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More thoughts on Moelis, Wagner, and Precommitments

I have been thinking some more about VC Travis Laster’s new opinion in Wagner v. BRP Group. BTW, thanks to Lauren Pringle of the invaluable Chancery Daily for posting it.

Wagner is a Moelis follow up. My initial take is here.

There will be lots more to say.

At the moment, I’m pondering the absence of any discussion of Omnicare. I would have thought Omnicare complicates the question of whether a precommitment contract requires a fiduciary out to be valid. (I’m going to have to back to Moelis to see if Omnicare is discussed there.) For my take on Omnicare go here.

To be clear, I am not a fan of Omnicare. Far from it.

I am also strongly in favor of boards being able to make precommitments that are binding, which I think is consistent with Moelis and Wagner. I wrote about this some years ago in Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law (October 30, 2002), available at SSRN.

But even so, I still wonder why Omnicare is not more of a problem for Moelis and Wagner.

Smith-Madrone Chardonnay (Napa Valley Spring Mountain District) 2019

Another stellar wine from our friends at Smith-Madrone. Great match for a roast chicken with stuffing and honey glazed carrots. Apricot, pear, and lemon on the nose. Pear, lemon, kiwi on the palate. A distinct mineral note on both, somewhat reminiscent of a Chablis. Unlike most Napa Chardonnay, it will age. If I had a criticism, I'd like a pinch more new oak. But just a pinch. Highly recommended. 

Yours Truly Quoted in WSJ re Tesla Shareholder Vote

From the Journal:

Most of the explicit legal differences between Delaware and Texas are minor, corporate attorneys said, echoing Tesla’s argument that the states’ laws are substantially equivalent.

“There are minor differences ,” said Stephen Bainbridge, a law professor at the University of California, Los Angeles. “Most of those are technical, and likely to come into play in relatively few circumstances.” Mergers, for example, can require a higher shareholder vote in Texas, while it is harder for a shareholder to inspect a company’s books there, he said.

One of the biggest advantages Delaware has: extensive precedents on nearly every facet of corporate law, giving boards and attorneys a better sense of likely outcomes and how to make their cases. “It’s much harder for anybody to predict how Texas courts are going to rule,” Bainbridge said.

Contrary to what The Hill and its Opinion Contributor Michael Toth Would Have You Believe, Companies are not Fleeing Delaware

I was (understandably IMHO) annoyed when former Trump AG William Barr suddenly decided that Delaware was going to lose its dominance of the market for corporate charters because Delaware has gone woke. Not surprisingly, I am now annoyed by a column on The Hill by Michael Toth, in which he claims that:

Delaware’s secret sauce has long been its corporate jurisprudence. But recently, activist judges in the state have set out to padlock Delaware’s main attraction. They are sending companies packing for states like Texas, which for its part is doubling down on its efforts to recruit businesses to the Lone Star State. 

Contrary to the headline to Toth's column, companies are not fleeing Delaware. I've got a law review article in the works on the subject and have some actual data on the topic (like most lawyers Toth seems to treat anecdotes as data).

In total, there are almost 400,000 companies incorporated in Delaware. Although Delaware accounts for less than one-third of one percent of the United States’ population, it is the legal home for two-thirds of the Fortune 500 companies.[1] As for the broader set of all public corporations, Delaware is home to more than half of the corporations listed for trading on U.S. stock exchanges.[2] As for newly formed corporations, while most business entities form under the law of the state in which they have their primary place of business, Delaware is the leading choice of businesses that opt to incorporate outside their home state.[3]

Guess how many publicly held Delaware corporations reincorporated outside of Delaware between 2012 and 2024. My research assistants and I have scoured SEC filings and various databases to get the answer. The answer? A whopping total of 65, with seven pending. That’s a total of 72 over 12 years. Six per year.

That’s not flight. That’s rounding error.

So why’s Toth boosting Texas and slamming Delaware? Might we draw an inference from the fact that he’s a partner at a Texas law firm that represents Texas (and other corporations).

By the way, only 6 of the corporations in our dataset moved to Texas. Six.

