What did business journalists do before the arrival of Elon Musk? In those by-gone days, their page in the newspaper was gray, dull, and strewn with statistics. Now, it is filled with a continuing soap opera, as exciting as the sports page because it has drama, intrigue, and high emotion. The trash-talking that one hears in the NBA playoffs pales in comparison with Musk’s daily name-calling.
Currently, it appears that Musk wants to re-negotiate his $54.20 share price for Twitter because he offered a price well over Twitter’s peak value in an overheated market. That market is no longer overheated and may decline a good deal further. Never has the generalization that hostile bidders tend to overpay appeared truer. If Musk had to pay $54.20 per share for Twitter, he could lose a substantial portion of his net worth and probably have to give back to Jeff Bezos the title of “World’s Richest Man.” To avoid this fate, Musk is hoping to rely on a provision in the merger agreement that limits liability for financial damages to $1 billion. But another provision makes reliance on this provision dangerous: The agreement also contains a “specific performance” clause. In principle, Twitter could ask a court to rule that Musk had to consummate his offer and close the deal at $54.20 per share. Would a Delaware court do this? In other recent cases, the parties have not been confident enough to wait for the court to rule, and so have settled. Thus, LVMH was able to negotiate only a small reduction in its offered price for Tiffany’s in 2020 based on its claim that Covid-19 had caused a “material adverse change” at Tiffany’s.
Musk seems in an even weaker position. He did not undertake any real due diligence, actually waiving it; he sought and received no representations about the percentage of fake accounts (or “bots”) on Twitter, but repeatedly showed considerable awareness of this problem. This is precisely the profile of a person who cannot expect to succeed with a claim of “material adverse effect” or otherwise expect much judicial sympathy.
Of course, Musk could ignore his lawyers and decide to gamble (as he has done before). But suppose the court rules against him. Musk may now have to post an extraordinary bond to appeal. And, being Elon Musk, he might even fail to comply with the terms of the injunction. He has already shown a seemingly reckless willingness to defy the terms of a settlement he signed with the SEC.
Musk’s exposure is compounded by the fact that he faces a potential two-front war. That is, the SEC could also sue him, both because (1) he made a late filing of his Schedule 13D when he crossed the 5 percent threshold at Twitter, and (2) he has repeatedly announced his strategy and intent in Delphic tweets without any accompanying SEC filing. If his plans changed, he was obligated to amend his Schedule 13D. If there is any mystery here, it is why the SEC has been so patient, bending over backward to avoid a confrontation with a person who regularly insults it.
Assume hypothetically the SEC does sue Musk, alleging that (1) he violated Section 13D by his late filing; (2) given this breach of duty, his purchases of Twitter stock after the date his filing was due amounted to insider trading (or at least a violation of Rule 10b-5); and (3) his constant tweets were attempts to manipulate the market. These theories can be debated at some length, but assume in any event that a federal court grants the SEC a preliminary injunction. Still, unrepentant and as outspoken as ever, Musk continues to tweet. Of course, the SEC can seek to hold Musk in contempt, but suppose it has an alternative idea: Under Section 21(d)(2) of the Exchange Act, the Commission could ask a federal court to prohibit Musk “from acting as an officer or director” of any “reporting” issuer. This bar could be temporary or permanent, and it could be “conditional” or “unconditional.” In effect, this is the SEC’s “nuclear option.”
To even seek such a remedy would send tsunami-like shock waves through the market. Remember that Musk has a following on Twitter of between 80 and 90 million persons, probably more people than can identify what the initials S-E-C stand for (the plurality of the American public would likely respond with the name of a football conference in the Southeast).
But the SEC need not start with a proceeding in court. It could offer a settlement where he was disqualified for only a period of years (Martha Stewart, it will be recalled, agreed to such a multi-year settlement following her conviction). At last, the SEC may have found a threat that will make Musk pay attention. Also, the standard under Section 21(d)(2) is not that demanding. The SEC must only show that “the person’s conduct demonstrate unfitness to serve as an officer or director of any such corporation.”
But here we need to pause and recall that Musk is the iconic entrepreneur who built Tesla into the world’s most valuable auto company (at least for the present). Barring him from Tesla’s management would certainly injure Tesla’s stock price and its shareholders. Further, his alleged unlawful acts do not directly relate to Tesla. One possibility then is that the SEC could seek only to disqualify him from serving on Twitter’s board or as a Twitter officer. But then who would control Twitter, which Musk is seeking to buy in order to radically reform it? These considerations may make it very difficult to convince a federal judge to bar Musk from serving as an officer or director of either firm.
That leaves one last possibility: A court could find that Musk was unfit to serve as an officer or director, but then stay its order so long as Musk fully complied with the federal securities laws and ceased to tweet about Twitter and Tesla (he could still tweet about politics, Trump, and Biden). This might be enough to make Musk cautious – but we are not sure yet if Musk is capable of caution.
Let’s return to Twitter’s likely lawsuit against Musk. Rare as orders of specific performance have been, this infrequency may be attributable both to the fact that the clause is not commonly used and that the parties generally settle, rather than wait for a court to rule. But suppose a court does order Musk to buy Twitter at $54.20. Given the recent decline in high-tech stock prices, the $54.20 price is now extremely high, and the private investors who once were willing to join with Musk to finance the acquisition may no longer be willing to pay what has become a very inflated price.
So what would Musk have to do? Although his “wealth” is extraordinary, it is nearly all in Tesla’s stock. Tesla’s stock price has sunk like a stone since April (as much as 35 percent to 40 percent, depending on the date used). Multiple reasons explain this decline ( including problems in China and lawsuits against him for discrimination and harassment). Still, another major reason for the Tesla share decline may be that the arbs expect that Musk will be forced to sell a huge block of Tesla’s stock ($10 billion or more) to pay any settlement with Twitter. Such a sale should depress Tesla’s stock price. The result is an irony: The better that Twitter (and its shareholders) do in their negotiations with Musk, the worse that Tesla (and its stockholders) will do. The two stocks are inversely related.
Suppose that the parties do not settle, and a court orders Musk to pay the $54.20 price. Vainly but characteristically, he refuses. We are now in the world of contempt penalties. The Delaware Chancery Court could conceivably impose a continuing penalty of $100,000 a day until he complied. A lesser daily contempt penalty was recently imposed on Donald Trump by a New York State judge, and Trump did eventually pay it. But such a penalty is chicken feed for Musk (only about $36.5 million a year – well below the termination penalty). The alternative is to order Musk to prison until he complies. He would then hold the keys to his own jail door – a fascinating spectacle. In a civil case, of course, use of jail as a contempt sanction is highly unlikely. One would have to thumb one’s nose at the judge to incur such a penalty. But Musk has done that before also!
The first rule for a person who has dug himself into a deep hole is to stop digging. Musk may not have yet learned that lesson! If he is rational, we should expect that he will quietly negotiate a settlement with Twitter, but the premise here that he is rational remains open to question.
This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.