Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article

The Delaware Court of Chancery recently declined to revise its January post-trial decision that the Tesla Inc. directors’ more than $55 billion pay package for CEO Elon Musk was a breach of duty that must be rescinded — despite what the electric carmaker’s board called a ratifying shareholder approval vote, in Tornetta v. Musk, et al. C.A. No. 2018-0408-KSJM (Del. Ch. Dec. 2, 2024).

Chancellor Kathaleen McCormick’s December 2 opinion rejected the director defendants’ plethora of objections to her January post-trial decision that the pay plan was a waste of corporate assets and could not pass the entire fairness test. That allowed plaintiff Richard Tornetta to continue his ultimately successful derivative suit seeking recission of Musk’s record-setting stock grant.  

She awarded the investor plaintiff a $345 million fee in cash or stock, limiting the amount only because of the windfall rule exception.

In the December opinion, the Chancellor had occasion to address myriad novel arguments and legal theories because, “The large and talented group of defense firms got creative with the ratification argument, but their unprecedented theories go against multiple strains of settled law” in four ways, each of which could defeat defendants’ motion.

Four flawed fault theories fail

“First, the defendants have no procedural ground for flipping the outcome of an adverse post-trial decision based on evidence they created after trial.

“Second, common law ratification is an affirmative defense that must be timely raised, which means that, at a minimum, it cannot be raised for the first time after the post-trial opinion.

“Third, what the defendants call “common law ratification” has no basis in the common law—a stockholder vote standing alone cannot ratify a conflicted-controller transaction.

“Fourth, even if a stockholder vote could have a ratifying effect, it could not do so here due to multiple, material misstatements in the proxy statement.”

Fee limited by Windfall Rule

The Chancellor said the suit brought about the rescission of the $55-plus billion grant, which might theoretically generate a multi-billion fee by the usual way of calculating awards in successful derivative plaintive suits based on the value of the savings for the stockholders.  But here, the “eyepopping” result of that method must yield in this way, because the multi-billion amount at issue is a windfall no matter the methodology used to justify it.” 

”To reach a reasonable number”, she said, ”this decision adopts the defendants’ approach and uses the $2.3 billion grant date’s fair value to value the benefit achieved,” and that results in the $345 million fee using a “conservative” 15% rate. 

Background

The litigation arose from a 2018 board plan to grant Musk nearly the top amount of stock compensation he would be eligible to receive since he allegedly achieved all the performance goals in his contract at Tesla –resulting in the largest executive compensation award in the history of public markets and a six-year shareholder derivative suit battle.  Tornetta charged the directors — and Musk as controlling shareholder – breached their fiduciary duty through the grant,

Chancellor McCormick ruled on January 30 that the grant was a conflicted transaction and thus did not qualify for the protection of the defendant-friendly business judgment rule. C.A. No. 2018-0408-KSJM, Docket (“Dkt.”) 294, Tornetta v. Musk, 310 A.3d 430 (Del. Ch. 2024), 

Investor, not court, approval 

After she ruled in January that the suit could continue due to the directors’ possible conflict, and ordered rescission, plaintiff moved for a fee award.  Defendants sought revision of the ruling after obtaining a shareholder majority vote approving the compensation package — which they claimed was a ratification that met the requirements of entire fairness.

Were there other grant options?

The Chancellor noted that, “Contrary to how some have read the Post-Trial Opinion, the court did not find that the Board should have paid Musk nothing. There were undoubtedly a range of healthy amounts that the Board could have decided to pay Musk. Instead, the Board capitulated to Musk’s terms and then failed to prove that those terms were entirely fair.”

She also noted that, “Tesla did not issue any stock in connection with the Grant, and so rescission will not result in the return of any stock to Tesla’s treasury.  Rather, rescission terminated Tesla’s obligation to issue restricted stock and revoked Musk’s right to exercise the options.

What’s the difference in relief?

Additionally, she pointed out that although defendants’ briefing challenged the law supporting the rescission order, by the time the case reached oral argument, ‘defense counsel made “very clear” what they were seeking, stating: “This motion does not seek to vacate the Court’s factual findings or its legal conclusion. The only relief we are seeking at this point is that the Court modify the remedy set forth in the opinion.”  But that requested remedy would, in effect, result in reversing the January ruling, she said.

And she pointed out that Musk’s sway over Tesla was such that the directors agreed two weeks after the January decision to grant his wish to move the company’s charter to what he said on social media was the more corporate friendly environment of Texas.

Newly created, not newly discovered evidence

As to whether the Court should consider the purported ratifying effect of the shareholder approval vote on the grant’s ability to meet the entire fairness test, the Chancellor made a key distinction: Defendants urged the court to apply the more movant-friendly standard of Rule 54(b). But Rule 54(b) is “a poor fit at this procedural posture”, she said, because “judgment did not contain factual findings and in the context of representative litigation, the Delaware Supreme Court has held that “[a] judgment on the merits is not final until an application for an award of attorneys’ fees has been decided.”

Conclusions

Chancellor McCormick concluded that “Whether to permit a party to assert a late-raised defense is a matter of judicial discretion where the court must take into account the potential for prejudice to the other party.  This court has allowed a party to raise an affirmative defense based on a stockholder vote that occurred during litigation. But she said, “no court has ever allowed a party to deploy stockholder ratification as a defense after the close of fact finding, with one possible exception that did not apply here.” 

 Besides, the director’s proxy was misleading, and a shareholder vote alone cannot ratify a conflicted transaction, she ruled.