• If it survives appeal, the Court’s decision that Musk controls Tesla, Inc. ("Tesla" or the "Company") significantly expands the prospect that a stockholder owning as low as 20% of the voting power of a company will be deemed to be a controller, subject to rebuttal.
• Having found that Musk was a controller, the Court reviewed his equity compensation package (the “Grant”) under the standard of entire fairness.
• While disinterested stockholders overwhelmingly approved the Grant, the Court required Defendants to prove the Grant was entirely fair because of material misrepresentations and omissions in the proxy disclosures about the negotiation of the Grant.
• The Court concluded that Defendants failed to prove the Grant was entirely fair due both to conflicts in the negotiation process and the compensation package being inappropriate for achieving its stated ends given its size.
• The Court ordered rescission of the entire Grant, notwithstanding the substantial increase in Tesla’s market capitalization after the Grant was adopted.

The Delaware Court of Chancery issued a post-trial opinion, on January 30, 2024, in Tornetta v. Musk,¹ holding that Tesla’s board of directors (the “Board”) breached its fiduciary duties in awarding CEO Elon Musk (with the Board, “Defendants”) the Grant in early 2018 that ultimately realized its maximum potential value of US$55.8 billion. In an opinion from Chancellor Kathleen St. J. McCormick, the Court ordered that the Grant be rescinded entirely. The Court did not award monetary damages against the directors who negotiated and recommended stockholder approval of the compensation package. Defendants have not yet announced whether they intend to appeal the decision to the Delaware Supreme Court, but an appeal is widely expected.

Background

The Grant stemmed from a process whereby Musk and the Board’s Compensation Committee agreed to a new compensation package for Musk as the Company’s CEO. At the outset of that process, Musk proposed a package that closely resembled what was ultimately approved by the Board. The Court found that the only real changes to that initial proposal were when Musk reduced its terms by “negotiat[ing] against himself.”² The Grant provided 12 tranches of equity awards—each worth 1% of Tesla’s outstanding shares—that Musk could unlock for each US$50 billion increase in the Company’s market capitalization (along with EBITDA and revenue requirements). The maximum amount of the Grant—worth US$55.8 billion—would only be awarded if all 12 tranches were unlocked, corresponding with growth in Tesla’s market capitalization from approximately US$50 billion to US$650 billion. The Grant was announced on January 23, 2018, and a stockholder vote approving the Grant was held on March 21, 2018.

Following Tesla’s unprecedented performance, Musk unlocked all 12 grants of equity and received the full US$55.8 billion package, pending a five-year retention period required by the terms of the Grant. While the Grant was meant to provide ten-year goals for Musk, all of the Grant’s milestones were reached by June 30, 2022. Between the filing of Plaintiff’s original complaint on June 5, 2018, and the end of litigation on April 11, 2023, Tesla’s market capitalization jumped from US$58.2 billion to US$586 billion, and hit a peak of US$1.2 trillion in 2021.

Plaintiff, a Tesla stockholder, filed his complaint on June 5, 2018, alleging (i) breach of fiduciary duty against Musk, (ii) breach of fiduciary duty against the Board, (iii) unjust enrichment against Musk, and (iv) corporate waste against the Board. At the motion to dismiss stage, the Court dismissed only the waste claim and held that the stockholder vote approving the Grant was insufficient to restore business judgment deference to its approval by the Board. The remaining claims were tried in November 2022, with post-trial oral argument held on February 21, 2023. After Court-requested supplemental briefing, the Court issued its post-trial opinion on January 30, 2024, and ordered equitable rescission of the full Grant.

The Court’s Decision

In reaching its conclusion, the Court made four key legal determinations. First, the Court determined that Musk was a “controller” of the Company, thus requiring the Court to review the Grant under the entire fairness standard—the highest of Delaware’s three levels of scrutiny applying to business decisions. Second, the Court determined that an affirmative stockholder vote did not shift the burden of proof away from Defendants to prove the Grant was fair because stockholders were not fully informed in their vote. Third, the Court determined that Defendants failed to prove the Grant was fair to stockholders under the heightened standard. Fourth, and finally, the Court determined that full rescission of the Grant was the appropriate remedy.

Musk Controls Tesla

The Court deemed the Grant a controller-conflicted transaction because of a series of factors that, in the aggregate, evidenced Musk’s control over the Company and the Board.

