Musk: Feared or Loved? Delaware Chancery Court’s Controlling Shareholder Doctrine and the Expansion of Judicial Inquiry into Directorial Decision Making
I. Introduction
TOPElon 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.
A. In re Tesla Motors
TOPOn August 1, 2016, Tesla announced it had executed an agreement to acquire SolarCity Corporation in an “all-stock deal.”1
In re Tesla Motors, Inc. S’holder Litigation, 2018 WL 1560293, at *10 (Del. Ch. Mar. 28, 2018).
Id. at *2.
Interested parties are those with connections to Tesla and SolarCity.
In re Tesla Motors, 2018 WL 1560293, at *10.
Id.
Id. at *17.
Id. at *11.
The main focus of this case fell to whether Elon Musk is a controlling shareholder of Tesla.8
Id. at *12 (“Because I agree the Complaint pleads facts that allow reasonable inferences that Musk was a controlling stockholder and that Plaintiffs’ claims against all Defendants are subject to entire fairness review, I begin and end my analysis of the motion to dismiss there.”).
Id.
Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110, 1113 (Del. 1994) (quoting Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1344 (Del. Supr. 1987)).
In re Tesla Motors, 2018 WL 1560293, at *12.
The Court acknowledged that 22.1% voting power was “relatively low” in the controlling shareholder context.12
Id. at *14.
Four factors informed the Court’s determination that Musk was a controlling shareholder of Tesla:
Musk’s ability to influence the stockholder vote to effect significant change at Tesla, including the removal of Board members; (2) Musk’s influence over the Board as Tesla’s visionary, CEO and Chairman of the Board; (3) Musk’s strong connections with members of the Tesla Board and the fact that a majority of the Tesla Board was “interested,” as that term is defined in our law, in the Acquisition; and (4) Tesla’s and Musk’s acknowledgement of Musk’s control in its public filings.
Id. at *13.
In re Zhongpin Inc. S’holders Litig., No. CV 7393-VCN, 2014 WL 6735457, at *8 (Del. Ch. Nov. 26, 2014), rev’d sub nom. In re Cornerstone Therapeutics Inc, S’holder Litig., 115 A.3d 1173 (Del. 2015) (holding that a shareholder with 17.3% of the voting power was a controlling shareholder).
In re Morton’s Rest. Grp., Inc. S’holders Litig., 74 A.3d 656, 665 (Del. Ch. 2013) (citing In re Cysive, Inc. S’holders Litig., 836 A.2d 531, 551–52 (Del. Ch. 2003)).
Notably, the court’s determination that Musk is a controlling shareholder of Tesla is not final.16
In re Morton’s Rest. Grp., Inc. S’holders Litig., 74 A.3d at *19 (finding that Musk is a controlling shareholder, however, “[t]he facts developed in discovery may well demonstrate otherwise”); In re Cysive, 836 A.2d at 552–53 (determining the controlling shareholder issue post-trial).
Tornetta v. Musk, 250 A.3d 793 (Del. Ch. 2019).
B. Tornetta v. Musk
TOPBefore 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”).18
Id. at 796.
Id. at 803.
Id. at 797.
Id.
Id.
Tornetta v. Musk, 250 A.3d at 797.
Id. at 804 (“If none of the tranches of options vest, Musk will earn nothing under the Award.”).
Tesla’s board of directors brought the Award to the shareholders and received a majority of disinterested shareholder approval of the Award.25
Id.
Id. at 804–05 (“Plaintiff filed his Complaint in which he asserts four claims: (1) a direct and derivative claim for breach of fiduciary duty against Musk in his capacity as Tesla’s controlling shareholder for causing Tesla to adopt the Award; (2) a direct and derivative claim for breach of fiduciary duty against the Director Defendants for approving the Award; (3) a derivative claim for unjust enrichment against Musk; and (4) a derivative claim for waste against the Director Defendants.”).
Tornetta v. Musk, 250 A.3d 793, 805 (Del. Ch. 2019) (“A board’s decision to grant executive compensation is usually entitled to great deference.”).
Id. at 798, n.5. (explaining that as Vice-Chancellor Slights was the presiding judge—the same judge who determined Musk to be a controlling shareholder in In re Tesla, the defendants would not challenge the determination at this stage.)
88 A.3d 635 (Del. 2014), overruled on other grounds by Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).
Tornetta, 250 A.3d at 810 (citing M & F Worldwide Corp., 88 A.3d at 645).
Id. at 811.
Id. at 810.
Id. at 811. (“I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.”).
