Last week, the Court of Chancery’s ruling in Tornetta v. Musk rescinded Elon Musk’s unprecedented $55.8 billion pay package. Musk responded by tweeting that Tesla will hold a stockholder vote on reincorporating in Texas. The Houston Chronicle offered five reasons Musk might want to do so, including “politics” and “simplicity.” Professor Ann Lipton, on the other hand, argues that Musk wants the move “because he expects the judges will be biased in his favor.” I don’t find these explanations satisfying. If nothing else, Texas hasn’t appointed its new business court judges yet, and those judges will have two-year terms. If anything, the risk is that the character of the court can change with an administration.
But Musk’s tweets have put a spotlight on jurisdictional competition and, in that spirit, I’d like to offer five alternate reasons that Musk might find that a Texas move benefits Tesla. Fair warning: this analysis stems less from my perspective as a Delaware lawyer than from my status as a Tesla stockholder. I bought 50 shares—far more than the Tornetta plaintiff—in late 2022. My holdings have almost doubled in value, making Tesla my most successful investment since my law degree. Perhaps Tornetta will result in a more efficient, successful company and my investment will double again. Then again, perhaps not. With that in mind, here are five reasons Tesla might want to move to Texas.
- Musk and Delaware Just Don’t Vibe.
Even before Tornetta, there was little doubt that Elon Musk places little value on procedural niceties. Not his style. His Boring Company made a flamethrower. More seriously, he landed in hot water after tweeting about taking Tesla private. It is hard to argue with Tornetta’s proposition that Musk “has no filter.” But he’s also provided considerable stockholder value: even the Tornetta opinion concedes that Musk’s tenure coincided with remarkable growth in Tesla’s stock price, which is what made him eligible for a $55.8 billion payout in the first place. Process may not be a prerequisite to growth.
But Musk’s temperament may be ill-suited to Delaware, which places greater value on process. While nothing in Delaware statutory law bars Musk’s pay package, longstanding doctrine protects stockholders from “controlling shareholders” by subjecting conflicted transactions to entire fairness review, under which a company and its board must prove that a transaction is fair in price and process. While it is possible for a defendant to meet that burden—indeed, Musk did so in the SolarCity case—it’s challenging. To avoid this harsh burden, Delaware permits controlling stockholders to “cleanse” a conflicted transaction by seeking approval from both (a) a committee of independent directors and (b) fully-informed, disinterested stockholders.
After Tornetta, it is easy to see why Tesla (and Musk) may have difficulty meeting this burden, even outside the executive pay context. While director and stockholder approval are technically different analyses, in practice they can collapse into one another. Tornetta (a) finds that Tesla’s board was not independent of Musk, at least for this decision, and (b) holds that the vote was not fully informed because stockholders were told that the board was independent. Failing the first hurdle may lead to failing the second.
Thus, Delaware law leaves Tesla in a conundrum. Musk may be mercurial—but he’s led the business to profit. Perhaps Tesla can appoint a few directors that the Court of Chancery might ultimately consider independent of Musk. But perhaps not, or at least not without changing the corporate culture: the Tornetta opinion condemns the Tesla board’s negotiation of Musk’s pay package for being a “cooperative and collaborative process.” In a business context, cooperation and collaboration are generally considered positively, not negatively. Tornetta essentially imposes a choice between (a) adversarial, non-cooperative salary negotiations with Musk or (b) perpetual lawsuits where Tesla must prove that its decisions are fair. Tesla, and Musk, may desire other options, and Texas incorporation could provide an alternative.
- One More Delaware Lawsuit.
Tornetta leaves Tesla with another problem: even if it reformed its governance, it’s a large, successful company that’s an attractive target for plaintiffs’ lawyers. In the best of scenarios, it’s likely to get sued. And reality isn’t the best of scenarios: as Professor Lipton noted on Bluesky, a California lawsuit alleging that Tesla mishandled toxic waste will likely lead to a books-and-records and then a derivative suit against the Tesla board. The question isn’t whether Tesla will be sued in Delaware again, but how many times.
Reincorporation in Texas reduces that number to, potentially, one. Another Delaware plaintiff is currently suing to prevent TripAdvisor from reincorporating in Nevada. The Court of Chancery’s decision is pending. Barring total victory for TripAdvisor, however, the odds that Tesla can reincorporate in Texas without first facing expedited litigation in Delaware seem slim.
