Inside the Merger Agreement between Elon Musk and Twitter

May 02, 2022

In what seems like one of the speediest transaction processes ever for a deal of its size, Twitter agreed on April 25, 2022 to be acquired by Elon Musk for $54.20 per share or about $44 billion.  It all started with Musk disclosing on April 4 that he had taken a 9.2% stake in Twitter, followed by Twitter announcing the next day that it will appoint Musk to the board, Musk declining the appointment around April 11 and offering on April 13 to buy the company for $54.20 per share, Twitter adopting a poison pill on April 15, Musk announcing on April 21 he had secured $46.5 billion in funding commitments and finally the announcement on April 25 that the parties had signed a merger agreement (the “Merger Agreement”).  Only 12 days elapsed between offer and signing, and only four days between the funding announcement and signing.  That’s about as speedy a transaction as a SpaceX rocket.

Elon Musk’s acquisition of Twitter (the “Acquisition”) is structured as a reverse triangular merger, meaning that a shell subsidiary of the acquirer (or of an entity controlled by the acquirer) merges into the target with the target surviving as a wholly-owned subsidiary of the acquiring entity.  Musk formed two entities to effectuate the merger, X Holdings I, Inc. (“Parent”) and its wholly-owned subsidiary, X Holdings II, Inc., which will merge into Twitter at the closing with Twitter surviving as a wholly-owned subsidiary of Parent.  Parent is wholly owned by Musk.

Poison Pill Exemption

Before signing the Merger Agreement, Twitter first had to exempt Musk from the poison pill the company adopted in the form of a preferred stock rights agreement.  Under the rights agreement, if anyone crossed a 15% ownership threshold, all stockholders other than the 15% holder would have had the right to buy new shares at a 50% discount, resulting in massive dilution to the acquirer. The purpose of the poison pill/rights agreement was for the Twitter board to buy time and build leverage by effectively forcing Musk to negotiate with the board rather than launch a tender offer directly to the stockholders.   A useful feature of the rights agreement is that the board retained the right to amend the agreement without the consent of the rights holders. To avoid having the Acquisition trigger the pill, Twitter amended the rights agreement on April 25 to provide that neither the execution of the Merger Agreement nor the Acquisition itself will trigger the pill.

Material Adverse Effect

From the outset, Elon Musk’s offer for Twitter generated a great deal of skepticism.  He didn’t have either the cash or (initially) the funding, and his own credibility was called into question, not least because of his infamous 2018 tweet that he was “considering taking Tesla private … funding secured”, for which he was sued by the SEC for securities fraud.  So the Merger Agreement contains several features that are intended to protect Twitter and its stockholders from Musk walking away.

Most acquisition agreements allow the buyer to walk away if the target has suffered a material adverse effect (“MAE”) between the signing of the agreement and the closing.  The devil in this detail is what exactly constitutes a MAE.  The current trend with MAE clauses, particularly when the seller has some amount of leverage, is to include a long list of specific circumstances that are expressly stated to not constitute a MAE.

The Merger Agreement contains nine such MAE carveouts: (i) changes to the industry, (ii) changes to any law or to GAAP, (iii) general economic, regulatory or political conditions, or in the financial, credit or securities markets, in the U.S. or anywhere in the world, (iv) any act of God, force majeure, terrorism, cyberattack, war, etc., (v) any epidemic pandemic (including COVID-19), any measures in reaction thereto, or any political or civil unrest, (vi) the negotiation, execution, announcement or consummation of the Merger Agreement, including the identity of Elon Musk or his financing sources, (vii) any action taken pursuant to the Merger Agreement or will the consent of Musk or his affiliates, (viii) changes in Twitter’s stock price or trading volume, failure to meet analyst estimates or credit rating changes (unless thing giving rise to the foregoing is itself a MAE not otherwise excluded), and (ix) anything previously disclosed in an SEC filing.

Reverse Breakup Fee

Buyers often seek to protect themselves against the target terminating the deal and agreeing to be acquired by a third party bidder making a superior offer.  The standard protection for buyers in this regard is a breakup fee that the seller would be required to pay to the buyer if the seller accepts such a third party offer.  Sellers, on the other hand, also have an interest in protecting themselves against a buyer walking away other than for failure of the target to satisfy a condition to closing.  The remedy to the seller is referred to as a reverse breakup fee, payable by the buyer.

The Merger Agreement requires Musk-owned Parent to pay Twitter a reverse breakup fee equal to $1 billion if the conditions to Parent’s obligations to close are satisfied and Parent nevertheless fails to close, or if Parent breaches any of its representations, warranties or covenants in a manner that would cause a closing condition to not be satisfied.  Importantly, Elon Musk agreed to provide a limited guarantee in favor of Twitter to back up Parent’s obligation to pay the reverse breakup fee.  The Merger Agreement also requires Twitter to pay a breakup fee to Musk if Twitter enters into a definitive agreement with a third party bidder for a “superior proposal”, defined as a proposal to acquire at least 90% of Twitter or of its assets that the Twitter board determines in good faith is more favorable to Twitter’s stockholders than the Musk offer.

Ordinary Course Covenant

Buyers also typically seek protection against a target making significant changes to its business or its assets between signing and closing, such as terminating employees, customers or suppliers.  The applicable protection here is in the form of a covenant to operate the target in the ordinary course in between signing and closing, coupled with a right to terminate if this covenant is breached.

The Merger Agreement’s ordinary course covenant, however, has two important features that protect Twitter against Elon Musk using ordinary course as an excuse to walk away.  First, Twitter’s obligation with regard to operating in the ordinary course is qualified by “commercially reasonable efforts”, i.e., it must use “its commercially reasonable efforts to conduct the business of [Twitter] in the ordinary course of business”.  Many practitioners believe that “best efforts”, “reasonable efforts” and “commercially reasonable efforts” represent a hierarchy of standards to determine the level of effort that must be employed by the target to satisfy its ordinary course obligation, with “best efforts” demanding the greatest effort and “commercially reasonable efforts” the least.

The second pro-seller feature here is a carveout for COVID-19 measures.  The covenant states that Twitter must use commercially reasonable efforts to conduct its business in the ordinary course between signing and closing “except with respect to actions or omissions that constitute COVID-19 Measures”.  “COVID-19 Measures” are defined broadly to include every conceivable response to COVID-19 and any variants, mutations or associated epidemics, pandemics or disease outbreaks, including quarantine, “shelter in place,” “stay at home,” workforce reduction, shut down and closure, whether recommended or promulgated by any governmental authority, or other reasonable actions taken in response to the foregoing.

No-Shop

But not everyone is ready to concede that the Twitter board did its job of adequately protecting the stockholders (at least not when there’s potential money to be made).  One plaintiff’s firm has already reared its inevitable head, announcing it is investigating Twitter for possible breaches of fiduciary duty and other violations of law in connection with the Acquisition, and inviting stockholders to “join the action”.  The firm’s press release alleges the Merger Agreement unreasonably limits competing bids by prohibiting solicitation of further bids and imposing a significant penalty if Twitter accepts a superior bid.  That’s a reference to the Merger Agreement’s “no-shop” restriction and the aforementioned $1 billion breakup fee.  The no-shop provision prohibits Twitter from soliciting any offer from, or engaging in negotiations with, or furnishing any material non-public information to any third party relating to a possible competing acquisition proposal.  The Merger Agreement does provide Twitter with a fiduciary out, however, allowing Twitter to speak to third parties if the board determines in good faith that such discussions could result in a superior proposal.