Preliminary Thoughts on the Outcome of the Tesla Annual Shareholder Meeting Part 2: The Compensation Vote

In 2018, Elon Musk's compensation package from Tesla was a landmark deal that set a new standard for executive pay. Instead of a traditional salary or cash bonuses, Musk's compensation was tied entirely to Tesla's performance, specifically its market capitalization and operational milestones. The package included a series of 12 tranches of stock options, each exercisable only if Tesla reached specific targets related to market cap, revenue, and adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

For each tranche to vest, Tesla’s market cap had to increase by $50 billion increments, starting at $100 billion and going up to $650 billion. Additionally, Tesla had to achieve either revenue or EBITDA targets for each tranche. If all targets were met, Musk could receive stock options worth up to $55 billion at the time of the agreement, potentially making it the largest compensation deal ever. The ambitious nature of this package aimed to align Musk's incentives with those of shareholders, focusing on long-term growth and performance. However, if Tesla failed to meet these milestones, Musk would receive no compensation, emphasizing the high-risk, high-reward nature of the agreement.

By June 2022, virtually all of the milestones had been satisfied. The options have vested, although Musk has not exercised any of the options.

In 2018, Richard Tornetta, a Tesla shareholder who owned a whopping nine Tesla shares, brought a derivative suit on behalf of Tesla against Musk and the  board. (As I have said many times before, the real party in interest in derivative litigation is the plaintiff's lawyer not the nominal plaintiff. And boy do Tornetta's lawyers have an interest in this case. They're anticipated to ask for attorney's fees of $6 billion -- that's billion, with a b.)

After an interminable pre-trial process, the case finally went to trial in November 2022. Post-trial proceedings wrapped up in April 2023. In January 2024, Chancellor Kathleen McCormick finally issued her interminable opinion (occupying a whopping 118 pages in the West reporter). ("Those familiar with the common structure of Chancery Court opinions will recall that there is uniformly a lengthy and very detailed account of the facts--who negotiated with whom, what did they say, etc.--in cases that apply a fiduciary standard." Robert E. Scott, Contract Design and the Shading Problem, 99 Marq. L. Rev. 1, 33 n.85 (2015). Personally, I think they do that to make it harder for the Delaware Supreme Court to reverse on appeal.)

The opinion has flippant moments. For example, McCormick described her decision as "daring to 'boldly go where no man has gone before,' or at least where no Delaware court has tread." Tornetta v. Musk, 310 A.3d 430, 446 (Del. Ch. 2024). It also implies a certain amount of disdain for Musk on McCormick's part. At multiple points, for example, she takes pains to highlight some of Musk's more idiosyncratic actions and statements, most of which seems to have little to do with the merits of the case. Who cares, for example, that Musk calls himself Tesla's "Technoking" or Twitter's "chief twit." Of course, Musk infamously returns the favor with bells on.

In any case, Chancellor McCormick determined that Elon Musk was Tesla's controlling shareholder. I think it is fair to say that Delaware courts are increasingly pushing the edge of the envelope on the definition of controller, in part because they have embraced this idea that "superstar CEOs" are controllers. Which means what? You become a controlling shareholder if People or the Daily Mail cover your doings? Can you be a controller if you own 1 share but you're the CEO and you've got a lot of Twitter followers? Apparently so. the academics who brought forward the superstar CEO McCormick adopted in Tornetta have said: "We should stress ... that significant share ownership is not a necessary condition of superstar status." Assaf Hamdani & Kobi Kastiel, Superstar Ceos and Corporate Law, 100 Wash. U. L. Rev. 1353, 1376 (2023). In fairness, of course, they don't just tot up Twitter followers to determine superstar status. On the other hand, they also don't offer much in the way of guidance: "We view superstar CEOs as individuals who directors, investors, and markets believe make a unique contribution to company value. ... For our present purposes, the precise factors that could make certain individuals uniquely valuable are less important." Id. at 1367-68. I find this whole concept deeply troubling, as it vastly expands the universe of controllers. I plan to address it in a forthcoming article. For now, suffice it to say, that McCormick didn't need to go there in Musk's case and her decision to do so opened a can of worms. And not just any worms, but microchaetus rappi.

Anyway, at Tesla's just concluded annual meeting the board put the following proposal to the shareholders for a vote:

Following the recommendations of the Special Committee, the Board, with Mr. Musk and Kimbal Musk recusing themselves, has determined to seek ratification by stockholders of the 2018 CEO Performance Award (such ratification of the 2018 CEO Performance Award, whether under common law or under Section 204 of the DGCL, the “Ratification”), and determined that the Ratification is in the best interests of the Company and its stockholders, and recommends that our stockholders vote to ratify the 2018 CEO Performance Award at the 2024 Annual Meeting.