Id. at 810, 812.
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.35
Id. at 797–98.
Tornetta, 250 A.3d at 812.
Id.
Id.
Id. (“Tesla will be one of the most valuable companies in the world and all stakeholders will have reaped the benefits of Musk’s incentivized focus.”).
II. Discussion
TOPThese 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.”40
In re Pure Res., Inc., S’holders Litig., 808 A.2d 421, 436 (Del. Ch. 2002).
A. Is Elon Musk an 800-pound Gorilla or an All-Star Quarterback?
TOPThe 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.41
Unless the fear is, as described in Tornetta, based in Musk’s potential departure from the company.
In re Tesla Motors, Inc. S’holder Litig., No. CV 12711-VCS, 2020 WL 553902, at *12 (Del. Ch. Feb. 4, 2020).
Id. at *6.
@elonmusk, Twitter, (Apr. 16, 2021 8:37 PM), https://twitter.com/elonmusk/status/1383233200885882885.
B. Does the Implementation of MFW go too far?
TOPAssuming 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.”45
William T. Allen et al., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287, 1308 (2001).
Berteau v. Glazek, No. CV 2020-0873-PAF, 2021 WL 2711678, at *14 (Del. Ch. June 30, 2021) (“The [Tornetta] court did not opine on which controlling stockholder transactions might not require the dual protections of MFW to obtain a lesser degree of scrutiny than entire fairness.”).
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.47
Tornetta, 250 A.3d. at 798.
M & F Worldwide Corp., 88 A.3d at 642.
Id. at 646.
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.50
Tornetta, 250 A.3d at 796–97 (“A board of directors’ decision to fix the compensation of the company’s executive officers is about as work-a-day as board decisions get. It is a decision entitled to great judicial deference.”).
III. Conclusion
TOPThe saga of Elon Musk is fascinating, from Joe Rogan51
Tom Krisher, Tesla shares fall after Elon Musk smokes weed on Joe Rogan’s podcast, Global News (Sept. 8, 2018) https://globalnews.ca/news/4435710/elon-musk-weed-tesla-shares-drop/.
Diksha Madhok, Dogecoin price soars more than 100% to new record after Elon Musk tweets, CNN Business (Apr. 16, 2021).
See Lyman P.Q. Johnson, Corporate Officers and the Business Judgment Rule, 60 Bus. Law. 439, 455 (2005) (Preserving the business judgment rule “encourage[s] directors to serve and take risks; avoid[es] judicial encroachment into business decisions; and preserv[es] the board’s central decision making role in corporate governance”).
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.
- 1In re Tesla Motors, Inc. S’holder Litigation, 2018 WL 1560293, at *10 (Del. Ch. Mar. 28, 2018).
- 2Id. at *2.
- 3Interested parties are those with connections to Tesla and SolarCity.
- 4In re Tesla Motors, 2018 WL 1560293, at *10.
- 5Id.
- 6Id. at *17.
- 7Id. at *11.
- 8Id. at *12 (“Because I agree the Complaint pleads facts that allow reasonable inferences that Musk was a controlling stockholder and that Plaintiffs’ claims against all Defendants are subject to entire fairness review, I begin and end my analysis of the motion to dismiss there.”).
- 9Id.
- 10Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110, 1113 (Del. 1994) (quoting Ivanhoe Partners v. Newmont Mining Corp., 535 A.2d 1334, 1344 (Del. Supr. 1987)).
- 11In re Tesla Motors, 2018 WL 1560293, at *12.
- 12Id. at *14.
- 13Four factors informed the Court’s determination that Musk was a controlling shareholder of Tesla:
Musk’s ability to influence the stockholder vote to effect significant change at Tesla, including the removal of Board members; (2) Musk’s influence over the Board as Tesla’s visionary, CEO and Chairman of the Board; (3) Musk’s strong connections with members of the Tesla Board and the fact that a majority of the Tesla Board was “interested,” as that term is defined in our law, in the Acquisition; and (4) Tesla’s and Musk’s acknowledgement of Musk’s control in its public filings.
Id. at *13.
- 14In re Zhongpin Inc. S’holders Litig., No. CV 7393-VCN, 2014 WL 6735457, at *8 (Del. Ch. Nov. 26, 2014), rev’d sub nom. In re Cornerstone Therapeutics Inc, S’holder Litig., 115 A.3d 1173 (Del. 2015) (holding that a shareholder with 17.3% of the voting power was a controlling shareholder).
