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Online Edition '22

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

Sam Ellis
TABLE OF CONTENTS

I. Introduction

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.

A. In re Tesla Motors

On August 1, 2016, Tesla announced it had executed an agreement to acquire SolarCity Corporation in an “all-stock deal.”1 Elon Musk sat on SolarCity’s board of directors at the time of the transaction and was its largest shareholder.2 Musk and similarly interested parties3 excused themselves from the vote to achieve approval from a majority of disinterested shareholders.4 On November 17, 2016, Tesla stockholders approved the acquisition.5 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.6 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.7

The main focus of this case fell to whether Elon Musk is a controlling shareholder of Tesla.8 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.9 In Delaware, a controlling shareholder “owns a majority interest in or exercises control over the business affairs of the corporation.”10 Given Musk’s voting power was not over 50%, the question became whether Musk exercised control over the business affairs of Tesla.11

The Court acknowledged that 22.1% voting power was “relatively low” in the controlling shareholder context.12 Even so, the Court found that Musk was a controlling shareholder.13 The Court’s determination that a shareholder with substantially less than 50% voting power was controlling, while not unprecedented,14 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.”15

Notably, the court’s determination that Musk is a controlling shareholder of Tesla is not final.16 The importance of this determination has significant impacts not only in this case but in the following case, Tornetta v. Musk.17

B. Tornetta v. Musk

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”).18 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.19 The Award consisted of a 10-year incentive plan that can award Musk stock options worth $55.8 billion.20 The stock options would vest contingent upon “market capitalization and operational milestones.”21 These milestones, however, were not just drops in the bucket; each market capitalization milestone required a $50 billion increase in Tesla’s market capitalization.22 Under the board’s initial Award proposal for shareholder approval, the first milestone would be doubling Tesla’s market capitalization.23 While the Award could result in a $55.8 billion payday for Musk, it could also award him nothing.24

Tesla’s board of directors brought the Award to the shareholders and received a majority of disinterested shareholder approval of the Award.25 Upon the board’s disclosure of the Award’s approval, the plaintiff, a minority shareholder, brought suit challenging the Award.26 Courts typically meet decisions of officer compensation with extreme judicial deference to the board of directors.27 The Court proceeded with the understanding that Musk is a controlling shareholder of Tesla,28 holding that while a majority of disinterested shareholders approved the Award, Musk failed the framework established in Kahn v. M & F Worldwide Corp (“MFW”).29 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.30 The Court acknowledged that nothing in the opinion suggests the Court’s holding was to extend any further than controlling shareholder mergers.31 The holding and framework of MFW specify a merger or a “transformative transaction.”32 Nevertheless, the Court found nothing to limit the framework of MFW.33  Without an independent special committee, Musk was not worthy of the business judgment rule but the entire fairness standard.34

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  The Court found that the plaintiff “barely” cleared this bar and did not warrant dismissal at this stage.36 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.37 The Court highlighted that the Award is incentive-based.38 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. 39

II. Discussion

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.”40 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?

A. Is Elon Musk an 800-pound Gorilla or an All-Star Quarterback?

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.41 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.42 The court acknowledged that the doctrine of “inherent coercion” is not without its critics.43 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.”44 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.

B. Does the Implementation of MFW go too far?

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.”45 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.46

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 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.48 Furthermore, the Court’s analysis applied to “circumstances that will enable a controlled merger” to retain the business judgment rule.49

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 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. 

III. Conclusion

The saga of Elon Musk is fascinating, from Joe Rogan51 to Doge Coin,52 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.53 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.

  • 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.
  • 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).
  • 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”).