This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.
The Delaware Court of Chancery recently found that a trial is needed to decide whether, despite his minority share of Tesla Motors Inc., CEO Elon Musk could exert a controller’s “coercive influence” over the electric carmaker’s shareholders who approved the 2016 acquisition of Musk’s struggling SolarCity Corp. in the matter styled: In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS (Del. Ch., Feb. 4, 2020.)
The Court’s February 4 decision largely denied dueling summary judgment motions by plaintiff investors — who say they’ve proved Musk and the directors hid SolarCity’s virtual insolvency, and the defendants — who claim that without proof that Musk is a conflicted controller, the shareholders’ uncoerced approval vote cleanses the deal.
How did he allegedly do it?
The Court scheduled a trial for March that is expected to focus on whether Musk’s alleged dominance of Tesla was so pervasive that he could advance his self interest at the expense of the public investors, triggering a court review under the exacting requirements of the entire fairness standard.
If plaintiffs fail to demonstrate Musk’s control, the directors would be shielded by the deferential standard of the business judgment rule, which would give their actions the benefit of the doubt, and make it tough to prove breach of fiduciary duty and corporate waste charges.
Importantly, the vice chancellor rejected the defense argument that after his March 2018 decision allowed the suit to survive a motion to dismiss and move from the pleading phase to the proof stage, the plaintiffs were now obligated to show exactly how Musk used his alleged control to coerce the investors’ SolarCity deal approval. See In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS (Del. Ch., Mar. 28, 2018).
Only have to prove ability
Vice Chancellor Slights said a line of Delaware Supreme Court decisions beginning with Corwin v. KKR Financial Holdings, only requires plaintiffs to prove that an alleged controlling shareholder was so dominant that he had the ability to coerce shareholders to consent to a merger that benefited him at their expense. Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015)
But he found both parties’ summary judgment motions regarding stockholder ratification and director conflicts were not ripe because “it is desirable to inquire more thoroughly into the facts,” before deciding whether Musk possesses “inherently coercive influence over the other stockholders.”
He said, under Delaware law, a minority shareholder could be a controller if he was shown to possess “other factors” such as the “managerial supremacy” of a “hands-on” CEO and “inspirational force” whose loss would cause a “material adverse effect” on the company’s business operations. Musk is commonly referred to as the heart and soul of Tesla.
The assumption that such a conflicted controller “has strong incentives” to exert an “inherently coercive” effect on a transaction is “a finding of empirical fact rooted in the Supreme Court’s perception of how the world works,” Vice Chancellor Slights said, citing In re JCC Hldg. Co. Inc., 843 A.2d 713 n.25 (Del. Ch. 2003).
However, the vice chancellor noted that even if a trial demonstrates that Musk was Tesla’s controller at the time of the merger, defendants could still avoid liability if they could prove the deal was entirely fair to the shareholders.
The opinion also found summary judgment was not appropriate for either party regarding certain disclosure claims because there are genuine issues of material fact to be resolved at trial regarding whether the shareholder approval was fully informed as to:
- SolarCity’s alleged near insolvency at the time of the merger
- Tesla’s financial advisor’s purportedly omitted material information about the deal
- Alleged misleading disclosures hiding Musk’s merger talks role despite his recusal
- Whether Tesla misrepresented the status of SolarCity’s solar roof product.
- Whether Tesla misrepresented the expected financial impact of the merger on Tesla
- The independence of the Tesla board
“A failure adequately to disclose all material facts to voting shareholders will serve both as a bases for director liability and to preclude a stockholder vote from having a ratifying effect,” and the burden of demonstrating the vote was fully informed “falls squarely on the board,” Vice Chancellor Slights wrote.
He found that at trial, plaintiffs may prove at least four of the seven Tesla directors had divided loyalties because of their SolarCity stock holdings and/or dual positions at Musk companies and that there is a genuine material fact dispute as to whether the merger was a waste of assets.
According to press reports, shortly after the February summary judgment opinion, the Tesla directors agreed to pay plaintiffs $60 million from the company’s insurance to settle their liability, leaving Musk the sole defendant in the scheduled 10-day March trial before Vice Chancellor Slights.