As we get closer to the October 17th scheduled trial date for the Twitter lawsuit to compel Elon Musk to complete his proposed $44 billion acquisition of Twitter, the charges and allegations are getting wilder and woolier. Once, this was a case in which the party seeking to escape the merger agreement (i.e., Musk) asserted that the percentage of Twitter accounts that were “bots” (or fake) amounted to a “material adverse change” that permitted the buyer to back away. Given both Delaware’s strong commitment to deal certainty and Musk’s seemingly reckless indifference to due diligence, most law professors saw Musk as facing a decidedly uphill battle in the Delaware courts.

But now, new actors have appeared in this drama. Most notable is Peiter Zatko, a former computer hacker who somehow became Twitter’s security chief until he was fired in January 2022 (before Musk’s bid) and then paid $7.8 million in a private settlement with Twitter. He has accused Twitter’s senior management of willfully ignoring cybersecurity problems, the privacy rights of its customers, and basic integrity. Clearly, he is now the wild card in the case. For the Hollywood directors, who will cast the inevitable film based on the Twitter drama, an early question will be who should play the role of Zatko: Humphrey Bogart or Peter Lorre? In short, is Zatko a hero or a self-seeking blowhard?

In light of these developments, some question whether Musk would not do better suing in federal court for securities fraud, based on Rule 10b-5 (a claim that cannot be asserted in state court). In the Delaware court, Musk must show a material adverse change. Once the issue is framed this way, the advantage tilts toward Twitter because Delaware has a strong commitment to deal certainty and Musk, while sophisticated about social media, did little, if any, due diligence. Even if there were fraud, it is not clear that it would rise to the level of a material adverse change. In federal court, however, the “fraud on the market” doctrine would likely apply (while it does not apply in Delaware). Thus, individual reliance would normally not need to be shown. Conceivably, if Musk lost in Delaware, he might even seek to sue for securities fraud in federal court.

But here we come to the heart of the matter. In the Twitter Merger Agreement, two clauses — Section 4.25 (“No Other Representations or Warranties”) and, even more importantly, Section 5.11 (“Acknowledgement of Disclaimer of Other Representations and Warranties”) — arguably preclude Musk from relying on Zatko’s assertions.

Specifically, Section 5.11 states:

[The Musk team] has conducted to its satisfaction its own independent investigation, review and analysis of the business, results of operations, prospects, condition (financial or otherwise) or assets of [Twitter and its subsidiaries]. In making its determination to proceed with the transactions contemplated by this Agreement…, [it] has relied solely on the results of its own independent review and the covenants representations and warranties of…[Twitter] contained in this Agreement.

Section 5.11 then adds that:

Neither [Musk nor his affiliates] is relying on any express or implied representation or warranty, or the accuracy or the completeness of the representations and warranties set forth in Article IV with respect to [Twitter and its subsidiaries] or their respective business or operations in each case, other than those given solely by the Company in Article IV.

Put simply, this provision is close to a standard “non-reliance clause” that in effect says you can rely on nothing more than our express representations.[1] In an earlier day, these agreements were known as “Big Boy Letters” (as in: “We are Big Boys who do our own investigations”). Of course, express representations in the Merger Agreement remain actionable. Here, the most relevant express representation in Article IV of the Merger Agreement is that Twitter’s SEC filings since January 1, 2022 “complied in all material respects with the requirements of the Securities Act and the Exchange Act,” and did not contain any “untrue statement of a material fact” or other material omission. In this light, even if Twitter made some extra-contractual representations to Musk, these would not be actionable. Although the SEC filings cannot materially misrepresent, current SEC rules require little, if any, discussion as to Twitter’s compliance with prevailing cybersecurity norms.

Non-reliance and “Big Boy” clauses have been debated for years, but they are increasingly likely to be upheld, at least when the party who executed such a clause was truly a sophisticated “big boy” (as Musk is — both big and juvenile). In contrast, many of the allegations made by Zatko, the alleged whistleblower, seem extra-contractual and hence non-enforceable. In fairness, Delaware law does have some tension in it. In RAA Mgmt., LLC v. Savage Sports Holdings, Inc.,[2] the Delaware Supreme Court held that “[where a sophisticated investor]…agrees to perform due diligence with the understanding that the seller disclaims any warranty of accuracy or completeness in the information it provides to the potential buyer, the due diligence is governed by… a buyer beware notion, that even absolves theseller from intentional fraud.”[3] More recently however, in CLP Toxicology, Inc. v. Casla Bio Holdings LLC,[4] the plaintiff’s fraud claim survived despite a non-reliance provision, because the non-reliance provision represented only that the parties were not relying on extra-contractual representations (plaintiff’s claims apparently arose from contractual representations).[5]

In contrast, the Third Circuit (which is a jurisdiction in which a Rule 10b-5 action might be filed) takes a different position than Delaware. In AES Corp. v. Dow Chemical,[6] the Third Circuit ruled that a non-reliance provision does not automatically bar a Rule 10b-5 action where the plaintiff buyer could show a reasonable reliance upon the seller’s representations. Even when the parties are sophisticated, a non-reliance provision then does not provide complete immunity from a Rule 10b-5 claim (at least where the seller apparently concealed facts about the facility being purchased by the plaintiff).

Bottom Line: The Musk side needs to show an express representation that is clearly false and material. For example, if his side could show that Twitter altered documents or covered up serious problems, this could carry weight under the CLP Toxicology decision in Delaware. Absent such conduct, silence is seldom actionable. To sum up, non-reliance provisions are effective and can be the grim reaper of those who do not do due diligence.

Of course, there are still two weeks to go before the trial. The kaleidoscope could shift again (as it has repeatedly in the past), and new puzzles could emerge. Or, in the unlikely event that rationality broke out, the parties could even settle.

ENDNOTES

[1] Although Section 29(a) of the Securities Exchange Act prohibits waivers of compliance with the federal securities laws, the Supreme Court has permitted the parties to skirt this limitation. See Shearson/Am. Exp., Inc. v. McMahon, 482 U.S. 220, 228 (1987)(upholding mandatory arbitration in lieu of in-court litigation). The most common distinction that courts have made in reviewing non-reliance provisions is between those that waive compliance with the securities laws (which provisions are seldom upheld) and those that require the plaintiff to prove reasonable reliance on the misstated or omitted information. For recent New York decisions upholding such provisions, see Silver Point Capital Fund L.P. v. Riviera Resources, Inc., 155 N.Y.S. 3d 155 (1^st Dept. 2021), and McBeth v. Porges, 171 F. Supp. 3d 216, 221-22 (S.D.N.Y. 2016).

[2] 45 A. 3d 107 (Del. 2012).

[3] Id. at 109.

[4] 2020 WL 3564622 (Del. Ch. 2020).

[5] Id. at 16-17.

[6] 325 F. 3d 174, 176-177 (3d Cir. 2003).

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.