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that the Tesla Inc. directors’ more than $55 billion pay package for CEO Elon Musk was a breach of duty that must be rescinded — despite what the electric carmaker’s board called a ratifying shareholder approval vote, in Tornetta v. Musk, et al.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.

Aimee Czachorowski, an attorney in the Delaware office of Lewis Brisbois, prepared this post.

Chancellor McCormick’s recent letter decision in Floreani, et al. v. FloSports, Inc., C.A. No. 2023-0684-LM-KSJM (Del. Ch. Oct. 31, 2014), illustrates the pitfalls of non-compliance with the technical requirements of a Section 220 demand by a stockholder for corporate books and records.

The Chancellor summarized the statutory form-and-manner requirements–as well as those imposed by case law–that must be complied with when making a Section 220 books and records request, as follows:

“Breaking it down, Section 220(b) requires that a demand: (1) be in writing, (2) be under oath, (3) state the stockholder’s purpose, and (4) be directed to the corporation at its registered agent or principal place of business. (5) If the stockholder is not a record holder, then the demand must be accompanied by documentary evidence of beneficial ownership of the stock. (6) If the demand is sent by an attorney, then it must be accompanied by a power of attorney. That’s four form-and-manner requirements that apply in all circumstances and two that apply in certain circumstances. The form-and-manner requirements are not onerous, but they are strictly enforced.”

The Court further noted that an “implied condition of the fifth and sixth form-and-manner requirements” is that the demand must “identify the stockholders on whose behalf [the demand] is sent.”

Concluding that three separate demands made under Section 220 were deficient, the Court granted the defendant’s exceptions to the Master’s report. Notably, Section 220 requires a five-day waiting period after the demand–before filing suit.

But here, the five-day waiting period was not complied with when plaintiffs made their third demand; plaintiffs made a motion to amend the same day they served the demand, although they waited an additional five days after the demand to serve the proposed amended complaint. The Chancellor found that the motion to amend, made before the statutory five-day window closed, did not comply with the requirements of Section 220(c).   

Aimee Czachorowski, an attorney in the Delaware office of Lewis Brisbois, prepared this post.

The Delaware Supreme Court, in In re Mindbody, Inc. Stockholder Litigation, C.A. No. 2019-0442 (Del. Supr. Dec. 2, 2024), affirmed the Court of Chancery’s finding  that Mindbody’s founder and CEO had breached fiduciary duties in connection with actions he took to monetize his Mindbody investment and sell Mindbody to Vista.

The Court of Chancery found he had both breached his Revlon duties and had breached the duty of disclosure. The Supreme Court affirmed that finding, but reversed the Chancery’s finding of aiding and abetting the disclosure breach, and affirmed that Court’s decision regarding waiver of a right to seek settlement credit. Because the aiding and abetting determination was reversed, the Court did not reach the trial court’s award of disclosure damages.

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery and Professor Elise Bernlohr Maizel recently published a law review article entitled Discovery as a Compliance Problem, available at this hyperlink, 50 J. Corp. L. 53 (2024), which should be read by all lawyers involved in commercial litigation in Delaware.


Highlights include the following bullet points:

  • Civility expectations, and a reminder that the duty of a lawyer to the Court supersedes the duty to a client. See pages 73-77.
  • There is no such thing as “local counsel” in Delaware. That is, Delaware counsel will be held responsible for all court filings and all positions taken–even if out-of-state counsel is taking the lead. See footnotes 148-149 and accompanying text.
  • Deposition rules in Delaware impose more restrictions and duties on lawyers compared to many other states. See page 77.
  • Deadlines in scheduling orders are strictly enforced in Delaware. See page 79.
  • Privilege may be waived if a privilege log is not properly compiled. See pages 79-80.
  • Boilerplate objections to discovery requests are not truly replies at all–especially when the objection does not make clear what exactly is being withheld and what is being produced. See pages 80-82. See also Del. Ct. Ch. R. 34(b) (requiring specific objections and explanations about what is being withheld based on objections.)

Several recent articles by corporate law scholars and a jurist (who also deserves to be called a scholar) are worth highlighting. Professor Stephen Bainbridge, often cited in Delaware court decisions and a friend of this blog, and Vice Chancellor Travis Laster, have authored recent articles that should be of interest to those who follow Delaware corporate law.