The proposal was overwhelmingly approved:

The board sought to ensure that the MFW conditions discussed in the prior post were met. There was a special committee comprised of a single independent director (as noted in the prior post, the use of a single member committee is permitted but not preferred). There was a vote of the majority of the minority shareholders. It'll be hard to argue that the vote was not an informed one. The discussion in the proxy statement consumed some 27 pages, including a detailed analysis of McCormick's opinion setting forth the myriad defects she had identified with the first approval. They also included the full text of the opinion as an annex to the proxy statement.

Instead, as I see it, the big problem is that objecting shareholders (more precisely, the plaintiff lawyer who finds a shareholder to act as the representative plaintiff) will have a plausible argument that the vote was not uncoerced. 

Elon Musk appears to confirmed and even clarify what can be seen as a threat to Tesla shareholders: give me 25% of the company or I won’t build AI and robotic products at the company, after making clear that the company is worthless without those. ...

More recently, the CEO has not only said that but has also been making moves to ensure that this is the only path for Tesla, like canceling the cheaper Tesla vehicle on the unboxed platform in favor of its upcoming Robotaxi.

That’s why it was really concerning when the CEO suggested that he is “uncomfortable” building AI products at Tesla unless he has “25% control over the company” – something he doesn’t have right now – partly because he decided to sell tens of billions of dollars worth of Tesla shares to buy Twitter.

In effect, one might argue, Musk is threatening to usurp corporate opportunities and to devote even more of his full and attention to his non-Tesla investments. If so, "Delaware decisions recognize that when controllers actually make retributive threats, that fact has legal significance." In re Ezcorp Inc. Consulting Agreement Derivative Litig., No. CV 9962-VCL, 2016 WL 301245, at *41 (Del. Ch. Jan. 25, 2016). What significance? Among other things, "Delaware decisions recognize that when controllers actually make retributive threats, that fact is evidence of unfair dealing." In re Sears Hometown and Outlet Stores, Inc. Stockholder Litig., 309 A.3d 474, 537 (Del. Ch. 2024). It's not much of a stretch to think retributive threats would invalidate a MFW defense.

(I note in passing that Musk is already being sued for having usurped a corporate opportunity from Tesla in connection with his involvement wiith xAI.)

But let us assume for sake of argument that the vote satisfied MFW. What impact will it have? Will it cause McCormick to revisit her opinion? Could it impact the appeal?

If you asked 10 corporate law professors that question, you'd get at least 15 different answers. (And, yes, I checked my math.)

The one thing I am 100% confident about w/r/t to the future of the compensation litigation challenging Elon Musk’s pay at #Tesla, is that anybody on Twitter (including fancy law professors) who says they’re 100% confident should be ignored and/or mocked.

— Steve Bainbridge (@PrawfBainbridge) June 14, 2024

Tesla relies on DGCL section 204, which provides that "no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in this section ..." Ratification requires approval by the board (check) and by a the holders of a majority of the shares present at a stockholder meeting. 

Sadly, there is little caselaw interpreting section 204. One problem I nevertheless see is that McCormick did not hold Musk's compensation package to be either void or voidable. Instead, she granted the equitable remedy of rescission. Another is that it is far from clear that Section 204 even applies to a failure to satisfy the MFW conditions. It appears that section 204 was intended to allow ratification of acts that were determined to be void or voidable for failing to comply with some technical aspect of the Delaware statute, the articles, or the bylaws. 

Indeed, Tesla's own proxy statement admitted:

The Special Committee and its advisors noted that they could not predict with certainty how a stockholder vote to ratify the 2018 CEO Performance Award would be treated under Delaware law in these novel circumstances.

We shall simply have to wait and see.

1/ The #Tesla shareholder vote to approve Elon Musk’s pay package is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning. #TeslaAnnualMeeting

— Steve Bainbridge (@PrawfBainbridge) June 14, 2024

 

Ann Lipton's Takes on the Tesla Shareholder Vote

Are a must read.

Preliminary Thoughts on the Outcome of the Tesla Annual Shareholder Meeting Part 1: The Reincorporation Vote

Tesla's much anticipated annual shareholder meeting is now in the books. The two headline issues both passed with strong support: The vote to ratify Elon Musk's 2018 pay package passed with 72% in favor (excluding the stock owned by Musk and his brother). The vote to reincorporate in Texas required a majority of the outstanding shares and received 63%. The Form 8-K filed today provides a detailed breakdown:

Let's take up the reincorporation issue first. VC Travis Laster's TripAdvisor decision is widely regarded as a template for how the courts would review any challenge to the reincorporation. In that case, VC Laster refused to grant an injunction against the transaction taking place:

