(Bloomberg Opinion)—The weird merry-go-round involving Twitter’s unpaid bills shows no sign of slowing. On this whirl, it is KKR suing the social media company for failing to pay rent on office space in Oakland, California. Already in arrears in Boston, San Francisco and London, the beleaguered bird is now facing a demand for $1.3 million due to the alleged breach of contract.
Possibly these are strategic pauses, an effort by Elon Musk to extract better lease terms. Classically, however, failure to make payments under a commercial lease has often signaled that a company has severe cash flow problems.
Nowadays, few people remember that for half a century, the Great Atlantic and Pacific Tea Company was the nation’s largest retailer. But in 2010, when a much-smaller A&P stopped making lease payments on the space it had left, nobody was surprised that bankruptcy soon followed. During the 1990s, observers knew the end of Home Insurance Co. was near when the onetime industry giant suspended its multi-million-dollar annual lease payments on its classic building at building at 59 Maiden Lane in New York’s financial district. (Ironically, the plaza still bears the company name.)
Let’s be clear: Nobody thinks Twitter is about to go under. Prior to Musk’s takeover last fall, the company had been expanding its user base at a steady clip, even among the younger generation. Between 2020 and 2022, the proportion of 12-34 year-olds using Twitter rose from 29% to 42%, according to Edison Research.
So what’s going on?
Maybe Musk is withholding payment as a move in what is known among scholars as the “holdup game” — an opportunistic effort to force better terms from a counterparty who’s poorly positioned to resist your demands. Think of a seller about to deliver a generator, who waits until after the buyer has finished renovating the factory according to the seller’s specs before demanding a higher price.
If that’s the move, it’s a risky one. The courts and commentators increasingly take the view that the terms of contracts renegotiated under threat of breach should be subjected to special scrutiny. And if indeed holdup is Musk’s strategy, the landlords, by suing, are calling his bluff.
Small wonder. Theory teaches that one reason commercial leases are lengthy is to make it harder for either side to play the holdup game. For commercial landlords, finding new tenants and renovating spaces to suit their needs can be costly. Were commercial leases of shorter duration, lessees would constantly demand better terms under threat of non-renewal.
Long leases also benefit corporate tenants, who face a mirror-image risk. Without them, landlords might demand huge increases, because for a large company it is costly to find alternate quarters, renovate them, and get everyone moved on schedule.
In other words, the reason Twitter is stuck with long leases is that, in theory, both sides benefit. That’s also the reason that, if Musk’s refusals to pay rent are indeed strategic, they’re unlikely to work.
The Financial Times reported recently that Musk has told Twitter executives worried about unpaid bills to “let them sue.” But even though postponing payments to landlords and vendors might stave off the reckoning, it’s not an actual plan. An unnamed executive quoted in the same article bemoaned “the very short-term thinking” behind the decision to suspend payments to vendors and landlords.
Perhaps Musk is simply displaying his trademark optimism, and plans to catch up on payments, with interest, once advertisers return to Twitter — an event whose occurrence he keeps predicting. But “you know we’re good for it” is an excuse a counterparty can accept for only so long. After all, landlords have expenses, too.
Companies aren’t supposed to behave this way – not if their plan is to stay in business. A company that stops paying bills takes a significant hit to reputational capital. That hit, in turn, implies that future vendors will charge a premium to insure against the risk that the same thing happens again.
When the stakes are large, a company might have no choice. For Twitter, however, the unpaid bills so far reported amount to small beer. The Wall Street Journal estimated last month that the total sought in all the Twitter lawsuits, by landlords and vendors alike, is $14 million — a paltry sum for a company just purchased for $44 billion and still valued (by its own CEO) at $20 billion.
Yes, the company needs to cut costs, and by all accounts has been busily, and controversially, doing exactly that. But when it comes to paying rent, it’s difficult to work out Musk’s end game. Today’s small savings lead to tomorrow’s hefty penalties.
To contact the author of this story: Stephen L. Carter at [email protected]
© 2023 Bloomberg L.P.