Presentation of Arguments in a Brief of Current and Retired Practitioners and Professors as Amici Curiae in Support of Reversal of the Opinion of the Delaware Court of Chancery in In Re Tesla, Inc. Derivative Litigation

Tesla directors and stockholders ratified the stock-option incentive compensation contract between Tesla and Elon Musk twice, once in 2018 and again in 2024. Following each ratification, the Delaware Court of Chancery found flaws in the approval process, overrode both the shareholders and the board, and rescinded the compensation agreement.  Following the second opinion, a group of practitioners and professors, including the authors of this Post, filed an amicus brief in the Supreme Court of Delaware in support of reversing the Chancery Court.

Our amicus brief focused on two principal defects in the opinion, although we did not intend for our focus on these two defects to indicate that there are no other issues that should be examined on appeal. First, we challenged the reasoning used to determine that Elon Musk was a “transaction-specific” controller, which the court based, in part, on Musk’s status as a “Superstar CEO.” Second, we challenged the reasoning the Chancery Court used to determine that Tesla’s disinterested stockholders lacked the power to ratify Musk’s compensation contract in 2018 or even in 2024. We of course focus on issues of law and corporate governance and express no views on Elon Musk either as a corporate executive or as a political figure.

Both of these holdings were contrary to the best interests of Delaware stockholders, not just in theory, but in practice, as evidenced by the fact that these decisions thwarted the express preferences clearly expressed by Tesla’s independent shareholders when they (twice) voted to approve the compensation arrangement. As such, the opinion conflicts with the bedrock principle of corporate governance that courts should not substitute their own business judgment for that of the shareholders, which has guided Delaware law for nearly a century.

Transaction Specific Control

The Court of Chancery’s approach to determining whether a person has “transaction-specific control” created substantial uncertainty about whether courts would respect ordinary business decisions regarding issues like executive compensation that threaten long-standing standard operating procedures in U.S. companies. The consequence of the Court’s determination that Musk’s compensation plan was a “conflicted-controller transaction” was that it became subject to rigorous, highly non-deferential “entire fairness” review under the precedent established in In re MFW S’holders Litig. Labelling Elon Musk as a “transaction-specific controlling stockholder” was unprecedented. Prior decisions such as Corwin v. KKR Fin. Holdings, LLC, required that a person either be a majority stockholder or have a “a combination of potent voting power and management control such that the stockholder could be deemed to have effective control of the board without actually owning a majority of stock.”

The justification for being suspicious of – and applying greater judicial scrutiny to – controller transactions is the worry that controllers have the power to coerce and/ or to seek retribution over the board and unaffiliated stockholders. Musk should not have been deemed to be a controller because he had no such coercive or retributive power.

The notion that Musk had retributive power over Tesla’s independent stockholders who lacked any connection or affiliation with Musk is particularly disturbing because it is entirely lacking in either evidentiary support or logical basis. Musk’s only conceivable response to stockholder rejection of his compensation package was to resign. And, of course, resignation is an option available to any CEO. Moreover, by the time the stockholders voted on Musk’s compensation plan in 2024, he had already met the required milestones to qualify to receive the option awards. As such, resignation would not have deprived the Tesla stockholders of the benefits of Musk’s performance under the plan.

Notably, the Court of Chancery’s opinions did not conclude that Musk had coercive or retributive power. Instead the opinions shifted the focus to whether, in the Court’s opinion, the directors appeared to act independently. Musk’s strong personality was a concern to the court, despite the fact that Musk lacked veto power over board decisions and lacked the authority to nominate candidates for the board. This approach differed markedly from prior Delaware decisions that focused on a person’s unilateral ability to replace the board, to obtain a particular desired result, to prevent an undesired result at the board level, or to displace the business judgment of the directors, as the proper indicia of control.

Thus, the Court of Chancery opinion was flawed because it confused and collapsed the inquiry into whether Musk was a controller with its inquiry into whether the Tesla board was sufficiently independent. This is a major flaw because a finding that the board lacked independence would not render Musk’s compensation plan incapable of ratification by the stockholders, while a determination that Musk was a “transaction-specific controller” would, at least according to the Court of Chancery would.