In that sense, Tornetta presents a challenge to states like Nevada and Texas that have created business courts to compete with Delaware. If Delaware plaintiffs can make it more difficult for corporations to leave the First State, can competitors adopt legal provisions making it easier, or allowing corporations to recover after reincorporation from shareholders who frustrated an attempted exit? I don’t know—but given that Governor Abbott explicitly encouraged Tesla’s move, it would not be surprising if some legislative aid has been diligently researching possible reforms over the last week.
- Stockholders Might Recover More in Texas.
Meanwhile, stockholders may be better off litigating against Tesla in Texas. A Texas business court might not have decided Tornetta any differently. As Professor Ben Edwards notes, “The last thing Texas is going to want is a reputation that their corporate law is a game where billionaires always win, because then investors aren’t going to trust it.” Unlike Nevada (where X/Twitter is now incorporated), Texas has not statutorily abolished entire fairness review. It remains to be seen whether the Lone Star state will be any less plaintiff-friendly than Delaware.
However, Texan tort reform may benefit post-reincorporation Tesla stockholders by allowing them to keep a greater percentage of recovery from a successful lawsuit. In class actions, Texas limits attorneys’ fees to 400% of the plaintiffs’ attorneys’ lodestar. If the recovery is in “noncash common benefits,” then attorneys fees must also be noncash. Texas has yet to apply this rule to derivative lawsuits like Tornetta, but that is a potential next step for the business court.
Were the Tornetta plaintiffs to receive fees in this fashion, each attorney would still make thousands of dollars per hour—but even at 400% of lodestar, the fee probably wouldn’t reach $1 billion. And Tornetta did not result in a cash judgment but the rescission of Musk’s unexercised stock options. It seems odd, but a Texas court could potentially compensate a Tornetta-style plaintiff by awarding their counsel an interest in Musk’s options—which the attorneys would have to pay to exercise and perhaps, like Musk, hold for a period of time. That might not be bad: the attorneys would immediately become some of Tesla’s largest stockholders, but they would also have skin in the game. A cash award offers attorneys no reason to care whether Tornetta benefits or harms Tesla in the long term. (And stockholders who, like Tornetta, own nine shares have little interest altogether.)
Delaware is very different: rather than using lodestar, Delaware bases fee awards on a percentage of any benefit secured in litigation. And a recent Delaware decision, In re Dell Technologies Inc. Class V. Stockholders Litigation, held that the percentage awarded does not decline in mega-settlements. (Full disclosure: I represent some law professors pro bono as amici curiae in Dell, which is on appeal.) Instead, Delaware plaintiffs’ attorneys typically receive somewhere between 10-15% of a class recovery in cases that settle early, 15-25% that settle after some motion practice and depositions, and up to 33% after trial (as in Tornetta). The Court of Chancery has yet to award fees to the Tornetta attorneys, and the award will be complicated by the need to determine how much Musk’s shares are worth to Tesla. (A similar issue has arisen in a dispute over pay to Tesla’s other directors.) But lawyers are already speculating that the award may exceed $1 billion.
Tornetta highlights two paradoxes in Delaware mega-cases. First, even when plaintiffs win big, stockholders might be better off with smaller victories if their attorneys were limited to, say, a mere $5,000 per hour in fees. Second, Dell and Tornetta set different standards for directors and attorneys. Plaintiffs’ lawyers in the Court of Chancery receive an ever-greater percentage of stockholder gains based on a set of milestone payments. One doesn’t have to squint hard at Musk’s pay package to recognize that it is also an escalating percentage award based on milestone payments—although the percentage increases more slowly than the brackets in Dell. Yet Tornetta repeatedly faults Tesla’s directors for not considering whether Musk warranted any incentive pay beyond the 21.9% of Tesla he already owned. Corporate directors might reasonably ask why CEOs require less incentive to produce stockholder value than the attorneys who sue them.
- Tesla May Have an Easier Time Renewing Musk’s Pay Package.
In 2006, Professors Lucian Bebchuck and Jesse Fried published Pay Without Performance: The Unfulfilled Promise of Executive Compensation. Tornetta results in the opposite: performance without pay. Back in 2018, the New York Times Dealbook recognized the challenge for Tesla to reach $650 billion in market capitalization: “many experts would contend [it] is laughably impossible.” Dealbook offered that critics would say Musk’s pay deal was “the company’s latest publicity stunt.” Reaching a laughably impossible goal certainly seems to qualify as CEO performance in the Bebchuck/Fried sense.
Yet unless Tesla reinstates some form of pay package, Musk receives nothing for this achievement apart from his existing holdings. Thus, commentators have spent much of the last week speculating over whether, and how, Tesla might compensate Musk for past services.
