By: Andrew Elbaz and Zachary Janes - Securities and Capital Markets Group, Tamara Markovic - Litigation, and Birpal Benipal (Student-at-Law)

Elon Musk recently announced that he is backing out of his US$44 billion deal to acquire Twitter, Inc., an agreement the company is seeking to enforce through the U.S. courts. Can a billionaire walk away from a high-profile agreement to acquire a public company? In Canada, the terms of the agreement, the common law of contract, and relevant securities legislation are among various factors that would determine the legal outcome. 

Timeline of Events

Musk announced on April 5, 2022, that he purchased a 9.2% stake in Twitter, making him the largest shareholder of the social media platform. Musk then rejected Twitter’s offer for a seat on its board of directors in exchange for Musk agreeing to refrain from purchasing more than 14.9% of the company. On April 14, 2022, Musk publicly announced an offer to take Twitter private at US$54.20 per share for a total purchase price of approximately US$44 billion (the “Merger”). Musk and Twitter subsequently entered into a merger agreement dated April 25, 2022 (the “Merger Agreement”), to govern the transaction.

Musk announced on May 13, 2022, that the Merger was on hold pending investigation into the number of fake “bot” accounts on Twitter, accounts Twitter had claimed in public disclosures consisted of less than 5% of total users. Twitter subsequently gave Musk access to its comprehensive user data.

From April 14 to May 16, 2022, Musk’s tweets on the status of the deal and the inquiry into the number of bot accounts on the platform coincided with a 21% decline in Twitter’s share price (approximately US$6 billion in lost value). In response, Twitter’s shareholders filed a proposed class action lawsuit in California on May 25, 2022, alleging, among other claims, that Musk’s tweets and untimely disclosure regarding his Twitter holdings and the deal's status constituted market manipulation. The complaint alleges that Musk’s actions were designed to drive down Twitter’s stock price to improve his leverage in renegotiating the Merger Agreement at a lower price.[1]

Musk announced on July 8, 2022, that he was walking away from the Merger. By July 12, 2022, Twitter filed a lawsuit in the Delaware Chancery Court to pursue legal remedies for breach of the Merger Agreement. [2]

As of July 12, 2022, Twitter’s stock price had suffered an approximate 32% decline from the date the deal was first announced, fueling Twitter shareholders’ unease.

Implications under Canadian Contract Law

Whether Musk can walk away from the Merger will be determined under U.S. law. However, it serves as a useful case study in Canada.

Twitter Claims

Twitter claims that Musk breached the Merger Agreement by backing out of the Merger. Under common law of contract in Canada, Twitter would seek “expectation damages” for Musk’s breach of contract because such damages strive to put the party enforcing the agreement in the position they would have enjoyed had the agreement been fulfilled. Expectation damages are usually capped in large commercial transactions and, in this case, the Merger Agreement capped the damages Twitter could seek from Musk at US$1 billion. [3]

Limitation of liability clauses capping damages are generally enforceable in Canada unless the clause is considered unconscionable or contrary to public policy – conditions unlikely to be met in a negotiated contract between sophisticated parties.

This is a good thing for Musk. Musk agreed to purchase Twitter at US$54.20 per share at the time the Merger Agreement was executed. Twitter’s current price is around US$34 per share. Expectation damages sought for Musk’s breach of contract would be approximately US$15 billion (the difference between US$54.20 and US$34 per share) if there were no cap on damages.

Twitter may also decide to sue for specific performance, a contractual remedy where a party is ordered to perform its obligations under a contract. While specific performance is expressly permitted within the Merger Agreement, limitation of liability clauses apply to it as well.

In order to succeed in its claim for specific performance, Twitter will need to convince the court that monetary damages would be inadequate to remedy the harm caused by Musk’s breach of the Merger Agreement. It is unlikely Twitter would succeed in this argument before the Canadian courts. Among other reasons, it is unlikely that Twitter could convince a Canadian court to compel Musk to complete the purchase rather than pay the US$1 billion termination fee contemplated under the agreement.

