Musk: Feared or Loved? Delaware Chancery Court’s Controlling Shareholder Doctrine and the Expansion of Judicial Inquiry into Directorial Decision Making

Elon Musk has been a prominent star in recent years, specifically as Tesla’s CEO. While Musk’s tweets have been a focal point of his media attention, his dealings with Tesla, Inc. have grabbed the attention of minority shareholders and the Delaware Chancery Court. This article focuses on two pending cases against Musk and Tesla’s board of directors that raise interesting questions that will shape corporate law in the United States.

On August 1, 2016, Tesla announced it had executed an agreement to acquire SolarCity Corporation in an “all-stock deal.”11

Elon Musk sat on SolarCity’s board of directors at the time of the transaction and was its largest shareholder.22 Musk and similarly interested parties33 excused themselves from the vote to achieve approval from a majority of disinterested shareholders.44 On November 17, 2016, Tesla stockholders approved the acquisition.55 Tesla’s board of directors relied on this approval by the majority of disinterested shareholders and did not invoke a special committee to approve the acquisition.66 Soon after the transaction, Tesla shareholders brought a claim challenging the acquisition of SolarCity, a claim that the defendants, Tesla and its board of directors, sought to dismiss.77

The main focus of this case fell to whether Elon Musk is a controlling shareholder of Tesla.88

Even though Elon Musk only owns 22.1% of the voting power in Tesla, the Delaware Supreme Court does not require a defendant to own more than 50% of the voting power of the corporation.99 In Delaware, a controlling shareholder “owns a majority interest in or exercises control over the business affairs of the corporation.”1010 Given Musk’s voting power was not over 50%, the question became whether Musk exercised control over the business affairs of Tesla.1111

The Court acknowledged that 22.1% voting power was “relatively low” in the controlling shareholder context.1212

Even so, the Court found that Musk was a controlling shareholder.1313 The Court’s determination that a shareholder with substantially less than 50% voting power was controlling, while not unprecedented,1414 was unusual: the Delaware Court of Chancery had described a previous controlling shareholder determination of a shareholder with 35% of voting power as “perhaps, its most aggressive finding that a minority blockholder was a controlling stockholder.”1515

Notably, the court’s determination that Musk is a controlling shareholder of Tesla is not final.1616

The importance of this determination has significant impacts not only in this case but in the following case, Tornetta v. Musk.1717

Before Tesla’s remarkable growth over the past two years, Tesla’s board of directors approved a compensation package for Elon Musk coined “The 2018 Performance Award”(“the Award”).1818

Faced with the possibility Musk may direct his focus to other business ventures, such as SpaceX, Tesla’s board sought to keep Musk’s primary focus on Tesla.1919 The Award consisted of a 10-year incentive plan that can award Musk stock options worth $55.8 billion.2020 The stock options would vest contingent upon “market capitalization and operational milestones.”2121 These milestones, however, were not just drops in the bucket; each market capitalization milestone required a $50 billion increase in Tesla’s market capitalization.2222 Under the board’s initial Award proposal for shareholder approval, the first milestone would be doubling Tesla’s market capitalization.2323 While the Award could result in a $55.8 billion payday for Musk, it could also award him nothing.2424

Tesla’s board of directors brought the Award to the shareholders and received a majority of disinterested shareholder approval of the Award.2525

Upon the board’s disclosure of the Award’s approval, the plaintiff, a minority shareholder, brought suit challenging the Award.2626 Courts typically meet decisions of officer compensation with extreme judicial deference to the board of directors.2727 The Court proceeded with the understanding that Musk is a controlling shareholder of Tesla,2828 holding that while a majority of disinterested shareholders approved the Award, Musk failed the framework established in Kahn v. M & F Worldwide Corp (“MFW”).2929 The MFW framework requires both a vote by a majority of disinterested shareholders and an independent special committee of the board to deem a conflicted controller buyout worthy of the business judgment rule.3030 The Court acknowledged that nothing in the opinion suggests the Court’s holding was to extend any further than controlling shareholder mergers.3131 The holding and framework of MFW specify a merger or a “transformative transaction.”3232 Nevertheless, the Court found nothing to limit the framework of MFW.3333  Without an independent special committee, Musk was not worthy of the business judgment rule but the entire fairness standard.3434

Following MFW, the Court explained that in the presence of a majority of disinterested shareholder approval, the burden to prove entire fairness does shift to the plaintiff.3535

 The Court found that the plaintiff “barely” cleared this bar and did not warrant dismissal at this stage.3636 Seemingly a win for the plaintiff shareholders, the Court evaluated the fairness of the Award at a general level and hinted that Musk might indeed prevail even under the entire fairness standard moving forward.3737 The Court highlighted that the Award is incentive-based.3838 Musk may not reach any milestones and thus would be awarded nothing, or may reach all of the milestones, in which case the Award would compensate Musk far more than any other officer in history. But the latter would mean that Tesla is one of the most valuable companies in the world. 3939

