ProfessorBainbridge.com

How does Delaware decide cases so quickly?

Matt's theory is that " It is the expertise within Chancery’s broader ecosystem – both bench and bar – that fuels the court’s performance." Makes sense to me.

— Steve Bainbridge (@PrawfBainbridge) August 14, 2022

Corporate social responsibility can backfire

John List & Fatemeh Momeni, 2017. "When Corporate Social Responsibility Backfires: Theory and Evidence from a Natural Field Experiment," Natural Field Experiments 00618, The Field Experiments Website.

Corporate Social Responsibility (CSR) has become a cornerstone of modern business practice, developing from a "why" in the 1960s to a "must" today. Early empirical evidence on both the demand and supply sides has largely confirmed CSR's efficacy. This paper combines theory with a large-scale natural field experiment to connect CSR to an important but often neglected behavior: employee misconduct and shirking. Through employing more than 3,000 workers, we find that our usage of CSR increases employee misbehavior - 20% more employees act detrimentally toward our firm by shirking on their primary job duty when we introduce CSR. Complementary treatments suggest that "moral licensing" is at work, in that the "doing good" nature of CSR induces workers to misbehave on another dimension that hurts the firm. In this way, our data highlight a potential dark cloud of CSR, and serve to forewarn that such business practices should not be blindly applied.

David Skeel on The Corporation as Trinity

I am reminded of a line of dialogue from the musical 1776. After Richard Henry Lee returns from Virginia with the proposal for independence, Edward Rutledge states:

"Mr. President, although we of South Carolina have never seriously considered the question of independence, when a gentleman proposes it, attention must be paid."

This came to mind as I read my friend David Skeel's CLS Blue Sky Blog post, The Corporation as Trinity. I have seriously considered the question of corporate personhood. It is a doctrine for which I have very little patience. But when a scholar such as Skeel proposes it, attention must be paid.

Christian theology, as brilliantly explicated in [St. Augustine's] The Trinity, states that God consists of three different persons – the Father, the Son, and the Holy Spirit – but is a single divine being. Drawing on recent work by the theologian Curtis Chang, I argue that corporate personhood has similar qualities and that the analogy is not accidental. According to Christian scripture, the universe is a reflection of God. If this is true, the echoes – in particular, echoes of the Trinity – extend even to human institutions such as corporations. Much as theologically orthodox Christians understand God to be both one and three, I argue that corporations are best seen as having a corporate identity distinct from their managers, shareholders, and other constituents and reflecting the qualities of these constituents. ...

The Trinitarian perspective combines attributes of both the aggregate and the real entity theories of the corporation. The distinction is that the Trinitarian perspective insists that both theories are needed, rather than one or the other.

He elaborates on the argument in a paper posted to SSRN.

I mused on the nature of corporate personhood in my post The corporation is not a real entity and to argue to the contrary is "transcendental nonsense." In it, I confessed that:

I have a very practical mind. Most abstract reasoning strikes me as metaphysical mumbo jumbo. ... Put simply, I just can't wrap my head around the metaphysical abstractions required to think of the corporation as an entity--real or otherwise--rather than as an aggregate. Being unable to perform the mental gymnastics necessary to "thingify" the corporation, I am happy to find such a distinguished precedent for dismissing the effort so blithely. 

The precedent to which I referred to was Felix S. Cohen's wonderful article, Transcendental Nonsense and the Functional Approach, 35 Colum. L. Rev. 809 (1935). In it, he referred to the question of where a corporation is located as "a question identical in metaphysical status with the question which scholastic theologians are supposed to have argued at great length, 'How many angels can stand on the point of a needle?'”

To that confession I must now add that, for me, analogizing the corporation to the Trinity doesn't help much. For while it is the case that I believe in the Trinity (I give it what we Catholics call religious assent), I don't claim to understand it. I take comfort in C.S. Lewis' point that while the Trinity is something that is ultimately beyond our intellectual understanding, we can experience it. Or, as Lewis explained, “We cannot compete, in simplicity, with people who are inventing religions. How could we? We are dealing with Fact. Of course anyone can be simple if he has not facts to bother about.”

If you're more comfortable with metaphysics and philosophy that I am, however, you likely will find Skeel's analysis helpful. Conversely, if you're not, you would still benefit from reading Skeel's article. After all, I'm still trying to understand the Trinity.