Professor Bainbridge penned a law review article entitled: A Course Correction for Controlling Shareholder Transactions, which, as the title suggests, analyzes the duties of controlling shareholders and related issues.

Vice Chancellor Laster also penned an article on the duty of controlling shareholders, that appeared on LinkedIn.

Professor Bainbridge commented on that article on his blog at this link.

Then, Vice Chancellor Laster made observations on LinkedIn about Professor Bainbridge’s blog post regarding the Vice Chancellor’s article.

Lastly, on a somewhat different aspect of corporate law, more recently the good professor addresses on his eponymous blog an article by another law professor, and incorporates responses to that article by a Delaware practitioner, that together address the perennial question of whether other states are seriously challenging Delaware’s prominence in the corporate law universe–especially in light of recent Delaware court decisions that, in the view of some, are perceived as anti-business.

Fanta Toure, a law clerk in the Delaware office of Lewis Brisbois, prepared this post.

The Supreme Court of Delaware issued a significant ruling in Kellner v. AIM Immunotech Inc., No. 2023-0879 (Del. Supr. July 11, 2024), addressing a legal challenge related to advance notice bylaws adopted by AIM Immunotech’s board in response to new universal proxy rules. The case arose after a group of dissident stockholders sought to nominate a slate of directors to AIM’s board. Following a previous proxy contest, the AIM board amended its bylaws, and the stockholders failed to meet the new requirements, leading the board to reject their nominations. The Delaware Court of Chancery initially found several provisions of the amended bylaws invalid but upheld the board’s decision to reject the nominations.

The Supreme Court affirmed some aspects of the lower court’s decision while reversing others. It clarified the standards for determining the validity of bylaws, emphasizing that the burden of proving a bylaw invalid rests with the party challenging it. The Court held that bylaws must align with the law and the corporation’s charter, and they must address legitimate corporate matters. While the Court found most of the contested bylaws to be valid, it ruled that the “Ownership Provision” bylaw, which required extensive disclosure of ownership interests, was overly broad and invalid due to its excessive complexity.

The Court further refined the test for evaluating bylaws, referencing its earlier decision in Coster v. UIP Companies, Inc., which required a two-pronged approach. First, it must be determined whether the board faced a genuine threat to a corporate interest, and second, whether the board’s response was reasonable and not unduly coercive to shareholders. The Supreme Court agreed with the lower court’s finding that several amended bylaws were designed to undermine the stockholders’ proxy contest, and breached the duty of loyalty, rendering them unenforceable. The Court ultimately declined to offer relief to the plaintiff, citing false and misleading submissions.

Lawrence Cunningham is the new Director of the Weinberg Center for Corporate Governance at the University of Delaware. He is a prolific corporate law scholar and provides thought leadership on the perennial issue of Delaware’s role in the nation’s corporate law in a new article entitled: Delaware Corporate Law Still Gold Standard Amid ESG Blowback.

In a masterpiece of contract interpretation and statutory analysis, the Delaware Court of Chancery recently reconciled juxtaposed provisions in the Delaware General Corporation Law and a Certificate of Incorporation to allow a reincorporation of a Delaware company in Nevada with a majority vote—as compared to requiring a supermajority vote. Gunderson v. The Trade Desk, Inc., C.A. No. 2024-1029-PAF (Del. Ch., Nov. 6, 2024).

Brief Overview

Naturally, the detailed facts of this case are important but, in essence, the company involved proposed to effect its reincorporation pursuant to a conversion under Section 266 of the Delaware General Corporation Law. Section 266 allows a conversion by a majority of the outstanding shares of stock of the corporation entitled to vote upon the proposal. Article X of the corporation’s Certificate of Incorporation, however, requires the approval of 66 2/3rds of the outstanding voting power of the corporation’s stock, voting as a single class, to “amend or repeal, or adopt any provision” of the certificate inconsistent with certain enumerated articles of the certificate.

A stockholder alleged that the conversion resulted in an amendment of the Certificate of Incorporation and, therefore, triggered the supermajority requirement. The court disagreed.

Key Holding

Relying on the doctrine of independent legal significance, and a long line of cases upholding that doctrine, the court reasoned that the conversion was not subject to the supermajority vote requirement in the charter or certificate of incorporation.

In order for that supermajority provision to have applied, among other reasons, the charter would have needed to include additional language required to specify that the provisions of the charter applied outside of Section 242 of the DGCL, which governs amendments to a charter.