The Court of Chancery designated Musk as a ”Superstar CEO” and a ”visionary” leader and then used those designations to provide another justification for determining that Musk had “transaction-specific control” with respect to his 2018 stock option compensation plan. The Court reasoned that CEO superstardom is relevant to controller status because the belief in the CEO’s singular importance shifts the balance of power between management, the board, and the stockholders. According to the Court of Chancery, “Superstar CEO status creates a distortion field that interferes with board oversight[,]” justifying a finding of control and enhanced judicial oversight.

This analysis magnifies and repeats the error of conflating concerns about independence with concerns about control. Superstar CEOs are not necessarily controllers because a Superstar CEO is simply someone who is valuable to a company. As Larry Hamermesh has pointed out, “[b]eing valuable to the company does not make an executive a controlling stockholder, nor does it implicate concerns [such as] the potential to use affirmative voting power to unseat directors and implement transactions that the minority stockholders do not like, and use blocking voting power to impede other transactions.” Musk lacked “transaction-specific control” because any leverage he had in negotiating the 2018 stock option plan did not derive from any coercive authority associated with his status as a stockholder. Rather it derived from his right to say “no” and direct his talents and attention elsewhere. This is a right that every executive negotiating compensation has. The “Superstar CEO” wields comparatively greater influence by dint of his or her greater perceived value to the company, not because of coercion based on actual control. The Court’s treatment of “Superstar CEOs” creates perverse incentives and punishes success by eliminating the “Superstar CEO’s” ability to have compensation approved by the stockholders just like any other CEO. Adopting this concept would allow Delaware courts to intrude on the executive compensation of its most successful executives.

For these reasons, in our amicus brief we ask the Delaware Supreme Court to reject the flawed notion that “Superstar CEO” is a jurisprudential category worthy of suspicion. We implore the Delaware Supreme Court to reaffirm the law that to be considered a “controlling stockholder” one must have the power to coerce based on voting power (i.e., is a majority owner) or on “a combination of potent voting power and management control” that results in “effective control” of the company.

Finally, we note that, even if one were to characterize Musk as a “transaction-specific controller,” the Court of Chancery opinion is still wrong in our view. This is because the court was wrong to conclude that Delaware law automatically requires compliance with MFW for every contract or transaction with a “transaction-specific controller,” In fact, under Delaware law stockholder approval is only required for significant, existentially important corporate transactions like mergers or the sale of all or substantially all corporate assets. Stockholder votes are not required for executive compensation agreements. Compliance with MFW, however, requires not only a fully-informed vote of a committee of independent directors; it also requires a fully-informed vote of shareholders. Requiring compliance with MFW’s stockholder vote mandate for executive compensation contracts will create an untenable situation in which a stockholder vote will be required in every situation in which a CEO who also owns shares is critical to the company. Leaving this result intact will lard a stockholder approval requirement on to executive compensation decisions despite the fact that the legislature in Delaware (like the legislature in every other state) has refrained from doing so. For this reason, in our amicus brief, we asked the Delaware Supreme Court to restore the well-settled prior law that approval by either a fully independent committee or a majority of the minority vote suffices to invoke the business judgment rule, as to the compensation of a controlling stockholder or his affiliate.

Ratification

The Court of Chancery’s approach to determining that the shareholder vote on June 13, 2024, should not be respected was as flawed as its holding about “transaction-specific control.” The Opinion rejecting the ratification of the compensation plan treated Musk’s status as a “transaction-specific controller” as permanently disabling the stockholders from ratifying an executive compensation plan. This meant that, even after Musk achieved all of the agreed-upon benchmarks, the court would not respect a vote to uphold the plan by Tesla’s independent shareholders, some of whom numbered among the world’s most sophisticated investors.

Stunningly, the Chancery Court even determined that no amount of disclosure would have been sufficient to validate the shareholders’ attempt to ratify the pay package. Of course, the Court had to opine that no amount of disclosure would have been sufficient because the massive disclosure provided to shareholders prior to the second vote likely represented the most complete and through disclosure in the history of corporate law.

Even though the trial court determined that no amount of disclosure would have been sufficient, the court nevertheless took it upon itself to reject the 2024 stockholder ratification vote on disclosure grounds. This is, perhaps, the most astonishing aspect of a very astounding opinion. The ostensible “disclosure flaw” in the second vote was that the proxy statement wrongly indicated that the ratification vote might extinguish the fiduciary duty claims. The court ignored the fact that the proxy statement also noted the possibility that the trial court could reach a different conclusion (which, of course, it did). The stockholders knew exactly what they were being asked to ratify in 2024, and they chose to do so. It makes no sense to say that the vote was uninformed because stockholders voted to ratify based on statements that their vote might have even more effect than the trial court gave it. The imagined disclosure flaw identified by the court was not merely immaterial in a legal sense: it was completely irrelevant. Indeed, to the extent that the shareholders voting on the plan thought that the ratification would result in Musk actually receiving his promised compensation, they would be more likely, not less likely, to vote against it.

