Thread by @RomeenSheth

Time to dust off the corporate law textbooks...

"Would Elon win if he sued Twitter’s Board?"

Doubtful. In this case, it’s actually pretty cut and dry.

But this could get a lot more complicated if Elon wanted to make it so.

Here's why:

First, it’s important to understand what a Board actually does legally.

Under Delaware Law, the Board is an agent for the owners of a corporation (stockholders).

The Board doesn’t manage the actual business. It’s responsible for the management of the corporation.

Plain English Meaning:

The Board is responsible to ensure Executives act in the interest of shareholders.

- The Executive Team works for the Board
- The Board works for Shareholders

Shareholders are the ultimate beneficiaries of a corporation's success or failure.

How does the Board work for shareholders? Through fiduciary duty.

The Board has 2 fiduciary duties to shareholders:

1. Duty of Care
2. Duty of Loyalty

The Duty of Care is a requirement that a Board makes decisions with reasonable diligence and prudence.

A Board must:

- Assure they have the right information to act
- Devote sufficient time to review the information

They can’t delegate this duty.

Sounds vague right? That’s intentional. We’ll get back to that in a bit.

That said, DE Law has given some parameters around this duty:

- Was the Board engaged?
- What materials did they review / consider?
- Was there ample time for them to deliberate?

The Duty of Loyalty is the second fiduciary duty.

DoL necessitates the Board act in the best interest of shareholders and doesn’t put personal interest ahead of these interests.

Directors can’t have an undisclosed interest in the transaction that is different from stockholders.

If Elon wants to bring a case, he needs to provide evidence the Board has either violated its Duty of Care or its Duty of Loyalty.

How does the court review violations?

There are 2 standards:

- Business Judgment Rule (BJR)
- Enhanced Scrutiny (Revlon + Unocal)

The BJR is the presumption that Directors act in good faith and in honest belief the decision they make is in the best interest of the corporation and its stockholders.

Translation: If the Board can show a rational basis for their decision, the Court will side with the Board.

Elon would have to show facts that one of 3 things has happened:

- The Board has acted disloyally
- The Board has acted in bad faith
- The Board has acted with gross negligence

Let’s pause for a second to talk about the “why”

It’s important to think about this irrespective of Twitter.

Why do Courts apply BJR? It’s a fundamental principle of capitalism.

Courts are not well positioned to make business decisions.

Frankly we shouldn’t want them to be.

If Courts adjudicated whether a business decision by a Board was substantively sound, it would be a heavy overstep.

The Court system in the US would have more authority than a Board.

Remember - The Board is the agent of the shareholder.

Who is the Court the agent of?

You want a system where there is a “check and balance” on the Board, not a system where there is a higher power than the Board.

The role of the Court should be to judge whether the Board has acted reasonably in coming to a decision.

This is what Dow Chemical Derivative (c. 2010) covered:

“The substantive second guessing of the merits of the business decision is precisely the kind of inquiry that the business judgment rule prohibits.”

In a change of control situation, there is a higher level of scrunity - makes sense, because there is more potential for divergence in Board / stockholder interest.

The two cases that are the authority on this matter are Revlon and Unacol.

Revlon says - in the context of a change of control, the Board must take efforts to achieve the highest value reasonably attainable for stockholders.

But even in Revlon, there is latitude - the decision as to what produces the best value for stockholders falls under the BJR.

The strictest standard is when there’s a hostile takeover - which is what this situation is. This is when the Unacol standard applies:

When Directors unilaterally adopt defensive mechanisms, then the defensive mechanism has to pass the test of reasonableness and proportionality.

If Elon brings a suit, he will have to show proof that the Board did not act:

- Reasonable: Board must show it had reasonable grounds to believe that a danger to corporate policy existed

- Proporortional: The action taken by the Board was not coercive or preclusive

So how does this shake out?

It’s really a function of how much Elon wants to fight.

But he’s got a much better play in the court of public opinion vs. in a court of law.

Most folks in favor of Elon are making the claim that fiduciary duty has been violated.

The basis is:

- Stock price has been terrible the last 10 years!

- The Board is conflicted and in the pockets of Management!

- The Board doesn’t like Elon’s political beliefs!

Here’s where it gets tricky for Elon (and most activist investors):

None of that is remotely enough to overcome the business judgement rule and the presumption that the Board violated its duty of care and duty of loyalty.

The Board has a pretty easy argument to make.

It just needs to show that it reasonably believes there is a pathway to +18% to the stock price (difference between current stock price and Elon’s offer).

Considering the price of the stock was at $72 less than 9 months ago, the Board can also say it believes this hostile takeover attempt is opportunistic and doesn’t represent the value of the company.

This is a key part of the argument and will play well in a Court of Law.

Why?

Because the poison pill was formed in part to fend off outlandish and opportunitstic corporate raiders.

Forget Twitter for a second and think about this thought exercise:

Stock Price of ABC company is $100.

A massive macroeconomic shock occurs and now the price is $50.

I see a buying opportunity and say I will offer $75 for the company.

This is a 50% premium.

Should a Board be obliged to take that offer?

Where you shake out on that thought exercise is likely how you feel about this situation.

One side will say: “Yes it’s 50% premium. Case closed.”

The other side will say: “No way, the price didn’t decline because of the company. Regardless, the Board should make that decision.”

My take: Activist investing is healthy.

We should want management to feel pressure; that is a “necessary check” in capitalism.

But the idea that a Board *has to* accept any offer that comes in at a premium to the current stock price is a dangerous precedent to establish.

Elon is uniquely positioned to pull this off in a court of public opinion.

If he really wants Twitter, launch a tender offer. Go around the Board and directly to shareholders.

But if anybody can pull it off, it’s probably him - imagine the engagement he’d get on Twitter ;)

It’s important to separate how you feel about this particular situation, e.g. whether you:

- Like or dislike Elon
- Like or dislike Twitter
- Are right or left for free speech / censorship

And think about the implications of this situation on corporate governance broadly.

I think Elon would take this company to new heights.

I think Elon would do that in any company he runs - he’s probably the greatest entrepreneur of all time.

But that’s not the issue at hand.

The issue is whether a Corporate Board violates its fiduciary duty for not accepting an unsolicited offer.

It’s pretty cut and dry to me whether the Board is within its rights here.

Twitter has yet to issue a response beyond instituting the poison pill.

I think they’ll come out with a statement that generally falls in line with what I outlined in this thread.

The wildcard is how Elon will react.

Grab your popcorn…the saga may just be getting started.