Professor Lipton argues that awarding Musk “compensation for services provided would likely be waste. . . .” I don’t think that’s right, for two reasons. First, the Court of Chancery has dismissed waste claims challenging one-off payments for past services rendered, albeit typically in the context of a severance or retirement arrangement. I’m only aware of one case where a waste claim concerning executive compensation withstood a motion to dismiss, and there a company agreed to a continuing salary payment in exchange for services that it allegedly knew the executive could not render due to age and disability. That’s certainly not the case here. Second, the standard for waste is severe. A corporation must enter into a transaction “so inadequate in value that no person of ordinary, sound business judgment would deem it worth that which the corporation has paid.” A cursory glance at the internet—where Tesla stockholders are debating the decision—shows that at least some stockholders believe Musk’s compensation was fair and want it reinstated. A plaintiff would need to argue that these stockholders are, essentially, not in their right mind. Even Tornetta does not go that far.
But another lawsuit for breach of fiduciary duty would be likely. Suppose Tesla comes up with an alternate pay package. Even if Tesla nominates some new directors, it can’t know that the Court of Chancery will ultimately find them to be independent. It certainly can’t have a “cooperative and collaborative process.” And even if Tesla offers ridiculously thorough disclosure—perhaps it livestreams the relevant board meeting?—it can’t ensure that the Court will find its vote fully informed. Without both conditions, it will just get sued again, with (at best) the plaintiff bearing the burden of proving the deal unfair. As Matt Levine puts it:
It is possible that the rule of this case is that Tesla is not allowed to pay Musk $55.8 billion, no matter what its shareholders think, no matter how many of them vote to approve it in a fully informed vote. It’s enough to make you want to move to Texas.
Tesla may find it easier to reinstate Musk’s pay package—or adopt an amended pay package—after reincorporating. That would raise another thorny question: given that the new pay package would largely moot the benefit in Tornetta, is there a mechanism to make the plaintiffs’ firms give the fees back?
- Tesla Might Adopt Fee-Shifting Bylaws and Texas May Make Additional Legislative Reforms.
The Texan legal environment could provide Tesla with further protection against inevitable stockholder litigation. While Delaware’s corporate statute is notably flexible, it has limits—such as its famous prohibition against corporations adopting bylaws requiring unsuccessful stockholder litigants (or their attorneys) to bear a corporation’s legal fees. Professor Bainbridge described this ban as “Delaware’s self-inflicted wound.” Several states adopted similar legislation after Delaware did so. To my knowledge, Texas has not. A post-reincorporation Tesla could potentially make itself a less-attractive target by requiring plaintiffs—whose lawyers make millions, and potentially billions, by suing the firm—pay fees when they fail.
Tesla’s Delaware experience already puts the lie to the old plaintiffs’ saw that fee-shifting bylaws are “one-sided” in favor of corporations. While the popular observation is that Tesla won its derivative litigation over SolarCity, it is more accurate to say that Musk won, and won again on appeal. Every other director settled before trial for $60 million (from insurance), and the SolarCity plaintiffs received over $16 million in fees. Tesla did not get the fees back, or its own fees covered, after plaintiffs lost. As Professor Griffith puts it, with only slight exaggeration, in Delaware stockholder litigation “the starting point is not the American Rule, under which each side bears its own fees, but rather the Delaware rule, under which the corporation always pays.” Texas might correct this imbalance.
Texas could consider other reforms. For instance, Reuters reported that the Tornetta plaintiff is a former drummer who owned only nine shares. The Tornetta opinion, however well-reasoned, eloquently constructed, and doctrinally correct, remains just that: an opinion. It has the force of law because a tiny stockholder, backed by one of the world’s wealthiest law firms, convinced a judge. That procedure overrides the opinions of other stockholders, including the vast majority who voted in favor of Musk’s pay, because Tesla did not fully disclose all material facts when it asked for stockholder approval. Again, as a matter of Delaware doctrine, this fits: an omitted fact need not change the outcome of a stockholder vote, or even sway any stockholder’s vote, to be material. Thus, Tornetta faults Tesla’s failure to disclose that certain directors were not “independent” and that Musk and another director discussed his pay before the Compensation Committee did. But while the reasoning is doctrinally sound, the result has an Alice-in-Wonderland feel to it. I’d be surprised if one could find more than a few dozen stockholders who would have changed their votes based on that fact, much less enough to affect the outcome. Again, Matt Levine has a point:
But I think that if you put it to a vote of Tesla shareholders — “would you rather give Musk $55.8 billion of Tesla stock for running Tesla, or these lawyers $1 billion of Tesla stock for suing Tesla?” — you’d get a pretty large majority for Musk? I’m not Musk’s biggest cheerleader or anything, but I feel like he has probably done a lot more for Tesla than these lawyers have.
