Co-founder’s compensation deal worth over $100 billion today

Tesla, Inc. (“Tesla”) and Elon Musk suffered another setback in their continuing efforts to overcome a legal challenge to a 2018 performance-based stock option grant (the “Grant”) that, at today’s stock price, would be worth over $100 billion to Musk. Although Tesla stockholders have now considered and approved the Grant twice—both in 2018 at a special meeting and in 2024 at Tesla’s annual meeting—last week, the Delaware Court of Chancery denied a motion from the Tesla defendants seeking to reverse the court’s January 30, 2024, order rescinding the Grant.

The reaction from the defendants was immediate and combative. Tesla said the decision is “wrong” and “means that judges and plaintiffs’ lawyers run Delaware companies . . . rather than the shareholders.” Musk denounced the decision as “[t]otally crazy,” saying that “[s]hareholders should control company votes, not judges.”

A summary of important points follows.

2018 Stock Grant

In January 2018, the Tesla Board of Directors (the “Board”) approved the Grant, which was comprised of 12 tranches, each of which would vest upon Tesla satisfying one market capitalization and one operational milestone. Each of the tranches allowed Musk the option to purchase shares equal to 1% of Tesla’s outstanding common stock as of January 19, 2018. The Grant, once fully vested, provided Musk options to purchase 20,264,042 Tesla shares (with a strike price for each option of $350.02). Giving effect to stock splits in 2020 and 2022, the total options increased to 303,960,630, and the strike price decreased to $23.33.

Tesla’s February 8, 2018 Proxy Statement, which described the Grant for purposes of seeking stockholder approval at a special meeting, placed a maximum value on the Grant of $55.8 billion. At the 2018 special meeting, Tesla’s stockholders approved the Grant, with 73% of the votes cast by disinterested stockholders being in favor of the proposal, i.e., the votes of shares that are not owned, directly or indirectly, by Musk or his brother, Kimbal Musk.

Despite the fact that, among other things, Tesla’s market capitalization would need to increase by nearly $600 billion from January 2018 for all Musk’s options to fully vest, by the end of January 2024, they were fully vested and all milestones were achieved.

Legal Challenge and Delaware Post-Trial Opinion

In June 2018, a Tesla shareholder filed suit in Delaware, challenging the Grant and alleging breaches of fiduciary duties, unjust enrichment, and waste. In January 2024, the plaintiff “achieved a total victory” according to the court, whose opinion (the “Post-Trial Opinion”) rescinded the Grant on grounds that (i) the Tesla Board breached its fiduciary duties and could not prove the Grant met the entire fairness standard of review; (ii) the Grant’s development process was “deeply flawed”; (iii) Musk controlled the compensation process; (iv) Tesla’s independent directors were not actually independent, i.e., they received considerable compensation through Tesla or had other investments tied to Musk; and (v) the stockholder vote was not valid due to material facts being left out of the disclosures in Tesla’s proxy statement. For more information on the Post Trial Opinion, please see: Easy Come, Easy Go: Delaware Court Upends Elon Musk’s $56 Billion Equity Incentive Plan.

Post-Trial Reaction

Musk did not waste time before criticizing the case on social media, saying “[n]ever incorporate your company in the state of Delaware” and that Tesla would “move immediately to hold a shareholder vote to transfer state of incorporation to Texas.” He described the judge, who also presided over Twitter’s lawsuit to force Musk to consummate his $44 billion acquisition of that business, as “an activist and politician, first and foremost.”

Second Stockholder Vote

On April 29, 2024, Tesla filed a proxy statement seeking shareholder ratification of the Grant. The proxy statement included a copy of the court’s 200-page Post-Trial Opinion. At Tesla’s annual meeting on June 13, 2024, stockholders again approved the Grant, with 72% of the votes cast by disinterested stockholders being in favor of the proposal. In addition, stockholders overwhelmingly approved the redomestication of Tesla from Delaware to Texas by conversion.

According to the court, Musk “effectively declared victory before the polls closed.”

