- Vox Nihili
- May 28, 2008
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Matt Levine broke down Elon's latest idiotic lawsuit. He called the underlying Twitter case really accurately, so I imagine he's probably correct here as well:
quote:Disclosure! A long time ago I used to work as a very junior mergers-and-acquisitions lawyer at Wachtell, Lipton, Rosen & Katz. The hours were way too long, but I remain fond of the firm and the people there. Meanwhile I have no real personal connection to Elon Musk except that (1) he keeps doing weird stuff financial stuff for me to write about, which I love and (2) he keeps doing it while I am on vacation, which I do not love. And so I went away on Friday and Musk did a thing. He sued Wachtell, which represented Twitter Inc. when Musk tried to get out of his deal to buy Twitter, claiming that Wachtell’s fee for that litigation — $90 million — was too big. I just want to be clear up front about my biases.
Wachtell is a fairly small law firm that makes a specialty of sell-side public-company M&A work. It is “among the most profitable firms in the US.” Those facts are related. Sell-side public-company M&A work is a pretty lucrative legal specialty.
Partly this is for the usual obvious reasons: It is high-stakes, complicated, high-pressure, high-dollar stuff. But there is another reason that is perhaps less obvious, which is that your clients don’t pay your bills. Here is how a public-company merger works:
A company decides to sell itself and hires lawyers.
The buyer does a lot of due diligence, looking into things like the company’s audited financial statements, to figure out how much the target company is worth.
A buyer signs an agreement to buy it for some fixed price, say $54.20 per share, in cash, to all of the target’s shareholders. [1]
After the agreement is signed, there is a delay of several months before it closes, during which the companies get regulatory approvals to merge, the target’s shareholders vote on the deal, the buyer lines up financing, etc.
During that delay, the target continues operating as an independent company, making its own business decisions with limited coordination with the buyer.
The agreement contains a covenant saying that the target will operate “in the ordinary course of business” and won’t make any drastic changes, pay out any huge bonuses, etc., so that, when the deal closes, the buyer gets more or less the same company that it thought it was buying. But with a big public company, this covenant can’t be all that fine-grained; the company just has to be able to continue making business decisions. For one thing, its own expert executives need to make lots of decisions to preserve the target’s value for the buyer when the deal eventually closes. [2] Also though the deal might not close: What if the shareholders vote no, or the buyer doesn’t get its financing? Then the company will need to be ready to stay independent. The executives need to keep running the company on behalf of its shareholders until the moment the check clears and the merger closes.
Eventually the deal closes, the buyer pays the cash, it becomes the owner of the target, and it can do whatever it wants. It can fire the executives, make the business decisions, etc.
At closing, the buyer pays the amount of cash that it agreed to pay in the merger agreement. If it agreed to pay $54.20 at signing, it pays $54.20 at closing, even if circumstances have changed over the intervening months. If the market fell, or the target company had a bad quarter, or if its expenses got a bit out of hand, the buyer still pays the same amount.
You could imagine a different system: The buyer could get a price adjustment for changes in cash; it could agree to pay, like, “$10 billion, but if the target has less than $500 million of cash at closing, we will reduce the price by the difference.” And this is not uncommon in private-company M&A: If the seller of the target is a private equity firm, it can agree to a price adjustment. It is harder in public deals, though, mostly because the target company’s public shareholders have to vote on the deal, and you need to tell them the price so they can have an informed vote. And so public deals don’t really have price adjustments for things like how much cash is left in the target at closing. [3]
Instead, they just have that “ordinary course” covenant: If the target spends much too much money between signing and closing, the buyer can walk away, say “you didn’t operate in the ordinary course like you promised, so I don’t have to close.” Or it can threaten to walk away, and use that to renegotiate the price. (There are other covenants and representations that have to be true at closing. A big one is the “material adverse effect” representation; if the company spends so much money that it causes a material adverse effect on its business, the buyer can walk away. But that’s hard to do.) But if the target spends somewhat too much money between signing and closing, there is not a lot the buyer can do about it: It probably can’t walk away from the deal unless the spending is too egregious and out-of-the-ordinary-course, and it can’t just cut the price to make up for the target’s extra spending.
The result is that every dollar that the target company spends between signing and closing is free, to the target’s shareholders. They get their $54.20 per share no matter what; the cash left in the company’s treasury is no longer their concern. Every dollar that the target spends is the buyer’s problem.
