54.20 per share).

However, as the market and the stock has plunged since then, the board consequently sealed a really good deal for its shareholders. By taking the company private, Musk will not need to regularly answer to shareholders and can make changes without the prying public. To quote Musk, “the bird is freed”. Whether it will fly remains to be seen.

• Hackner is knowledge & learning lawyer: corporate, at Bowmans SA.