If left undisturbed, the result of the trial court’s view of the law would be that once a judge determines that an executive compensation transaction involves a conflicted controller—even a transaction-specific controller who is not a controller with respect to a future ratifying vote—then that transaction is forever outside the control of the corporation and its stockholders. This is not the legal rule of a state that hopes to maintain its position as the leader in our nation’s jurisdictional competition for corporate charters.

We argue that Delaware law should be restored to reflect the principle in place prior to the Chancery Court rulings in Tornetta, which was that an informed, uncoerced stockholder ratification vote approving equity compensation packages for directors or officers is entitled to judicial deference under the business judgment rule unless the transaction amounts to waste. This prior law, for which Delaware was justifiably venerated, was based on the simple proposition that reliance on the disinterested stockholders’ ratifying vote is “a more rational means to monitor compensation than judicial determinations of the ‘fairness,’ or sufficiency of consideration.”

Indeed, prior Delaware decisions sagely indicate that only those “unfamiliar with the limitations of courts and their litigation processes” possibly could prefer the approach championed by the Court of Chancery in the opinion on challenge here. See Lewis v. Vogelstein, 699 A.2d 327, 338 (Del. Ch. 1997). Put simply, we argue that judicial deference to the fully informed, uncoerced vote of disinterested stockholders is the optimal approach to executive compensation even if the recipient is deemed to be some variety of a controlling stockholder.

• Robert Anderson, Professor of Law, University of Arkansas School of Law
• Stephen M. Bainbridge, William D. Warren Distinguished Professor of Law at UCLA School of Law
• Jeffrey L. Coles, Samuel S. Stewart, Jr. Presidential Chair in Business and David Eccles Chair & Professor of Finance, University of Utah, David Eccles School of Business
• Ronald J. Colombo, Professor of Law, Maurice A. Deane School of Law at Hofstra University
• Benjamin Edwards, Professor of Law, William S. Boyd School of Law, University of Nevada, Las Vegas
• Martin Edwards, Assistant Professor of Law, The University of Mississippi School of Law
• Richard A. Epstein, Laurence A. Tisch Professor of Law, New York University Law School and Senior lecturer at the University of Chicago
• Caleb N. Griffin, Associate Professor of Law, University of North Carolina School of Law
• Sean J. Griffith, T.J. Maloney Chair and Professor of Law,
• Fordham Law School
• M. Todd Henderson, Michael J. Marks Professor of Law, University of Chicago Law School
• Swaminathan Kalpathy, Professor of Finance, Neeley School of Business, Texas Christian University
• Stephen Neil Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance, Booth School of Business, University of Chicago
• Stanley Keller is Counsel at Troutman Pepper Locke LLP
• Jeremy Kidd, Professor of Law at Drake University Law School
• Jonathan R. Macey, Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law, Yale Law School and Professor, Yale School of Management
• Ivan Marinovic, Professor of Accounting, Stanford Graduate School of Business.
• Robert T. Miller, F. Arnold Daum Chair in Corporate Finance and Law, University of Iowa College of Law
• George Mocsary, Professor of Law, University of Wyoming College of Law
• Charles R. T. O’Kelley, Professor, Seattle University School of Law
• John F. Olson, Distinguished Visitor from Practice, Georgetown Law School (retired); founding Chair, American College of Governance Counsel
• Seth C. Oranburg, Professor of Law, University of New Hampshire Franklin Pierce School of Law
• Keith Sharfman, Professor of Law, St. John’s University
• David Schellhase, Former General Counsel, Salesforce and Slack
• Kelly Shue, Amman Mineral Professor of Finance, Yale School of Management
• Marc Sonnenfeld, Retired partner, Morgan, Lewis & Bockius LLP
• J.W. Verret, Associate Professor of Law, Antonin Scalia Law School at George Mason University
• Charles K. Whitehead, Myron C. Taylor Alumni Professor of Business Law, Cornell Law School