In sum, attention must be paid to Skeel's article because it's a wonderful example of intellectual arbitrage. Few other scholars would be so smart, adventurous, and widely read to pull off such a feat.

A Critique of Hart and Zingales "New Corporate Governance"

Oliver Hart and Luigi Zingales are pushing a concept they call the "New Corporate Governance," none of which is exactly new and from which I must dissent.

They start with two anecdotes: The 2021 approval of a shareholder proposal at Dupont "requiring the company to disclose how much plastic it releases into the environment each year and to assess the effectiveness of DuPont’s pollution policies." Actually, their description of the proposal is inaccurate in an important way. The proposal does not require such a report, it merely requests such a report. This is important because part of their claim is that we are seeing (and should see even more of ) a shift towards a more shareholder-centric model of corporate governance.

The other anecdote is the 2021 approval of a shareholder proposal at ExxonMobil "requiring the company to describe 'if, and how, ExxonMobil’s lobbying activities … align with the goal of limiting average global warming to well below 2 degrees Celsius…'" Once again, they misdescribe the proposal. In fact, as with Dupont, the actual proposal was a request not a mandate.

Based on these anecdotes, they argue that:

It is hard to explain this behavior using the dominant corporate governance paradigm, according to which shareholders have a single objective: shareholder value maximization (SVM). In the above examples, shareholders seem to be pushing companies to do things that might reduce value. Many scholars have criticized the SVM paradigm, arguing that managers should act in the interest of other stakeholders – workers, consumers, the community – or that companies should have a social purpose over and above making money.

It turns out that lawyers are not the only ones who think data is the plural of anecdotes.

When we look at the data it remains the case that the majority shareholder proposals in the ESG space (i.e., environmental, social, and governance) still fail. According to Gibson Dunn's analysis of the 2021 proxy season, in 2021, environmental proposals averaged 42.% support, while social proposals averaged 30%.

Should Shareholders Vote on Corporate Strategy?

Hart and Zingales contend that these anecdotes tells us that the traditional norm of shareholder value maximization (SVM) is neither what shareholders prefer nor socially optimal.

In a classical world of perfect competition, complete markets, and no externalities, SVM will be unanimously favored by shareholders and will lead to a socially efficient outcome. These results still hold in the case of externalities as long as these externalities are perfectly regulated by the government. But what happens if the government has not regulated optimally, a particular concern when an externality is global, as with climate change, and coordination by many governments is required for optimal mitigation? There is then no reason to think that SVM will be unanimously favored by shareholders or be socially efficient. Consider the above DuPont example. Some shareholders may favor a less-polluting technology, even if it is more costly, because plastic waste affects them directly or they care about the effect of the waste on others. Other shareholders may not be personally affected or may care less about the welfare of others and so would like to stick to the current technology.

Hart and Zingales therefore want "to allow shareholders to vote on company strategy."

I could not disagree more.

No serious scholar of corporate law denies that shareholders have heterogenous preferences. In fact, however, it is precisely for that reason that SVM is the preferable decision-making norm and that corporate governance is board- rather than shareholder-centric.

In my book, The New Corporate Governance in Theory and Practice, I explain that claim at considerable length. But a short version of why shareholder heterogeneity leads to board-centric governance is available in an older post here.

As my colleague Iman Anabtawi observed: “On close analysis, shareholder interests look highly fragmented.” Iman Anabtawi, Some Skepticism About Increasing Shareholder Power 4 (unpublished manuscript on file with author). She documents divergences among investors along multiple fault lines: short-term versus long-term, diversified versus undiversified, inside versus outside, social versus economic, and hedged versus unhedged. Shareholder investment time horizons are likely to vary from short-term speculation to long-term buy-and-hold strategies, for example, which in turn is likely to result in disagreements about corporate strategy. Even more prosaically, shareholders in different tax brackets are likely to disagree about such matters as dividend policy, as are shareholders who disagree about the merits of allowing management to invest the firm’s free cash flow in new projects.