First, the Court evaluated Musk’s stock ownership, which at the time of the Grant’s approval stood at 21.9%. Black-letter law dictates that individuals owning 50.1% or more of a corporation’s shares have control, leaving Musk far short of that threshold. But the Court considered Musk’s 21.9% holding in the context of other instances where persons having less than a majority of the voting power nonetheless were found to exhibit “control.” For example, the Court noted the definition of control in Section 203 of the Delaware General Corporation Law, which provides that a person with ownership of 20% or more of the voting stock of a company “shall be presumed to have control of an entity, in the absence of proof by a preponderance of the evidence to the contrary.”³ The Court cited other examples where individuals without a majority of the voting power nonetheless were found to exhibit “control,” noting that “[c]ontrol of the ballot box is not always dispositive of the controlling stockholder inquiry.”⁴

The Court also examined whether Musk wielded power over the Board “by virtue of his high-status roles and managerial supremacy” and found that Musk, as CEO, Chair of the Board and founder of the Company, reached the “Superstar CEO” level at Tesla.⁵ According to the Court, a Superstar CEO is an individual “who directors, investors and markets believe make a unique contribution to company value.”⁶ The Court viewed Musk’s “CEO superstardom,” combined with his freedom to use company resources for personal projects and the lack of Board oversight, as evidencing his control of the Company because “[when] directors believe a CEO is uniquely critical to the corporation’s mission, even independent directors are likely to be unduly deferential.”⁷

Beyond stock ownership and Musk’s unique importance to Tesla, the Court noted that a majority of the Board was not independent from Musk due to significant business, financial and personal ties to him.⁸ The Court concluded without discussion that Musk’s brother, Kimbal Musk, was not independent. The Court likewise found two other directors (including one Compensation Committee member) were not independent due to their extensive business relationships—including US$1 billion invested in Musk-controlled entities—and deep personal relationships with Musk, including regular vacations with Musk and his family.⁹ The Court further noted that the other three members of the Compensation Committee were either beholden to Musk or potentially compromised on the issue of the Grant, including because the compensation each received as a director was either “life-changing” or a large portion of their wealth.¹⁰ The Court added that the one remaining director was straightforwardly independent.¹¹

Concerning process, the Court reasoned that “[t]here is no greater evidence of Musk’s status as a transaction-specific controller than the Board’s posture toward Musk during the process that led to the Grant.” While the Board tasked an ostensibly independent Compensation Committee to negotiate a package with Musk, the Court found that Musk effectively controlled the timing of the negotiations, the negotiation mechanics, and the Grant’s ultimate terms, with no adversarial negotiation. Indeed, the Court criticized the Compensation Committee’s process because it was Musk, not the Committee, who was “trying to single-handedly calibrate the compensation package to terms that were more reasonable.”¹² Finally, the Court credited admissions from Compensation Committee directors that they did not view the process as an arm’s length negotiation, and instead a “form of collaboration with Musk.”¹³

Thus, the Court concluded “with respect to the Grant, Musk controlled Tesla.”¹⁴ It therefore reviewed the Grant under entire fairness.¹⁵

The Stockholder Vote Did Not Shift the Burden of Proving Entire Fairness to Plaintiff

Under Delaware law, the entire fairness standard of review requires defendants to prove that the challenged transaction was entirely fair. However, defendants can shift that burden back to the plaintiff if the transaction was approved by a fully informed stockholder vote. Here, Tesla did in fact condition the Grant on a vote of disinterested stockholders, and it was approved with 73% of shares voting in favor.¹⁶

The Court nonetheless found that vote insufficient to shift the burden of proof to Plaintiff. Specifically, the Court found, for reasons similar to the above, that the description of the Compensation Committee as “independent” in the proxy was “untrue.”¹⁷ Tesla had disclosed some sources of potential conflict in previous filings, but the Court found the disclosures in the proxy statement for the Grant were “materially deficient” in disclosing the extent of the conflicts.¹⁸

The Court also found that the proxy statement concerning the Grant materially misrepresented a conversation between Musk and the chair of the Compensation Committee. While a description of the conversation had appeared in earlier versions of the proxy, it was changed in the definitive proxy to suggest that the full Compensation Committee had participated, rather than just Musk and the chair. The Court held that the revision implied that the private conversation had not happened, which was a material omission.

Defendants had argued that the stockholder vote was fully informed because, notwithstanding the above process issues, the economic terms of the Grant were all disclosed, and that in any event, the process disclosures were not material to stockholders. The Court rejected that argument, holding that the Defendants’ position was not supported by Delaware law and that, in any event, the assertion that key negotiators were independent was false. As a result, the Court found the stockholder vote had no effect on shifting the entire fairness burden from Defendants back to Plaintiff.

Defendants Did Not Prove the Grant Was Entirely Fair

With the full burden of entire fairness remaining on Defendants, they were required to prove that the Grant resulted from a fair process and represented a fair price.