Highlights of the Court’s Analysis and Decision

  • A key principle that is a bedrock of Delaware corporate jurisprudence is that actions of a director are “twice-tested”: first for legal authorization, and second by equity. See footnote 23.
  • A keystone of the court’s analysis was the well-established doctrine of independent legal significance which holds that “legal action authorized under one section of the corporation law is not invalid because it causes a result that would not be achievable if pursued through other action under other provisions of the statute.” Slip op. at 16.
  • The court discussed at length a multitude of cases discussing the doctrine of independent legal significance, beginning with a case that was decided about 90 years ago. Slip op. at 16-26.
  • A few eminently quotable statements of law buttress the court’s reasoning, including the following:

“General language alone granting preferred stockholders a class vote on certain changes to the corporate charter (such as authorization of a senior series of stock) will not be read to require a class vote on a merger and its integral and accompanying modifications to the corporate charter and the corporation’s capital structure.”

Slip op. at 24 -25 (citations omitted).

  • Delaware has long adhered to: “application of the doctrine of independent legal significance and refused to extend charter-based voting requirements to mergers and consolidations absent clear language . . ..” Slip op. at 25 (citations omitted).
  • The court underscored that: “. . . it is well-established that, like the preferences of preferred stock, ‘high vote requirements’ ‘must be clear and unambiguous,’ leaving ‘no doubt that the shareholders intended that a supermajority would be required.”’ (citations omitted). Slip op. at 27.
  • “Delaware decisions have made clear that: if a party wants a consent right that applies to mergers generally, or which applies to mergers that have the effect of altering, amending or eliminating the special right that the party possesses, then the consent right must refer specifically to a merger.” Footnote 31.
  • In addition to the basic contract interpretation principles that apply to interpretation of a certificate of incorporation, the court emphasized a consequential principle of interpreting a charter that is an essential tool for the toolbox of corporate litigators: “When it comes to the construction and interpretation of a certificate of incorporation, ‘the agreement as a whole’ includes the DGCL and all of its amendments, which the Delaware legislature has determined ‘shall be a part of the charter, or certificate of incorporation of every corporation except so far as the same are inapplicable and inappropriate to the objects of the corporation….’” Slip op. at 28-29. See 8 Del. C. § 394. Also included are cases interpreting the DGCL.
  • The court noted that the doctrine of contra proferentem was not applicable when a contract was not ambiguous. Slip op. at 42.
  • In closing, the court explained that it would enter a partial final judgment pursuant to Rule 54(b) to allow an expedited appeal if any of the parties so chose.

The current issue of Delaware Today magazine published this month a list of “Top Lawyers” in Delaware for various areas of the law. Yours truly was included in the list under the category of “corporate law”. (There was no separate category for corporate litigation.) Congrats to my fellow Delaware lawyers who were included in the list, including my Delaware partners, Scott Cousins for business bankruptcy and Ciro Poppiti for hospitality law.

This post was prepared by Aimee Czachorowski, an attorney in the Delaware office of Lewis Brisbois.

Specific costs recoverable by a prevailing party is an oft-asked question in the Delaware courts. The Superior Court’s Complex Commercial Litigation Division recently addressed what expert fees and trial technology costs can be recovered by the prevailing party in NewWave Telecom and Technologies, Inc. v. Ze Jiang, et al., C.A. No. N-20C-09-215 VLM CCLD (Del. Super., Oct. 24, 2024).

Although the Court discussed an award of attorneys’ fees pursuant to the applicable SPA, the Court’s discussion of allowable costs is of more widespread interest to practitioners. The Court indicated that expert witness fees were recoverable, but only for the portion of the expert’s time that was “necessarily spent in attendance upon the court for the purpose of testifying.” Slip op. at 9.

The Court also explained that: Time spent by the expert traveling to and from the courthouse, and time spent waiting to be called to the witness stand was recoverable. The Court also addressed what trial technology support costs could be recoverable.

Specifically, the Court allowed for: 1) Travel, lodging, and meals incurred while the expert was waiting to be called to testify (even while waiting to be called in rebuttal); 2) Time the expert actually spent waiting upon the Court—defined to mean the actual trial time plus an hour for travel to and from the courthouse; and 3) trial technology support for the actual trial time, not including preparation time.