Consequently, as I explain in The Case for Limited Shareholder Voting Rights, it is hardly surprising that the modern public corporation’s decision-making structure precisely fits Kenneth Arrow’s model of an authority-based decision-making system. Overcoming the collective action problems that prevent meaningful shareholder involvement would be difficult and costly, of course. Even if one could do so, moreover, shareholders lack both the information and the incentives necessary to make sound decisions on either operational or policy questions.  Under these conditions, it is “cheaper and more efficient to transmit all the pieces of information to a central place” and to have the central office “make the collective choice and transmit it rather than retransmit all the information on which the decision is based.”  Accordingly, shareholders will prefer to irrevocably delegate decision-making authority to some smaller group.

What is that group? The Delaware code, like the corporate law of virtually every other state, gives us a clear answer: the corporation’s “business and affairs ... shall be managed by or under the direction of the board of directors.”  Hence, as an early New York decision put it, the board’s powers are “original and undelegated.” Manson v. Curtis, 119 N.E. 559, 562 (N.Y. 1918). 

The central argument against shareholder activism thus becomes apparent. Active investor involvement in corporate decision making seems likely to disrupt the very mechanism that makes the public corporation practicable; namely, the centralization of essentially non-reviewable decision-making authority in the board of directors. The chief economic virtue of the public corporation is not that it permits the aggregation of large capital pools, as some have suggested, but rather that it provides a hierarchical decision-making structure well-suited to the problem of operating a large business enterprise with numerous employees, managers, shareholders, creditors, and other inputs. In such a firm, someone must be in charge: “Under conditions of widely dispersed information and the need for speed in decisions, authoritative control at the tactical level is essential for success.”  While some argue that shareholder activism “differs, at least in form, from completely shifting authority from managers to” investors, it is in fact a difference in form only. Shareholder activism necessarily contemplates that institutions will review management decisions, step in when management performance falters, and exercise voting control to effect a change in policy or personnel. For the reasons identified above, giving investors this power of review differs little from giving them the power to make management decisions in the first place. Even though investors probably would not micromanage portfolio corporations, vesting them with the power to review board decisions inevitably shifts some portion of the board’s authority to them. This remains true even if only major decisions of A are reviewed by B. The board directors of General Motors, after all, no more micromanages GM than would a coalition of activist institutional investors, but it is still in charge.

If Government is the Problem, Corporations are not the Solution

Note, by the way, that Hart and Zingales' argument depends on a multinational failure of governments to regulate optimally. This is actually a very old argument. 

Back in the 1930s E. Professor Merrick Dodd’s pro-corporate social responsibility argument rested in large part of the belief that society demanded that business assume social responsibilities.  Forty years later, liberals were still arguing that society was plagued by a host of urgent social ills and that, there being no time to wait for the political process to solve them, business should take the lead. They believed that business could effect social change faster and more effectively than politics.

Setting aside the inconsistency of this argument with democratic principles, does it make sense to draft the corporation to tackle social ills the government can’t or won’t solve?

A core problem thus is that most directors and officers likely lack the skill set necessary to make decisions about ESG issues. If asked to resolve the more complex and difficult questions required by stakeholder capitalism, managers therefore would need to acquire much new information and expertise.  As long as they lack such information and skills, asking managers to focus on such questions will inevitably distract them from ensuring that their company makes money for the shareholders.

Even if managers had the requisite knowledge and skills, they probably have a very weak idea of what shareholders would prefer with respect to social issues.  Of course, some large shareholders can communicate their preferences to management. Larry Fink’s annual letters to the CEOs of BlackRock’s portfolio companies are but the best known example of this phenomenon. Yet, as we’ll see below, those shareholders often act in ways that are inconsistent with the messages they are sending. Should management pay attention to what these investors say or what they do? In addition, it is hardly clear that Larry Fink’s preferences are representative of that of investors as a class, especially that of small retail investors.

Finally, corporate executives lack incentives to solve social ills especially insofar as those ills fall outside their enterprise’s business. Put another way, while business may have incentives to deal with the negative externalities produced by the enterprise’s activities, they lack incentives to generate positive externalities that bestow benefits on society without generating a return for their shareholders.  To the contrary, managers’ incentives are aligned more closely with the shareholders’ interest in value maximization than with ESG concerns.