Mapping the facts regarding Musk’s control onto the factors outlined by the seminal Delaware case on entire fairness, Weinberger v. UOP, Inc.,¹⁹ the Court determined that Defendants did not show the process leading to the Grant was fair. In particular, the Court found that Defendants’ assertions regarding the ostensible concessions gained by the Compensation Committee were unpersuasive because the Committee was “compromised by conflicts.”²⁰

On fair price, the Court rejected Defendants’ arguments that the size of the Grant was justified by the upside in the growth of the Company and the need to keep Musk as a “fully engaged CEO.”²¹ Instead, the Court held that the Grant was not a reasonable approach to attain the Board’s goals of retention and engagement, and that Defendants did not prove that the size of the Grant was a “necessary, much less fair” package to achieve its stated goal of keeping Musk’s attention focused on Tesla.²² Indeed, in the Court’s view, Musk’s existing 21.9% equity holdings already served as a “powerful incentive to stay and grow Tesla’s market capitalization.”²³ The Court also rejected Defendants’ argument that the Grant was “only upside” because the stockholder protections in the Grant—such as revenue targets and the five-year hold period—had limited value that did not “individually or in the aggregate lead to a finding of fair price.”²⁴

Because it found unfairness with respect to both the process and the price of the Grant, the Court determined that Defendants failed to prove the Grant was entirely fair.

The Court Rescinds the Entire Grant

With its finding the Grant was unfair to stockholders, the Court weighed the appropriate remedy. While Defendants argued that rescission would be a “harsh consequence that would leave Musk uncompensated,” the Court found that Musk’s preexisting equity already provided him tens of billions of dollars and Defendants had not offered a viable alternative remedy.²⁵ Defendants had argued that rescission’s purpose—to return parties to the status quo—made it an ill-fitting remedy where Tesla was now worth many times the value that it was when the Grant was made.²⁶ Nonetheless, the Court found that Defendants had not suggested that any portion of the Grant would be “more defensible than the remaining amount,” and that rescission was appropriate because the Grant was unexercised and subject to the five-year hold period.²⁷

Takeaways

We have written before about the procedural safeguards that can insulate a potential controller from the Board’s decision-making and preclude a finding of actual control, even where the stockholder is a founder whose name is synonymous with the company.²⁸ Pending an expected appeal from Musk and the Board to the Delaware Supreme Court, this case demonstrates that the need for strong safeguards is amplified when the decision at issue involves compensation of a controller.

Moreover, should it stand, the Court of Chancery’s decision will have a number of significant effects on Delaware law and corporate governance, including:

• The decision signals a potential trend by the Court to presume that stockholders holding at least 20% of the voting securities of a company are controllers, subject to rebuttal.²⁹
• The decision once again underscores the need to analyze both business relationships and the nature and duration of personal relationships in assessing director independence.
• Misrepresentations and omissions in disclosures related to process defects can render a stockholder vote uninformed—even where disclosure of the economic terms is accurate—and thus insufficient to achieve burden shifting or contribute to a reduction in the standard of review.
• Executives and founders may take steps to minimize the risk of rescission, including by insisting on shorter hold periods for equity awards.

1. No. 2018-0408-KSJM (Jan. 30, 2024).
2. Id. at 76.
3. 8 Del. C. § 203. Generally, Section 203 constrains certain financial transactions between a corporation and an “interested stockholder” for a period of three years after such stockholder acquires 15% of the voting stock of the company. The definition of control cited by the Court is used to identify who is an “interested stockholder” through its affiliates and is not clearly intended to define “control” in all circumstances beyond those governed by Section 203.
4. Slip Op. at 106.
5. Id. at 116.
6. Id. at 120.
7. Id. at 121.
8. Id. at 123-27.
9. Id. at 123-126.
10. Id. at 125.
11. Id. at 126.
12. Id. at 62.
13. Id. at 144.
14. Id. at 112.
15. At the motion to dismiss stage, the Court held that a fully informed stockholder vote alone was insufficient to restore business judgment deference to the Grant unless it was accompanied by the other procedural requirements of conflicted-controller transactions outlined in the seminal case of Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).
16. The votes of Musk and his brother were excluded from the vote. See Tesla, Inc. Current Report (Form 8-K) (Mar. 21, 2018).
17. Slip Op. at 150.
18. Id. at 152
19. 457 A.2d 701 (Del. 1983).
20. Slip Op. at 165.
21. Id. at 176.
22. Id. at 182.
23. Id. at 178-79.
24. Id. at 185.
25. Id. at 198.
26. Director Defs’ Supplemental Reply Br. at 7.
27. Id. at 198-199 (citation omitted).
28. See, e.g., “Delaware Court of Chancery Finds for Oracle Founder Larry Ellison and CEO Safra Catz in Post-Trial Decision Arising from Oracle’s Acquisition of NetSuite,” OnPoint (May 18, 2023); “Delaware Supreme Court Affirms Tesla’s Acquisition of SolarCity as ‘Entirely Fair,’” OnPoint (June 12, 2023).
29. See also Travis Laster, “Wondering About ‘Control’? The General Assembly Already Defined It.” (Feb. 4, 2024).