Recently, the Delaware Court of Chancery rejected—for the second time—Elon Musk’s historic $55.8 billion executive compensation package, despite Tesla Inc.’s efforts to have its stockholders purportedly ratify the grant. This opinion is the latest ruling from this six-year-long derivative dispute; a brief summary follows.[1]
Background
In January 2018, the board of directors of Tesla Inc. held a special meeting to award Elon Musk a 10-year performance-based compensation plan with an estimated maximum value of $55.8 billion—the largest executive compensation award in the history of public markets. Tesla stockholder Richard J. Tornetta sued Elon Musk and the Tesla board, claiming that each breached their respective fiduciary duties in approving such pay package.
In January 2024, the Court of Chancery analyzed the pay package under the entire fairness standard of review, as it was a conflicted-controller transaction.[2] The Court ultimately found that the approval of such pay package breached the fiduciary duties owed by Musk and the defendant directors to Tesla and its stockholders. Consequently, the Court ordered the rescission of the entire pay package.
A few months later, Tesla filed a proxy statement, recommending that its stockholders “ratify” the pay package that the Court previously rescinded. The proxy statement noted, among other things, that ratifying this pay package, in lieu of putting together a new pay package, could potentially save Tesla a $25 billion accounting charge. Indeed, at Tesla’s annual meeting, the stockholders voted to ratify the previously rescinded pay package.
Latest Ruling from the Court of Chancery
Two weeks after the purported stockholder ratification, the director defendants filed a motion to revise the Court’s post-trial opinion, submitting novel and “creative” arguments as to why the stockholder vote effectively ratified (i.e., cured) Musk’s pay package. Chancellor Kathaleen McCormick denied the defendants’ motion to revise, upholding her finding that the pay package was excessive, was the result of breached fiduciary duties, and was to be rescinded. The 101-page opinion identified four fatal deficiencies in the defendants’ arguments:
- The defendants had “no procedural ground for flipping the outcome of an adverse post-trial decision based on evidence they created after trial.”
Although certain Court of Chancery Rules allow litigants to proffer “newly discovered” evidence after trial, the rules do not anticipate the Court’s consideration of newly created evidence. At bottom, if this strategy were to be condemned, it would provide an end run for defeated litigants to annul judicial findings, in which case “lawsuits would become interminable.”
- As another procedural point, “common-law ratification is an affirmative defense that must be timely raised, which means that, at a minimum, it cannot be raised for the first time after the post-trial opinion.”
Notably, affirmative defenses can be waived if not raised in a timely manner. Here, as noted by the Court, the defendants raised the ratification defense six years after Tornetta first initiated the derivative suit concerning the pay package, one and a half years after trial, and five months after the Court’s ruling that rescinded the pay package. Unsurprisingly, the Court declined to exercise its discretion to legitimize this untimely raised affirmative defense.
- Most substantively, what the defendants referred to as “common law ratification” in conducting soliciting the stockholder’s post-trial approval of the previously rescinded plan “has no basis in the common law—a stockholder vote standing alone cannot ratify a conflicted-controller transaction.”
Delaware courts recognize two forms of stockholder ratification: (i) legal ratification, which has been codified by DGCL § 204 and allows stockholders to retroactively grant legal authority to agents acting on behalf of a corporation in “circumstances in which the agent had no authority or arguably had no authority,” and (ii) fiduciary ratification, which allows stockholders to vote that a corporate act taken was indeed “consistent with [stockholder] interests.” The defendants ultimately dropped their legal ratification argument, leaving the Court to determine whether the stockholder vote constituted a fiduciary ratification of the pay package.
Given that this was a conflicted-controller transaction, where Musk’s own conflict of interest “threaten[ed] the decision-making process,” the Court found that the “maximum effect of stockholder ratification” would not give rise to a complete defense; rather, such ratification, if successful, would only shift the burden of proof from the defendants to the plaintiff to prove that the transaction satisfied the entire fairness test. The defendants failed to shift such burden.
In order to meet the burden and evade the stricter entire fairness review, the defendant directors would have had to “precommit” to the MFW[3] protections when the negotiations of the pay package first began. Doing so would have required the board to appoint an independent special committee back in 2017, when the board and Musk began the negotiation of the pay package, and then the solicitation the uncoerced, informed vote of a majority of minority stockholders. Here, the defendant directors did not attempt to engage the MFW protections until 2024, when they prepared to have the Tesla stockholders vote to ratify the once-rejected pay package. But as noted by the Court, “[o]ne does not ‘MFW’ a vote, which is part of the MFW protections; one ‘MFW’s a transaction.” Accordingly, the entire fairness standard did apply and, as discussed above, was not satisfied.
- Finally, “even if a stockholder vote could have a ratifying effect, it could not do so here due to multiple, material misstatements in the proxy statement.”
The proxy statement “made multiple, inaccurate statements concerning the potential ratifying effect of the [s]tockholder [v]ote.” For instance, the proxy statement suggested to Tesla stockholders that “[t]heir vote could extinguish claims for breach of fiduciary duty by authorizing an act that otherwise would constitute a breach” and that “a new stockholder vote allows the disclosure deficiencies found by the Court to be corrected, among other things.” Given various instances where the proxy statement “mangle[d] the truth,” the resulting stockholder vote could not have been fully informed to yield an effective ratification.
Takeaway
This ruling underscores the need for both controlling stockholders and boards of directors to ensure that in conflicted-controller transactions, the MFW protections are established as a proactive rather than a reactive measure. Additionally, it serves as an admonition that after-the-fact stockholder approval is not an “elixir” that can “cure fiduciary wrongdoing.”
[1] Tornetta v. Musk, No. 2018-0408-KSJM, 2024 WL 4930635 (Del. Ch. Dec. 2, 2024).
[2] Tornetta v. Musk, 310 A.3d 430 (Del. Ch. 2024).