 

We are 40th

@BrianLeiter ranks law professors by H-scores. I'm in 40th place. My @UCLA_Law colleagues Eugene Volokh (48) and @rickhasen (63) are also on the list. As are corporate law giants Lucian Bebchuk (6), Jon Macey (13), and Bernie Black (14) https://t.co/mWee3X2721

— Steve Bainbridge (@PrawfBainbridge) August 11, 2022

How pro-business is the Roberts SCOTUS?

Lee Epstein and Mitu Gulati report:

A decade and a half into its life, we ask: How pro business is the Roberts Court? Using a simple objective measure – how often does business win in the Court when it is fighting a non business – we find that the Roberts Court may be the most pro business Court in a century. The win rate for business in the Roberts Court, 63.4%, is 15 percentage points higher than the next highest rate of business wins over the past century (the Rehnquist Court, at 48.3%). The question is why? It is tempting to conclude that this pro business result is purely a function of there being a Republican majority of justices on the Roberts Court. The data suggest that the story is more complex. Additional features that emerge from the data are: (a) It is not just the Republicans on the Roberts Court who are more pro business than in prior Courts, but the Democrats as well; (b) The Government, through the SG’s office and across both Democratic and Republican administrations, has been much more supportive of business positions than in prior eras; (c) An elite Supreme Court bar has emerged in recent years and businesses have hired them disproportionately so as to better influence the Court.

Epstein, Lee and Gulati, Mitu, A Century of Business in the Supreme Court, 1920-2020 (August 3, 2022). Virginia Public Law and Legal Theory Research Paper No. 2022-55, Virginia Law and Economics Research Paper No. 2022-16, Available at SSRN: https://ssrn.com/abstract=4178504 or http://dx.doi.org/10.2139/ssrn.4178504

The Business Lawyer's Symposium "The ESG Movement: Law, Economics and Values,” includes my paper "Don’t Compound the Caremark Mistake by Extending It to ESG Oversight"

Symposium behind a paywall.

My article behind a paywall.

Doris Bainbridge, RIP: Obituary and Eulogy

Obituary

Doris Ellen Bainbridge, 95, of Lynchburg, Virginia, passed away on Saturday, July 23, 2022. Born in Williamsport, Pennsylvania, she was the daughter of the late Irvin A. and Ethel M. Gottschall.

As an Army wife, Doris lived in many parts of the U.S.A. and the world, including Germany and Korea. After her husband retired from the military, they settled in Nelson County. Doris later moved to Amherst, where she lived for over 30 years, before finally residing in Lynchburg.

She was an active member of Clifford Baptist Church, where she was the organist for many years. She also spent many happy years as a singer with The Ageless Wonders.

She is survived by her son and daughter-in law, Stephen M. and Helen C. Bainbridge, of Los Angeles, CA, her younger brother Robert, and several nieces and nephews.

In addition to her parents, she was preceded in death by her beloved husband Chaplain (COL) Clarence A. Bainbridge III (US Army), and two brothers.

Doris’ funeral will be held on Tuesday, July 26^th, at Clifford Baptist Church with her friend of many years Rev. Michael Fitzgerald presiding. Doris will be interred with her husband at Arlington National Cemetery. There will be no graveside service.

Donations may be made in lieu of flowers to the Clifford Baptist Church Building Fund, 635 Fletchers Level Rd, Amherst, VA 24521.

Eulogy

My mother Doris was born August 6, 1926, into a warm and loving family. In addition to her parents Irvin and Ethel, she had three brothers. Two, Don and Dick, have gone to be with the Lord. The third, Bob, sends his love.

Mom met my dad Clarence in 1944, while he was serving in the Coast Guard. He was the Captain’s cook, which was ironic because Dad could get seasick in a bathtub.

After they were married at war’s end, Dad felt a call to the ministry, which Mom always supported. After seminary, Dad felt a further call to serve the Lord as a chaplain in the military. Wisely, he opted for the Army instead of the Navy.

For the next thirty years, this small-town girl travelled the world. Germany. Korea. All over the US. My dad’s career took him away from home a lot, but Mom was always there for me. Our bond was unshakeable, even when I was a teenager, which is saying something. When Helen came into my life, Mom embraced her. She never interfered or criticized. She just loved us.