These two cases highlight Delaware case law’s disdain for instances where a party, specifically a controlling shareholder, is on both sides of a transaction. The idea of controlling shareholders in the eyes of the court is best articulated as “as the 800-pound gorilla whose urgent hunger for the rest of the bananas is likely to frighten less powerful primates like putatively independent directors who might well have been hand-picked by the gorilla.”4040

Such a characterization is based on inherent fear on the part of seemingly independent directors and minority shareholders. Yet, these cases seem to center around an all-star quarterback rather than an 800-pound Gorilla. Elon Musk is the face of Tesla, has been a focal point of Tesla’s success, and it is possible that he would leave or diminish his role. Like fans of a football franchise whose all-star quarterback is leaving, Tesla and its shareholders need him to stay and lead Tesla to “victory.” These two cases provide two questions moving forward: (1) do Elon Musk and Tesla, Inc. provide a basis for reevaluating the controlling shareholder determination?; and if not, (2) will these cases unnecessarily expand Supreme Court jurisprudence and create the wrong incentives for officer compensation and incentive-based compensation?

The Court’s disdain for controlling shareholders on both sides of transactions is warranted. However, Elon Musk’s influence might not be based on fear by the shareholders but rather an admiration.4141

Should courts rethink the disdain for controlling shareholder transactions? Or can admiration, rather than fear, create the same instances where directors and investors alike do not act in the company’s best interest? Either way, the upcoming trial in In re Tesla should shed more light on Elon Musk’s role at Tesla and his influence over Tesla’s board and shareholders. When upholding Musk’s status as a controlling shareholder during motions for summary judgment, the Court found Musk’s position was “inherently coercive,” which was enough to support the determination regardless of if the court finds actual coercion.4242 The court acknowledged that the doctrine of “inherent coercion” is not without its critics.4343 Given Musk’s dedication to Tesla, Inc., his financial investment in Tesla, Inc., and his low voting power, the Court should address whether Musk is, in fact, an 800-pound gorilla, or is actually an innovative leader who is attempting and seemingly succeeding, to take Tesla “to the moon.”4444 The Court could easily conclude that admiration is just as bad, if not worse than fear, and could blind directors and investors alike to breaches of duty by the admired.

Assuming the Court upholds the finding that Elon Musk is a controlling shareholder, the question then arises whether the Court’s use of the MFW framework requires judges to “second-guess a business transaction that rational investors have approved.”4545

While the Court did acknowledge that the compensation package in Tornetta could prevail under entire fairness by stripping away the business judgment rule, the Court seems to expand the holding of MFW further complicating the Delaware jurisprudence of controlling shareholders.4646

The framework articulated by the Court in MFW did not deal with officer compensation but instead a merger that would transform the nature of the corporation.4747

Notably, the question presented and answered by the Court in MFW was specifically, “what should be the standard of review for a merger” where a controlling shareholder is on both sides of the transaction.4848 Furthermore, the Court’s analysis applied to “circumstances that will enable a controlled merger” to retain the business judgment rule.4949

While the framework did not suggest any limitations to such transactions, it did not expand the framework either.

Tesla’s board of directors had a legitimate fear that Musk may leave the company or limit his role to pursue alternative projects. Thus, the board decided to offer Musk a compensation package that could award Musk $55.8 billion, more than any officer in history. Still, it similarly had the potential to award him nothing. Tesla’s board did not need to subject the Award to a majority of disinterested shareholders, but it did anyway. Such shareholders voted and approved the Award.

Officer compensation has been a bedrock form of directorial discretion, which the Delaware court gives extreme judicial deference.5050

Such historical deference could have played a part in dissuading the court from expanding the holding of MFW. The court in Tornetta seeks to uproot the decision of Tesla’s board and shareholders without any direction from the Supreme Court of Delaware and against historic deference for such decisions. 

The saga of Elon Musk is fascinating, from Joe Rogan5151

to Doge Coin,5252 and now to Delaware corporate law. The In re Tesla and Tornetta decisions articulate a framework that could prove dangerous to the incentives of directors that the Court has historically sought to protect.5353 To protect themselves from suit, should shareholders with a “minority block” of voting power seek to minimize their influence? Stay off social media? Refuse interviews? Keep strictly professional relations with board members and shareholders alike? It seems that no matter the voting power, shareholders with minority blocks will be under constant evaluation by the court. Such scrutiny by courts could disincentivize positive influence, which can spark growth and innovation.

Should directorial boards prevent these minority block shareholders with influence from using their knowledge and leadership skills from attempting to grow the company? What is the limiting principle of the MFW framework? While based on sound logic and a passion for protecting investors, the Court has placed these questions in the minds of directorial boards, officers, and shareholders alike.

Given the Chancery Court’s expansion of the framework laid out in MFW, the Supreme Court of Delaware should take the case to resolve this issue if and when appealed. The court in Tornetta may very well be correct that on the margin, utilizing both the approval of a majority of disinterested shareholders and the use of an independent special committee will best serve and protect shareholders. However, Elon Musk and Tesla present interesting questions for the Supreme Court of Delaware to answer before expanding the judiciary’s role in decisions given the Court’s utmost deference until recently.