"The standard legal remedy is money damages. It seems quite likely that the court can craft a monetary remedy in this case that would be adequate. The remedial challenge will be to quantify the extent of the harm, if any, that moving from Delaware to Nevada imposes on the unaffiliated stockholders." Palkon v. Maffei, 311 A.3d 255, 285 (Del. Ch. 2024), cert. denied, No. 2023-0449-JTL, 2024 WL 1211688 (Del. Ch. Mar. 21, 2024)

"A judgment against the defendants in that amount should provide the plaintiff with a fully adequate remedy. The court will retain jurisdiction over the individual defendants even after the conversion is complete. The court can enter a judgment against any of them who are held liable. The plaintiffs can use standard collection procedures to enforce the judgment. If that requires domesticating judgments in other jurisdictions and enforcing them there, then the plaintiffs can do that." Id. at 286.

"Injunctive relief is therefore off the table. The pendency of this litigation should not delay the conversions from closing." Id. at 287.

Could a plaintiff pursue a monetary claim for damages arising out of the reincorporation decision? In TripAdvisor, Laster concluded that the transaction involved a conflict of interest for the directors and controlling shareholders of the company and was therefore subject to the exacting entire fairness standard of review:

"Under Delaware law, a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary's risk of liability. Delaware decisions have applied that principle repeatedly to mergers.The parties posit that no Delaware decision has applied those principles to a reincorporation merger, but that is not so." Id. at 270.

The non-ratable benefit in this case was the substantial reduction in liability risk that the controlling shareholders and directors would get under Nevada's lax corporate law. Although the court did not make a final determination on that issue, it held that the plaintiffs had sufficiently established the existence of a non-ratable benefit for purposes of withstanding a motion to dismiss.

"When entire fairness is the standard of review, and when a plaintiff 'alleges facts making it reasonably conceivable that the transaction was not entirely fair to stockholders, the granting of a motion to dismiss is inappropriate, because the burden is on the defendants to develop facts demonstrating entire fairness.'

"The plaintiffs have pled facts supporting an inference that the conversions were not entirely fair. The plaintiffs have pled facts sufficient to call into question the substantive dimension of fairness, because the stockholders will not receive the substantial equivalent of what they had before. When the Company and Holdings were Delaware corporations, the unaffiliated stockholders enjoyed all of the litigation rights provided by Delaware law. After the conversion, the unaffiliated stockholders will possess only the litigation rights provided by Nevada law. For the reasons already discussed, those litigation rights are inferably less than what Delaware provides.

"The plaintiffs also have pled facts sufficient to call into question the procedural dimension of fairness. The goal of procedural fairness is to replicate arm's length bargaining. The defendants did not make any effort to replicate arm's length bargaining. Management proposed the conversions, the Board recommended them, and Holdings and Maffei [the controlling shareholders] approved them.” Id. at 280-81.

What are the implications for Tesla? Two thoughts. First, Texas fiduciary duty law is less well developed than either Nevada or Delaware, but insofar as director liability is concerned it seems closer to Delaware than Nevada. So the litigation risk reduction may not be as great. OTOH, whether a controlling shareholder like Musk owes fiduciary duties either to the corporation or the minority shareholders seems unsettled, so that question would need to be resolved. I note that Ann Lipton thinks the question is more settled than I do:

Notwithstanding Tesla’s assertions to the contrary, I think it’s fair to say most spectators associated a move to Texas with a reduction in fiduciary litigation, or at least, successful litigation.  Partly, this is just a mood, i.e., the expectation that Texas judges presiding over cases involving Texas employer Elon Musk, under the watchful eye of Musk’s good friend Greg Abbott, are more likely to rule in Tesla’s favor.  But it’s also potentially built into Texas law, which may be interpreted as requiring plaintiffs to clear a higher bar for showing a lack of board independence.

Second, not all conflict of interest transactions result in liability. Under Delaware law, a conflicted control transaction can be cleansed if the controlling shareholder complies with the MFW conditions. Hence, as VC Laster explained:

"If a board proposed a similar conversion for a corporation without a stockholder controller, and if the fiduciaries fully disclosed the consequences of the change in legal regimes, including the effect on stockholder litigation rights, then the stockholders’ approval of the conversion would be dispositive, triggering an irrebuttable version of the business judgment rule. If directors proposed a similar conversion for a corporation with a stockholder controller, and if they properly conditioned the transaction on the twin MFW protections, then the dual approvals would be dispositive, again triggering an irrebuttable version of the business judgment rule." Id. at 262-63.