Despite her travels, Mom remained a small-town girl at heart and when Dad retired, they answered a call to be the pastor at Woodland Baptist Church. After Dad retired from Woodland, he and Mom joined Clifford. They both loved this Church. It became their spiritual home.

Mom loved the Lord. She loved the good old hymns, singing in the choir and playing the organ. Her daily devotions were no chore, but rather the most important part of her day. I know she wore out at least three Bibles, because I gave her replacements for Christmas.

My faith road diverged from Mom's when I became a Catholic in 2001, but she was okay with it. She knew we both loved the Lord, just in different forms. And that love was what mattered.

I am confident Mom is with the Lord now. I know she was not afraid of death, because she was confident that she had been born again and knew where she was going. In recent years, she had a lot of pain. Suffering never disturbed her faith, but she did wonder why the Lord was waiting. So, as Pastor Clyde said to me, I suspect the first thing Mom said to the Lord when she arrived in Heaven was “what took you so long?”

St. Paul said “I rejoice in what I am suffering for you, and I fill up in my flesh what is still lacking in regard to Christ’s afflictions, for the sake of his body, which is the church.” I’m no theologian but I know that the sort of redemptive suffering of which Paul spoke is one of the great mysteries of the faith. I may not understand it, but I believe it is part of God’s plan. God always has a reason, even if we are unable to discern it. Mom believed that too and bore her pains and sufferings with grace and dignity, confident that the Lord knew what he was doing.

In any event, Doris is at peace now. She would want us to remember her, but even more important she would want us to reflect on the state of our own souls. I expect Pastor Mike will have more to say about that, but I know from personal experience how deep Mom’s concern was that people come to a saving knowledge of Christ as their Lord and Savior. She dedicated herself to that task for almost 30 years as a pastor’s wife and for the last 36 as a widow.

In closing, Helen and I are deeply grateful to all of you. Living on the other side of the country for almost 30 years now, we didn’t see as much of Doris as we might have liked. But we knew she was in the bosom of dear friends whom she loved and loved her. Thank you all.

Gary Gensler's Regulation of Crypto by Persecution

2/ @GaryGensler's SEC has adopted Sporkin's approach and is aiming it straight at crypto assets. Instead of having Congress decide whether the SEC or CFTC (or Treasury) is the correct regulator, Gensler is using enforcement suits to seize jurisdiction.

— Steve Bainbridge (@PrawfBainbridge) July 22, 2022

3/ Having staked out his claim to crypto by dragging industry players into court, @GaryGensler is trying to make new law not by complying with the Administrative Procedures Act but by what Karmel might call "regulation by persecution."

— Steve Bainbridge (@PrawfBainbridge) July 22, 2022

Recommended Reading: Grundfest's "The Most Curious Rule Proposal in Securities and Exchange Commission History"

Grundfest, Joseph A., The Most Curious Rule Proposal in Securities and Exchange Commission History (April 25, 2022). Rock Center for Corporate Governance at Stanford University Working Paper No. 248, Available at SSRN: https://ssrn.com/abstract=4094133 or http://dx.doi.org/10.2139/ssrn.4094133

The Securities and Exchange Commission advertises itself as a disclosure-based agency that eschews merit regulation. It logically and historically provides greater investor protection to less sophisticated investors. The Commission’s proposed Private Equity Rules, however, reject both principles. They would transform the agency into a merit regulator that provides greater “investor protection” to more sophisticated than to less sophisticated investors.

The world’s most sophisticated investors dominate the market for venture capital, hedge, and private equity fund investing. They are represented by expert counsel. Yet, with no evidence of market failure, the Commission would prohibit these most sophisticated of all investors from entering into fully disclosed contractual provisions that they are free to reject but willingly accept. This is merit regulation in a market that least requires merit regulation.

This transition to merit regulation is fraught with peril. Once the agency merit regulates in the absence of market failure, it invites special interest pleading by other constituencies seeking to further parochial interests. It will be difficult for the Commission to articulate a principled basis for adopting some forms of merit regulation but not others. The inevitable result is a more politicized agency that can no longer credibly limit its mission to disclosure regulation.

Moreover, while the Commission would prohibit the world’s most sophisticated investors from agreeing to certain contractual provisions, it would allow the least sophisticated to be bound by precisely the same conditions. The Commission nowhere analyzes or defends this odd inversion which conflicts with large bodies of law and precedent.