Or rather, that’s true as long as the merger closes. You can’t spend too drunkenly, if you’re the target, because the merger might not close — either because your drunken spending might violate the ordinary-course covenant and give the buyer a reason to walk away, or for unrelated reasons (antitrust, financing, etc.).
If you are the target company’s law firm, and you have successfully negotiated a merger agreement that the target is happy with, you can send them a bill for, I don’t know, $90 million, and they’ll be like “sure whatever looks great, it’s not our money!”
They’re not gonna pay that bill right at signing, because if the deal doesn’t close they will want the money back. But they’ll happily pay it just before the closing, when it is no longer their money.
There are some constraints on the fees. There is that “ordinary course” covenant, saying that the target company can’t do anything too egregious between signing and closing. There may be some more specific disclosure of the target’s fee arrangements — there normally is specific disclosure of its bankers’ fee arrangements — at signing, so if the target tells the buyer at signing “we have agreed to pay our lawyers $10 million” and then pays them $90 million there might be a breach of the covenant. (Though, again, the remedy for that breach is probably refusing to close the deal, not getting the money back.) And of course there is generally the fact that the target company’s executives would like to remain employed by the buyer, so they don’t want to spend the buyer’s money too aggressively. (Unless they are pretty sure that they won’t remain employed, in which case, who cares!) But these are pretty soft constraints.
And so if you are the target’s lawyers in a public M&A deal you can kind of send them a bill for whatever amount you like, and they will be like “hahaha great here you go, enjoy it,” and you will be like “we sure will,” and it’s all the buyer’s money and who cares.
If the deal doesn’t close, though, you are not going to get paid that much, because in that case the money really does belong to the target’s shareholders, and they’ll need it. But your job, as the target’s lawyer, is to make sure the deal closes! [4] The incentives are aligned.
Wachtell was not actually Twitter’s M&A law firm; it did not negotiate its deal to sell itself to Elon Musk for $54.20 per share. But when Musk decided to back out of the deal, Wachtell came in as Twitter’s lawyers to sue Musk into closing the deal. In this, Wachtell was entirely successful: Twitter sued Musk a year ago tomorrow, there was some fighting in court, and in October Musk dropped his opposition and closed the deal on its original terms. For this success, Twitter paid Wachtell a $90 million success fee. “The $90 million fee collected from Twitter for a few months of work on a single matter represented nearly 10% of Wachtell’s gross revenue in 2022, and over $1 million per Wachtell partner,” notes Musk’s complaint.
Musk complains that this fee was too big. It was big! But it was agreed to by Twitter’s legal department and board of directors, who ran the company and got to decide how much to pay the lawyers. Musk complains that Twitter’s legal department and board of directors were “lame duck fiduciaries who had lost their motivation to act in Twitter’s best interest” because they were about to sell it to Musk:
Fully aware that nobody with an economic interest in Twitter’s financial well-being was minding the store, Wachtell arranged to effectively line its pockets with funds from the company cash register while the keys were being handed over to the Musk Parties.
But this is wrong. Up to the moment before closing, Twitter’s managers and board of directors were fiduciaries for their existing shareholders, and their fiduciary duty was, essentially, to make sure that Musk bought Twitter. They did their fiduciary duty, which involved suing Musk to get him to close the deal. The moment before closing, they could not have been fiduciaries for Musk, [5] who was trying to hose the shareholders by getting out of the deal he had agreed to.
Everyone at Twitter who negotiated this fee agreement will say that they were happy with Wachtell’s work and even happier that Musk is mad about it. But also every Twitter shareholder who got Musk’s $54.20 is happy with Wachtell’s work! The person unhappy with their work is the guy whom they beat in court. Of course he’s unhappy! Because they did good work! If Elon Musk were happy with Wachtell’s work then their work would have been very bad.
Musk complains that the fee violated the “ordinary course” covenant:
Wachtell and Twitter’s directors and officers also knew that the Merger Agreement contained a provision that, in the words of an expert retained by Wachtell in connection with the merger litigation, was drafted to prohibit Twitter executives from agreeing to certain expenses prior to closing “outside the ordinary course of business in a manner that might ultimately harm the acquiror.”
