SolarCity was a market leader in manufacturing and installing solar energy generation systems. From 2015 to 2016, SolarCity was facing liquidity problems. Twice, Elon Musk, then CEO and chairman of the Tesla board (the Board), proposed to the Board that Tesla acquire SolarCity. The Board declined twice, but then agreed to acquire SolarCity in May 2016 when Musk proposed acquiring SolarCity for a third time. Due diligence revealed that SolarCity’s financial condition was even worse than publicly disclosed. Thus, the Board lowered its bid for SolarCity and conditioned acquisition on approval by minority shareholders. The shareholders approved the merger in November 2016.
Certain Tesla shareholders subsequently filed suit against each of the Tesla board members, including Elon Musk in the Delaware Court of Chancery. The plaintiffs claimed that Musk, as Tesla’s controlling shareholder, had overruled the Board and caused Tesla to acquire an insolvent SolarCity at an unfair price. The plaintiffs settled with all of the Board members except Musk, who opted for a trial on the remaining claims: breach of fiduciary duty as controlling shareholder, unjust enrichment, and waste. After an 11-day trial, post-trial briefing, and oral argument, the court dismissed all counts against Musk.
The court acknowledged, but did not decide, several conflicts issues, ultimately concluding that, even with these conflicts, the price of the transaction was fair. First, the court observed that Musk was a shareholder in both the target and buyer, but declined to decide whether Musk’s stake in SolarCity and Tesla (approximately 20 percent for both companies) was enough under Delaware law to make him a “controlling” shareholder. Second, the court noted that a majority of the Tesla Board was conflicted (with many directors also owning shares in SolarCity as well as Musk’s other company, SpaceX), but declined to decide whether the transaction should be judged by the entire fairness standard or business judgment standard.
The court found that the transaction would pass muster even under the more stringent entire fairness standard for two main reasons: (1) the Board meaningfully vetted the SolarCity acquisition, and Musk did not actively block the Board’s process; and (2) the preponderance of the evidence indicated that the SolarCity price was fair.
The court found there to be both weaknesses and strengths in the Tesla Board’s process. In terms of weaknesses, (1) the Board did not form a special committee of independent directors to negotiate the acquisition; (2) Musk failed to recuse himself from all discussions about the acquisition and, in fact, actively participated in some of the Board’s discussions; and (3) Musk discussed the acquisition with SolarCity leadership without notifying the Board that he was in contact with the target.
The court found that the Board did implement a number of safeguards, however, including, (1) the Board was led by a director who had no affiliation with SolarCity or Musk’s other companies; (2) Musk did recuse himself from some Board discussions, and, more importantly, Musk did not vote in any matter relating to SolarCity; and (3) the Board had pushed back against Musk’s suggestions, twice declining to pursue the merger, lowering the offer following diligence, and declining to make a bridge loan to Solar City.
Ultimately, the court concluded that Musk had not “coerced” the Board at any point, even when the Board went against his wishes. The court pointed out that the Board even required a vote by disinterested shareholders in favor of the acquisition, a vote that is not required under Delaware law.
However, the primary reason that the acquisition met the entire fairness standard was on “substantive” grounds – the “fair price” that Tesla shareholders received. The court rejected the plaintiffs’ assertion that SolarCity had no value on its own because SolarCity had a successful product and because, since the merger, Tesla had recognized significant cash flows from the acquisition. Moreover, SolarCity’s financial issues were fully disclosed to shareholders; news media had reported on SolarCity’s financial problems and the Board had lowered its price in response to due diligence findings.
The court noted that Musk and the Board had failed to implement certain processes under well-established Delaware law and that much of this litigation could have been avoided if those processes had been implemented. However, the “astronomic rise in Tesla’s stock price post-Acquisition is noteworthy . . . hindsight suggests that [Musk] is right.” While this decision does not render the rules of good corporate governance in conflicted transactions obsolete, it does demonstrate how a court may separate out procedural and substantive aspects of a conflicted transaction.
While prior Delaware precedent suggested that procedural failings would usually doom a conflicted transaction, this decision suggests that, in the end, a fair price may make up for some procedural deficiencies.