If the Commission’s rationales for adopting the proposed rules are sufficient under the Administrative Procedures Act, then the Commission will have established a foundation for far more muscular intrusions into a broad range of contractual arrangements involving publicly traded instruments and private placements. Put another way, if the SEC can so aggressively regulate the substance of freely negotiated contracts involving the most sophisticated investors absent evidence of market failure, it follows, a fortiori, that it can regulate most other contractual arrangement involving less sophisticated investors subject to its jurisdiction. Much more is therefore at stake than a set of specialized rules impinging on freely negotiated contracts involving venture capital, hedge, and private equity funds. The proposed rules implicate foundational questions about the SEC’s role and authority in governing US capital markets that should not be minimized or ignored.

This draft is in the form of a comment letter submitted to the Commission, and is being converted to a law review article for future publication.

JB Heaton and Todd Henderson Respond: They Think Twitter's Lawsuit is a Loser

I offered JB Heaton and Todd Henderson an opportunity to do a guest post responding to my post, Does Twitter's Lawsuit Against Elon Musk Really Look "Like a Loser"?, which had commented on their WSJ oped on the lawsuit:

J.B. Heaton and Todd Henderson

July 18, 2022

Thank you to the inestimable Steve Bainbridge for allowing us the opportunity to discuss the Twitter v. Musk lawsuit here. In our discussions with investors betting on the outcome, we heard that they all read Steve’s blog, confirming it as the essential place for corporate law commentary. This is a close case, and we are grateful for and fascinated by the ongoing debate.

Our Wall Street Journal commentary has provoked considerable discussion. Some of it serious and excellent (such as Steve Bainbridge on this blog and Yair Listokin Jonathon Zytnick in the New York Times); some of it the equivalent of the ranting of a hypoglycemic child. Some of it agrees with us; some of it does not. Of course, that’s why we have such opinion pieces: to state an opinion, usually on one side of an issue that might be seen differently by different people. Our original piece rose out of our own discussions on the Twitter v. Musk lawsuit, and primarily in response to what we saw as a chorus of agreement that Elon Musk was almost certain to be forced to close the deal he and his holding corporations made with Twitter, Inc. Clinical professors of marking, professional pundits, news anchors, and even constitutional law professors were suddenly experts on corporate law and M&A, and they all thought it was obvious that Musk would be forced to buy Twitter, even though it is far from clear this is something anyone (other than merger arbs invested in Twitter stock) wants to happen. If the Delaware courts are going to get this right, we thought it important to offer the other side of the case.

Our point is that specific performance is by no means the sure thing many pundits claim. The proof of the reasonableness of our view is in the pudding of Twitter, Inc.’s stock price. That stock price closed on Friday, July 15, 2022 at $37.74. The deal price that so many believe Musk will be ordered to pay is $54.20. As a back of the envelope calculation, if the average of all of the possibilities for the stock price without specific performance is, say $30.00, then the current stock price reflects about a 32% chance of specific performance. Maybe the case will settle for an amount less than $54.20, but if it were clear specific performance was an obvious option for Twitter, that settlement would be about $54.20 minus the cost of litigation, or about $54.20.  There are many ways to think about the possible outcomes of course, but there is no question that people with real money on the line are not viewing specific performance as even more likely than not, and definitely not as the slam dunk many commentators claim.

Could the Delaware Chancery Court order specific performance and could that ruling be affirmed on appeal? Of course. We don’t think otherwise. Has the same court ordered specific performance in the past? Of course. Enough times so that “rarely” is the wrong word? Perhaps. Remember, we had editors at the Wall Street Journal and they love to punch up their pieces. If we’d been mealy mouthed and hedged like lawyers do, we are doubtful the debate today would be as joined and as valuable as it is.

The question is whether specific performance is likely here. This case is not the same as the prior cases. For one thing, Musk’s lawyers at Quinn Emanuel will leave no stone unturned on the remedy of specific performance. This will not be IBP v. Tyson Foods, the 2001 case where then-Vice Chancellor Leo Strine observed that “[a]lthough Tyson’s voluminous post-trial briefs argue the merits fully, its briefs fail to argue that a remedy of specific performance is unwarranted in the event that its position on the merits is rejected” and where VC Strine observed that “[t] his gap in the briefing is troubling.” Quinn Emanuel won’t make that mistake. This case will be as much about the remedy as Musk’s defenses on the merits.