Now, this can’t be right. The argument here is that if Musk frivolously tried to get out of the merger agreement, and Twitter hired good lawyers to sue him to force him to close, then that would give Musk a way out of the merger agreement, because hiring expensive lawyers is not in “the ordinary course of business.” But even if it were right, then all it means is that Musk could have gotten out of the deal because Twitter overpaid its lawyers. But he didn’t get out of the deal, it’s too late now, and there is no provision for him to demand the money back.
Musk complains that the fee was too big because the case was simple:
Wachtell was one of six large law firms that represented Twitter in connection with the merger litigation, a relatively straightforward breach of contract dispute in which Twitter sought to hold the Musk Parties to the Merger Agreement and to close the transaction. While there were important factual disputes, there were not novel or difficult questions of law involved, nor did the litigation require any special skills beyond that which Twitter could have procured by paying hourly rates to many other reputable law firms with experience litigating in the Delaware Chancery Court, including those hired to work alongside Wachtell.
It was incredibly easy to beat Musk in court, says Musk, in court. Elon Musk does not abide by his contracts, and so you have to sue him to get him to keep his contracts, but when you sue him you will win, says Elon Musk, in a court case in which he is trying to get out of a contract. Musk, I should say, employed several high-powered and expensive law firms to take the losing side of the merger dispute. (Though maybe he didn’t pay their bills either?) It seems silly for him to fault Twitter for hiring expensive lawyers to beat him in a “relatively straightforward” dispute, when he was hiring expensive lawyers to lose it.
And the litigation was very valuable, to Twitter’s actual shareholders: Beating Musk in court, as opposed to losing to him, was probably worth about $25 billion to Twitter’s shareholders. Paying Wachtell 0.3% of the value recovered as a success fee seems pretty reasonable. Especially since shareholders didn’t pay it! The Wall Street Journal notes:
Bruce MacEwen, a legal consultant, said a $90 million payment didn't seem like a lot given that the acquisition deal was valued at $44 billion. "This does not strike me as out of line," said MacEwen, president of consulting firm Adam Smith, Esq.
If Wachtell was instrumental in getting Twitter the $44 billion price after Musk tried to get out of the deal, he said, that provided value. "Did old Twitter get its money's worth or what?" he said.
A $90 million payment isn't unusual for such a consequential case, said law-firm consultant Kent Zimmermann from Zeughauser Group. "I'd be surprised if Wachtell was faulted for the amount they charged, considering the stakes and the outcome," he said.
Wachtell is known to be a leading law firm for cases like the Twitter one, he added. "There's a limited supply of firms like Wachtell and a lot of demand for them, which drives the price up," he said.
Anyway though Musk’s complaint has lots of fun details about how Wachtell’s billing works. It’s a little casual:
Both the August 26 Hourly Invoice and the September 28 Hourly Invoice were approved for payment despite flagrantly improper billing practices. For example, six Wachtell timekeepers … billed a combined $2,200,893.75 in those two invoices with completely blank time entry descriptions. One Wachtell associate billed approximately $935,000 across the two invoices, with all of her time entry descriptions limited to either “strategy” or “factual analysis” without further elaboration.
Though all of this is much more detailed than the final bill, which is just “for all legal services relating to the acquisition of Twitter by Elon Musk through the closing: $90,000,000.00.” [6]
The final bill was based not on hours devoted to strategy or otherwise, but on deal size: Wachtell sent Twitter a memo [7] justifying its $90 million fee, which says that “as we discussed, in engagements relating to pending transactions as to which a premium fee is contemplated, our Firm often receives a fee in the range of 60 to 80 percent of the fees paid to investment advisors.” That’s pretty good! If you are the law firm getting paid 60% to 80% of the fees paid to the investment banks on a deal, you are doing better than the banks:
Many big deals have multiple banks, so each bank is probably getting something like 50% or less of the total banking fees. If the law firm is getting 60%, that’s more. [8]
Banks are largely in the business of marketing mergers, and a banker will spend a lot of time doing unpaid work pitching deals to companies for every one deal she completes and gets paid for. Lawyers are much more likely to work on actual deals and get paid for them.
There is also this on the timing of that payment:
Immediately following the Twitter board’s rubber-stamp approval, [Twitter Chief Legal Officer Vijaya] Gadde signed Wachtell’s letter agreement. Then, to ensure that the eleventh-hour fee payment went through before the Musk Parties (Twitter’s new owners) could learn about the massive gift included in that fee, [Twitter General Counsel Sean] Edgett expedited the wire payment on the invoice for the balance ($84,294,962.97) of the $90 million total fee that Wachtell had submitted to Twitter the day before. Twitter’s $84 million wire to Wachtell was posted only ten minutes before Gadde and Edgett were terminated upon the closing of the merger.