- 15In re Morton’s Rest. Grp., Inc. S’holders Litig., 74 A.3d 656, 665 (Del. Ch. 2013) (citing In re Cysive, Inc. S’holders Litig., 836 A.2d 531, 551–52 (Del. Ch. 2003)).
- 16In re Morton’s Rest. Grp., Inc. S’holders Litig., 74 A.3d at *19 (finding that Musk is a controlling shareholder, however, “[t]he facts developed in discovery may well demonstrate otherwise”); In re Cysive, 836 A.2d at 552–53 (determining the controlling shareholder issue post-trial).
- 17Tornetta v. Musk, 250 A.3d 793 (Del. Ch. 2019).
- 18Id. at 796.
- 19Id. at 803.
- 20Id. at 797.
- 21Id.
- 22Id.
- 23Tornetta v. Musk, 250 A.3d at 797.
- 24Id. at 804 (“If none of the tranches of options vest, Musk will earn nothing under the Award.”).
- 25Id.
- 26Id. at 804–05 (“Plaintiff filed his Complaint in which he asserts four claims: (1) a direct and derivative claim for breach of fiduciary duty against Musk in his capacity as Tesla’s controlling shareholder for causing Tesla to adopt the Award; (2) a direct and derivative claim for breach of fiduciary duty against the Director Defendants for approving the Award; (3) a derivative claim for unjust enrichment against Musk; and (4) a derivative claim for waste against the Director Defendants.”).
- 27Tornetta v. Musk, 250 A.3d 793, 805 (Del. Ch. 2019) (“A board’s decision to grant executive compensation is usually entitled to great deference.”).
- 28Id. at 798, n.5. (explaining that as Vice-Chancellor Slights was the presiding judge—the same judge who determined Musk to be a controlling shareholder in In re Tesla, the defendants would not challenge the determination at this stage.)
- 2988 A.3d 635 (Del. 2014), overruled on other grounds by Flood v. Synutra Int’l, Inc., 195 A.3d 754 (Del. 2018).
- 30Tornetta, 250 A.3d at 810 (citing M & F Worldwide Corp., 88 A.3d at 645).
- 31Id. at 811.
- 32Id. at 810.
- 33Id. at 811. (“I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.”).
- 34Id. at 810, 812.
- 35Id. at 797–98.
- 36Tornetta, 250 A.3d at 812.
- 37Id.
- 38Id.
- 39Id. (“Tesla will be one of the most valuable companies in the world and all stakeholders will have reaped the benefits of Musk’s incentivized focus.”).
- 40In re Pure Res., Inc., S’holders Litig., 808 A.2d 421, 436 (Del. Ch. 2002).
- 41Unless the fear is, as described in Tornetta, based in Musk’s potential departure from the company.
- 42In re Tesla Motors, Inc. S’holder Litig., No. CV 12711-VCS, 2020 WL 553902, at *12 (Del. Ch. Feb. 4, 2020).
- 43Id. at *6.
- 44@elonmusk, Twitter, (Apr. 16, 2021 8:37 PM), https://twitter.com/elonmusk/status/1383233200885882885.
- 45William T. Allen et al., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 Bus. Law. 1287, 1308 (2001).
- 46Berteau v. Glazek, No. CV 2020-0873-PAF, 2021 WL 2711678, at *14 (Del. Ch. June 30, 2021) (“The [Tornetta] court did not opine on which controlling stockholder transactions might not require the dual protections of MFW to obtain a lesser degree of scrutiny than entire fairness.”).
- 47Tornetta, 250 A.3d. at 798.
- 48M & F Worldwide Corp., 88 A.3d at 642.
- 49Id. at 646.
- 50Tornetta, 250 A.3d at 796–97 (“A board of directors’ decision to fix the compensation of the company’s executive officers is about as work-a-day as board decisions get. It is a decision entitled to great judicial deference.”).
- 51Tom Krisher, Tesla shares fall after Elon Musk smokes weed on Joe Rogan’s podcast, Global News (Sept. 8, 2018) https://globalnews.ca/news/4435710/elon-musk-weed-tesla-shares-drop/.
- 52Diksha Madhok, Dogecoin price soars more than 100% to new record after Elon Musk tweets, CNN Business (Apr. 16, 2021).
- 53See Lyman P.Q. Johnson, Corporate Officers and the Business Judgment Rule, 60 Bus. Law. 439, 455 (2005) (Preserving the business judgment rule “encourage[s] directors to serve and take risks; avoid[es] judicial encroachment into business decisions; and preserv[es] the board’s central decision making role in corporate governance”).