It should also be noted that the Tyson case was under New York law, not Delaware as in the Twitter case, that the court took into consideration the impact on all of the various corporate stakeholders, not just shareholders, and, most importantly, in asking whether the opportunity was truly “unique,” the court asked the same question we did in our oped, and noted that the decision to require specific performance was not one the court was confident about. In other words, in a highly contextualized analysis, the court found the case to be about a coin-flip.

In the Twitter case, Quinn Emanuel is likely to home in on the serious legal problem in Twitter, Inc.’s case with respect to specific performance: Twitter, Inc. is not obviously even harmed by the breach.

Corporations, as all readers of this blog know, are legally separate and distinct from their shareholders. Suppose a corporation enters into an agreement to merge with another entity, and under that agreement the corporation will cancel its existing shares, giving its then-former shareholders the right to receive money from the acquirer, although that money never enters the corporation itself. If the acquirer breaches its agreement and refuses to close, the shareholders will not receive the money promised to them by the agreement but the corporation itself will receive $1 billion (in the form of a termination fee) that it did not have before and would not have received if the merger proceeded. What rights do the shareholders have under Delaware law if the merger agreement disavows them as third-party beneficiaries for purposes of enforcing the agreement? Can the corporation itself ignore the benefit it receives from breach (the $1 billion termination fee) to ask a court to specifically enforce the merger agreement and, if it does, would it be lawful for the Delaware courts to award specific performance?

We think this is the situation presented by the case of Twitter v. Musk. There is an agreement and plan of merger among Twitter, Inc., a Delaware corporation, and X Holdings I, Inc. and X Holdings II, Inc. In the merger agreement, X Holdings I, Inc. is known as the Parent and X Holdings II, Inc. is known as the Acquisition Sub. The merger agreement reflects a plan for a so-called reverse triangular merger under which Acquisition Sub merges into Twitter, Inc. with Twitter, Inc. surviving to become a wholly-owned subsidiary of the Parent. Under the merger agreement, Twitter, Inc. cancels its existing shares and replaces them with certificates that then-former Twitter, Inc. shareholders can take to a bank acting as paying agent, receiving $54.20 for every former share of Twitter, Inc. stock held as reflected in the certificates.

Twitter, Inc.’s shareholders before the merger becomes effective are not parties to the merger agreement, and the merger agreement disavows those shareholders as third-party beneficiaries except as to a provision limiting Twitter, Inc.’s money remedies to a $1 billion termination fee, the purpose of which is to bind Twitter, Inc.’s shareholders to that part of the agreement without giving them wider rights. The merger agreement also entitles Twitter, Inc. to that $1 billion termination fee as one of three possible and mutually exclusive remedies, the other two being, first, a damages remedy capped by the amount of the termination fee ($1 billion) and so no better than and possibly worse than the termination fee and, second, the right to ask for specific performance.

On July 8, 2022, Musk (who is also a party to portions of the merger agreement), Parent, and Acquisition Sub purported to terminate the agreement. Twitter, Inc. sued Musk, Parent, and Acquisition Sub in Delaware Chancery Court alleging that the termination was wrongful and that the court should order Musk, Parent, and Acquisition Sub to close under an equitable remedy of specific performance.

Suppose that the Musk termination was wrongful. Should the court grant specific performance? To both lay persons and lawyers who spend little time on the legal distinction between a corporation and its shareholders, the appealing answer is, Yes. After all, Musk, Parent, and Acquisition Sub made a deal with Twitter, Inc. and under that deal the Twitter, Inc. shareholders would receive $54.20 per share, a huge premium over the Twitter, Inc. share price before Musk’s interest in acquiring Twitter, Inc. became public. Specific performance is worth as much as $30 per share at this point, assuming that a loss on specific performance might see the Twitter stock fall to $24.20 or so. By contrast, a $1 billion termination fee paid to Twitter, Inc. (not to its shareholders) is worth only about $1.30 per share, approximately 9% of which will accrue to Musk’s benefit as owner of about that percentage of Twitter, Inc. stock. Specific performance surely is the only remedy that can compensate Twitter, Inc.’s shareholders for the lost deal premium.