But in Delaware, the stockholders who disagree with the Tornetta plaintiff lack a mechanism to stop his lawsuit, even if other stockholders are much larger investors. Texas could consider legislative reforms that would strengthen corporate democracy, perhaps by requiring derivative plaintiffs to hold significant stakes before they can sue to redirect corporate decision making. I suspect that, if Tesla does reincorporate, the enthusiasm of the Texas legislature for other innovative reforms will intensify.
Of course, Tesla may not ultimately decide to reincorporate. Right now, the only indication that it will do so is Musk’s tweet. This may be much ado over nothing.
- Conclusion.
Still, I can’t end this post without addressing what most other commentators have pondered: how does a potential Tesla reincorporation affect Delaware? Professor Bainbridge concludes that, after Tornetta, “Delaware’s dominance will be preserved” because the decision demonstrates that Delaware will hold even one of the richest CEOs in the world to account. That is the conventional wisdom. And I hope Professor Bainbridge is correct. I’m a Delaware lawyer, after all. But that may be the wrong question.
In the recent debate between former attorney general William Barr and Vice Chancellor Laster, both discussed the New Jersey policy failures that led most corporations to move to Delaware over a century ago. But history need not repeat itself, it merely needs to rhyme. If Texas took 20 percent of Delaware’s corporations—or over the long term, attracted 20 percent of new firms—its new business court would turn the Lone Star State a tidy profit. The same loss to Delaware would perhaps not be apocalyptic for the First State’s finances, but it would certainly be uncomfortable. A still-dominant but less-dominant Delaware is not an optimal outcome, at least for my home team.
And, returning to my first point, the new competition may become a matter of “vibes.” Delaware law provides a broad enabling statute, and then every decision may be “twice tested” for compliance with both law and equity. The second test takes place in lengthy, expensive legal proceedings, and the results are not always predictable. (Take James Murdoch, former CEO of 21st Century Fox and himself wealthy beyond my imagining even apart from his Tesla investment. I did not attend the trial and I have not reviewed the evidence as the Chancellor has. But if you had asked me a month ago whether Murdoch was independent of Musk, I would have thought so.) For established, mature companies, Delaware’s equity-based jurisprudence may be ideal. But newer companies with differing business cultures—even companies whose CEOs don’t produce flamethrowers—may find more certain legal paradigms more attractive. Tornetta provides a potential roadmap for states that want to compete with Delaware: corporate law based less on equitable principles, with more clearly defined safe harbors for director conduct.
And while it has gone largely unremarked, the nature of state competition has changed since I co-authored a paper about it over a decade ago. In the early 2000s, most business courts imitated the Court of Chancery. Today, not only do they seek to differentiate themselves, but reforms—for instance, Nevada’s elimination of “inherent fairness” review and the Texas class action rules—are more often driven by legislatures rather than lawyers. The Texas legislature created its new business court despite substantial opposition from some local legal associations. By contrast, Delaware corporate legislation tends to be driven by the Delaware bar. Differing political economies may adopt different reforms that are attractive to different types of corporations.
Finally, I’ll end on a personal observation. It is not my intent to criticize the Tornetta decision’s legal reasoning. That is a task for other practitioners on appeal. The simple fact is that once a Delaware stockholder files a derivative complaint, a court must reach some decision: even if the parties settle, the settlement must be judicially approved. No opinion can satisfy everyone. But my mind keeps uneasily turning back to Tornetta’s criticism of the “cooperative and collaborative process” that led to Musk’s pay package. In fairness, Tornetta addresses my discomfort in footnote 733, assuming that perhaps “some level of cooperation and collaboration is called for” but that Tesla exceeded that level.
Still, that phrase pulls at the businessman in me that preceded the lawyer. Law firms, and particularly BigLaw firms, may have zero-sum distribution negotiations in partners meetings and lockstep compensation among associates, but that was never my expectation of work before law school. I didn’t join the bar until my early thirties. Before that, I was never a CEO or a director, but I did lead small teams and conduct salary negotiations. Perhaps my former teammates would not describe my discussions with them as a “cooperative and collaborative process,” but I hope they would.
Before my legal career, I would never have imagined that anything approaching adversarial salary negotiations were necessary for a process to be fair. Again, perhaps it’s “vibes,” but those passages about cooperation make me think that the conventional wisdom may be more fragile than we expect, and Tornetta more consequential.