Yes! Right! Ten minutes is the normal amount of time. If you pay Wachtell a $90 million success fee 30 minutes before closing, you haven’t had your success yet: What if something goes wrong in those 30 minutes, the deal doesn’t close, and Wachtell keeps the money? If you pay Wachtell a $90 million success fee 10 minutes after closing, you might not pay: “You” 10 minutes before closing are the company who hired Wachtell as your trusted adviser to sell yourself; “you” 10 minutes after closing are the guy who bought the company after negotiating against Wachtell. The right time to pay Wachtell’s giant bill is minutes, perhaps seconds, before closing.
Now, Musk did tell Twitter not to do this. He complains that Twitter paid the fee even though he told them not to:
The Musk Parties moved up the scheduled closing of the Merger Transaction by one day to October 27, 2022. At 5:11 a.m. (8:11 a.m. Eastern) on the morning of October 27, counsel for the Musk Parties sent a directive on behalf of their client instructing Twitter, Inc. “to immediately discontinue all outbound payments and other disbursements to third parties in order to assist Mr. Musk’s funds flow preparations for the completion of the pending merger.” See Exhibit 16 (the “Closing Day Directive”). The Closing Day Directive also provided advance instructions “in anticipation of the imminent completion of the merger” with respect to “outbound payments and disbursements to third parties following completion of the merger,” explicitly including “outside advisors, including, without limitation, financial advisors, legal advisors, accounting advisors, litigation experts, and all other external advisors.” The Closing Day Directive was an unequivocal statement on behalf of Twitter’s residual claimants of the corporation’s preference to pause outbound payments pending that day’s closing so that the company’s new owner could have “a reasonable opportunity to review such payments.”
Well! He sent Twitter a letter [9] :
Asking Twitter not to pay any bills before closing, and
Instructing Twitter not to pay any bills after closing.
One second after closing, Musk owned Twitter, and could tell Twitter not to pay any bills. (And he did, and he has gotten sued for it.) But one second before closing, Musk did not own Twitter, and Twitter could pay all the bills it wanted to. He asked it not to, and it did anyway, and that was fine. “Twitter executives ignored the first half of the Closing Day Directive and instead accelerated Twitter’s outbound payments to third parties,” complains Musk.
By the way, it is not totally clear to me whether Musk knew the size of Wachtell’s bill before closing. The complaint says this:
Around this time, the Musk Parties requested details from Twitter regarding its expected transaction expenses, including legal fees. On October 11, 2022, Twitter emailed Wachtell to request an estimate of Wachtell’s October fees “assuming a closing date of 10/28/22.” Wachtell does not appear to have ever sent that estimate or any details regarding its hourly billing or expenses—let alone an invoice or its hourly fees and expenses—in connection with its work on the merger litigation after August 31, 2022.
But it also says that on Oct. 14, “Twitter circulated a draft chart of transaction expenses to its counsel and listed $95 million for Wachtell’s fees,” and that on Oct. 24, they agreed on $90 million and Twitter said “we can update our transaction expenses file.” My assumption is that Twitter did send Musk a list of transaction expenses before closing, and Musk didn’t focus on it until afterwards, but I am not really sure.
In any case, what I do know is that (1) Musk asked for the list of transaction expenses before closing and (2) he “moved up the scheduled closing of the Merger,” so he must have either gotten what he asked for or decided he didn’t care. You could imagine Musk demanding a list of transaction expenses, not closing the deal until he got it, getting it, reviewing it, saying “this Wachtell bill is too big,” and refusing to close the deal until it was renegotiated. Or you could imagine him settling the merger litigation by signing some sort of settlement agreement that covered, among other things, litigation expenses. But he didn’t do that. He settled the merger litigation by saying “never mind, I’ll close the deal,” not a negotiated settlement but a pure capitulation. And then, once he did that, he closed the deal as quickly as possible. He did everything impetuously, and one result of that is that he paid a $90 million fee to the law firm that beat him. And now he is complaining! Fine. But it is only his fault.
Anyway now Musk owns Twitter, after paying $44 billion for it, and he is using it to talk about the size of his penis. These facts are also related.
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Jul 11, 2023 18:21