But not so fast. The readers of this blog can see that the problem for the court is this: Twitter, Inc. is not obviously harmed by the breach. Form matters in these things. Twitter, Inc. is the surviving corporation in the reverse triangular merger reflected in the merger agreement. Twitter, Inc.’s assets and profits are exactly the same in the instant after the merger becomes effective as they were in the instant before the merger became effective. In fact, if Twitter, Inc. collects the $1 billion termination fee as its remedy (and we assumed it can; debate on that point is small potatoes), then Twitter, Inc. is $1 billion better off than it would have been had the merger closed.

That is, Twitter, Inc., the corporation, suffers no harm and, even if it did suffer some, there’s no indication that the $1 billion termination fee would leave Twitter, Inc. anything other than financially better off than it would have been with the merger, even if some of the $1 billion does compensate Twitter, Inc. for de minimis harm from, say, legal and consulting fees in pursuing the termination fee in court.

Twitter’s shareholders are obviously injured by the loss of the deal to have their stock cancelled and replaced with certificates that then would be presented to a paying agent funded by Parent. But shareholders have no damages remedy in the merger agreement for injuries that are separate and distinct from any injury to the corporation. Twitter, Inc. might have negotiated for that right but it did not, except that it asserted that it could seek damages for shareholder losses as well, but only up to $1 billion. Twitter, Inc.’s shareholders have no right of their own to pursue specific performance under the merger agreement.

This leaves the Delaware courts in a predicament. To order specific performance of the deal is to order contract parties to perform so that non-parties to the contract (the Twitter, Inc. shareholders) who were expressly disavowed as third-party beneficiaries for remedy purposes can receive payment for cancelled shares, even though an award of the termination fee would leave the legally distinct and actual party to the contract, Twitter, Inc., better off by $1 billion than would specific performance, which will leave Twitter, Inc. exactly as it was except for a new board of directors and new bylaws taken from the Acquisition Sub and the replacement of its pre-merger shareholders with a single shareholder, Parent. 

In substance under the merger agreement, Twitter, Inc. is acting as a commission-free broker of a deal where current Twitter, Inc. shareholders agree to have their shares cancelled in return for a payment and Musk’s parent holding company agrees to make that payment in return for  ownership of Twitter’s (one) new share. But rather than make a contract among shareholders and Musk and his holding companies, as a broker would do, Twitter, Inc. made itself the counter party to Musk and his entities. But as a commission-free broker, Twitter, Inc. loses nothing when the deal collapses. In fact, having negotiated a termination fee of $1 billion, Twitter, Inc. is actually better off with breach and that remedy than with either its limited (to $1 billion) damages remedy or specific performance. And shareholders, being nonparties disavowed as third-party beneficiaries, have no separate cause of action. Only by ignoring the legal distinction between Twitter, Inc., the corporation, and Twitter, Inc.’s pre-merger shareholders could specific performance make sense.

Of course, there is virtue in deal certainty. Parties may want to bind themselves, as Odysseus did to the mast. But Delaware courts scrutinize such acts of pre-commitment routinely, forbidding some kinds, as under the Unocal doctrine. One of our many points is that specific performance is, from a law and economics perspective, a bad deal device in all but a few kinds of cases. It would be better for the parties to contract in other ways, such as by including shareholders as third-party beneficiaries (and thus making the damages from a broken deal easily available). Deal structure matters. For instance, given the nature of the parties, it might have made much more sense for the Twitter board to let Musk deal directly with shareholders (as he wanted) than to force him to deal with the board. The poison pill may have been the original sin, since courts and the bluntness of specific performance would not have been needed had Musk been allowed to tender for Twitter shares.

Judges have ways of working around the law, and specific performance may well be awarded by a court that is loath to allow Musk, Parent, and Acquisition Sub to walk away from a $44 billion deal for a measly $1 billion.  To do so here, however, the Delaware court will have to ignore the most fundamental fact of corporate law, namely, that the corporation is not its shareholders. Wouldn’t that be a strange outcome in Delaware, of all places. Could it happen? Sure. It is more likely than not? We think no, and the stock market, so far, agrees with us.

Zohar Goshen on Twitter versus Elon Musk