Latest Court Ruling

Following the 2024 annual meeting, the Tesla defendants filed a motion to revise with the Delaware court, seeking (i) a reversal of the order rescinding the Grant because it had now been ratified, and any legal deficiencies in effect cured, by stockholder action, and (ii) entry of a judgment in their favor. However, the court denied the motion in strong terms, citing four fatal flaws:

1. Musk, other members of the Tesla Board, and Tesla had “no procedural ground for flipping the outcome of an adverse post-trial decision based on evidence they created after trial.” Defendants relied on three Delaware Court of Chancery Rules to make their argument: Rule 59(a), Rule 60(b), and Rule 54(b). The court flatly rejected the arguments concerning Rules 59(a) and 60(b), which allow “the court to reopen the trial record for the purpose of considering newly discovered evidence.” Newly discovered evidence exists at the time of trial but is hidden or unknown. The second stockholder vote did not exist at the time of the original trial; rather, it was “newly created evidence.” For Rule 54(b), which governs judgment on multiple claims, the typical case where a court admits new evidence under Rule 54(b) is a case where the prior judgment did not contain factual findings. Here, besides attorney’s fees, the Post-Trial Opinion “completed fact finding and resolved all claims and defenses timely raised.” The defendants, according to the court, sought to “introduce a new fact that they created for the purpose of flipping the outcome of the Post-Trial Opinion.” The court disagreed and held that defendants’ common law ratification argument “would allow a party found liable for fiduciary misconduct to deploy stockholder ratification to reverse the effects of a court finding long after that litigation is final” and that defendants’ “request flies in the face of the policy bases for all relevant rules of procedure and the law-of-the-case doctrine . . . .”
2. Defendants’ common-law ratification defense cannot be raised for the first time after the Post-Trial Opinion. The court has discretion whether to permit a party to assert a late-raised defense. The court has never allowed a party “to deploy stockholder ratification as a defense after the close of fact finding, with one possible exception” that the court found to be distinguishable. Ultimately, the court declined to exercise its discretion to allow defendants to raise the ratification defense because the defendants raised the defense too late: six years after the action was filed, one and a half years after the trial, and five months after the Post-Trial Opinion.
3. Defendants’ common-law ratification defense has “no basis in the common law,” i.e., the second stockholder vote cannot ratify the conflicted-controller transaction. Defendants unsuccessfully argued that “stockholders hold the power to adopt any corporate acts they deem in their own best interests.” According to the court, given Musk’s effective control of Tesla, the Post-Trial Opinion was a conflicted-controller transaction, which poses risks to minority stockholders that include the controller: (i) retaliating against the company; (ii) circumventing the board of directors; and (iii) especially relevant to Musk, “[using] its ability to direct corporate actions to extract corporate value through related-party transactions.” Because of these risks, Delaware courts apply the entire fairness standard of review, which is the most burdensome standard of review in conflicted-controller transactions, absent certain protections being in place at the outset of economic negotiations. Here, the defendants were unable to overcome that burden of proof.
4. Even if stockholder ratification could remedy the legal deficiencies associated with the Grant, the June 2024 stockholder vote could not have done so because the proxy statement contained multiple material misstatements. The court held that, since the Grant was a conflicted-controller transaction, the only possible effect of stockholder ratification would be to shift the burden of proof from defendants to the plaintiff. But in order to do so, the vote must have been fully informed and uncoerced, and the Tesla vote failed on that basis. The court in particular took issue with proxy disclosures saying that ratification by the stockholders would extinguish claims for breach of fiduciary duty, finding those statements to be in contravention of Delaware law.

Conclusion

Whatever anyone’s view as to the merits of the case, which the Wall Street Journal’s editorial board describes as “bad legal precedent that will damage American corporate law,” the immediate end result here seems hard to square. Musk, who leads Tesla and has been instrumental in guiding Tesla’s market capitalization from approximately $59 billion at the time of the Grant in 2018 to over $1 trillion in recent days, gets nothing. Meanwhile, the plaintiff’s attorneys, who sued Tesla on grounds that Musk’s compensation is excessive, requested a $5.6 billion fee award. The court considered this request and ultimately ordered the defendants to pay a $345 million fee award in cash or freely tradable Tesla shares.

Tesla indicates that it will file an appeal.