Musk Misrepresentation Claims

In his termination letter filed with the U.S. Securities and Exchange Commission, Musk argued that Twitter had breached multiple provisions of the Merger Agreement. Musk claimed that, among other breaches, Twitter’s public disclosures materially misrepresented the number of fake users on the platform and that such misrepresentations have had, or are likely to have, a material adverse effect on Twitter’s business, financial condition or results from operations. [4]

Whether or not Musk will be able to abandon the Merger on this basis remains to be seen. Musk would have to amass sufficient evidence to rely on the termination provisions in the Merger Agreement, which would permit Musk to terminate the agreement if his above claims were true. [5] However, proving this in court will be no easy task given the quantity of data involved and the flux of Twitter users.

In Ontario, the Securities Act defines “misrepresentation” as (a) an untrue statement of material fact, or (b) an omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the light of the circumstances in which it was made. “Material fact” means a fact that would reasonably be expected to have a significant effect on the market price or value of the securities of the company in question. [6] In Twitter’s case, a significant discrepancy in the true number of bot accounts and the number disclosed publicly would likely constitute a misrepresentation given that the vast majority of Twitter’s revenue comes from advertisements, which are of course targeted at real users.

As with many high-profile commercial disputes, settlement may be an attractive option for both parties to avoid a costly and public legal battle. In any event, many Twitter shareholders will likely continue to feel that Musk’s actions manipulated the value of their shares.

Market Manipulation in Canada

Under Canadian securities laws, Twitter’s shareholders could pursue a remedy for market manipulation. Ontario’s Securities Act prohibits persons from engaging in any act that they know or reasonably ought to know results in or contributes to a misleading appearance of trading activity in, or an artificial price for, a security (such as publicly-traded shares). [7]

To succeed in proving market manipulation, prosecutors must meet a high evidentiary burden. Among other things, prosecutors must establish (a) the free-market supply and demand for the subject shares, and (b) that the free-market activity was distorted by the person in question.

These factors are difficult to prove. Consider the various factors involved in establishing the “real” market price amidst the current global economic downturn or the scrutiny necessary to determine the difference between a legitimate social media post and one that attempts to distort free-market activity.

An influential social media user such as Musk, whose tweets have been linked with multiple public share price depreciations, may appear the perfect case study to apply Canada’s market manipulation laws. However, until the current regulatory regime is reformed to address the impact of social media posts on markets, what is and is not legitimate market activity will remain a tricky issue for our judiciary and our prosecutors to determine.

Until then, Twitter shareholders – and for that matter, any shareholders subject to the whims of tweeters – may find their fortunes changed with a single tweet.

This article was prepared on behalf of the Minden Gross LLP Capital Markets Institute (MGCMI). The MGCMI seeks to publish relevant topics on securities laws, corporate governance and other topics affecting the Canadian capital markets community. The MGCMI holds regular educational seminars for colleagues, clients, and friends of Minden Gross LLP. If you have questions about this article or any securities and capital markets issues for your business, contact any member of the MGCMI group below. To be added to our email list, contact info@mindengross.com.

Andrew Elbaz
Chair - Securities and Capital Markets
e: aelbaz@mindengross.com
p: (416) 369-4329

Zohar Barzilai
Securities and Capital Markets
e: zbarzilai@mindengross.com
p: (416) 369-4164

Alexander Katznelson
Securities and Capital Markets
e: akatznelson@mindengross.com
p: (416) 369-4434

Michael Shafarenko
Securities and Capital Markets
e: mshafarenko@mindengross.com
p: (416) 369-4145

Zachary Janes
Securities and Capital Markets
e: zjanes@mindengross.com
p: (416) 369-4146

The information contained in this article does not necessarily reflect the views or opinions of Minden Gross LLP, or any of its lawyers, employees, or clients, and does not constitute legal advice. This information should not be acted upon without prior consultation with legal advisors.