There are six MFW conditions, that boil down to (1) the decision was approved by a special committee of the board of directors comprised of independent board members, advised by independent legal and other advisors, and that is empowered to say no, and (2) whether the transaction was approved by a majority of the disinterested shareholders on a fully informed and uncoerced basis.

In TripAdvisor, the plaintiffs could only survive a motion to dismiss because the board had failed to comply with the MFW conditions: "The plaintiffs can only state a claim on which relief can be granted because (1) the corporation has a stockholder controller, and (2) the board did not implement any protective provisions."

In Tesla's case, the board appointed the requisite special committee.Sidley & Austin served as lead independent counsel to the committee. If you believe Sidley, the committee member was independent and devoted substantial amounts of time and effort to the decision. A key issue relating to this prong, however, is the fact that the special committee had a single member. Although a single member committee is permissible, there is Delaware case law holding that a multi-member committee is preferable. See, e.g., Gesoff v. IIC Industries, Inc., 902 A.2d 1130, 1146 (Del. Ch. 2006). There may also be questions about whether the committee member really had the power to say no, which is an essential MFW condition. Lastly, there may be a timing issue. MFW requires that the controller condition the transaction on the twin protections from the outset of the process. We might then ask when the process began and at what point did Elon condition the deal on the requisite protections.

As for the shareholder vote, the numbers satisfy the majority of the minority requirement. Given the considerable length of the disclosures in Tesla's proxy statement, it's hard to say the vote was an uniformed one. But, I think there's a plausible argument that the Tesla shareholders were coerced into approving the deal.

But the coercion issue arises again with the compensation vote, so let's turn to the compensation vote. See the next post.

Law Professors' Letter Opposing Amendment to DGCL 122(18)

Along with dozens of other top corporate law faculty, I signed a letter sent to the Delaware legislature opposing the proposed amendment to DGCL section 122(18). The amendment is designed to overturn VC Laster's recent decision in West Palm Beach Firefighters’ Pension Fund v. Moelis & Company.

I should stress that not everyone who signed the letter did so because they agree with Moelis. I would support a more carefully drafted legislative fix. But this proposal was drafted in a hurry and not very well. As the letter states:

The Proposal would do more than simply overturn Moelis. It would allow corporate boards to unilaterally contract away their powers without any shareholder input. It would also exempt such contracts from Section 115, thereby creating a separate class of internal corporate claims—including claims of breach of fiduciary duty—that could be arbitrated and decided under non-Delaware law. These would be the most consequential changes to Delaware corporate law of the 21st century, and they should not be made hastily—if at all.

Proponents of the Proposal argue that the Moelis decision struck down a common practice of Delaware corporations and that the Proposal merely restores the status quo ante. Not so. The contract in Moelis was far from typical, especially for public corporations, and the Moelis decision only held that certain of its provisions contravened the board-centric model of governance codified in Section 141(a). Those provisions could only be adopted in the corporate charter, and thus only after a majority of shareholders—who invested in reliance on Section 141(a)—gave their approval.

Pasta with Duck Ragu and Orin Swift 8 Years in the Desert

• 1 ounce dried porcini mushrooms
• 2 duck leg confit
• 2 oz guanciale, diced
• ¼ cup finely diced carrot
• 1 shallot, minced
• 3 cloves garlic, thinly sliced
• 1 tablespoon tomato paste
• ¼ cup red wine
• ½ tablespoon soy sauce
• 1 teaspoon Worcestershire sauce
• ½ teaspoon Better than Bouillon chicken base
• Kosher salt
• Black pepper, freshly ground
• A couple of grinds of nutmeg
• ¼ cup crème fraiche
• Chives, snipped into short pieces
• Pecorino cheese, freshly grated
• 5 oz dried pasta

Bring one cup of water to a boil. Add mushrooms and let soak off heat for 30 minutes. Remove mushrooms, rinse thoroughly, and dice. Set aside. Gently pour soaking liquid off the grit that will have collected on the bottom, while straining the water through a very fine mesh strainer. Set aside.

Remove the skin from the duck legs and discard. Remove the meat from the legs and discard the bones. Shred the meat and set aside.

Heat a large skillet over medium heat. Add guanciale to skillet and sauté until browned and crispy, which will take 6-9 minutes. Using a slotted spoon, remove guanciale to a paper towel0lined plate to drain. Leave fat behind in skillet.

Add carrots to skillet and sauté 2 minutes. Add shallots to skillet and sauté for 1 minute. Add garlic and sauté for 1 minutes. Do not let burn! Add tomato paste and cook 1 minute. Add mushrooms and duck to skillet. Sauté for 2 - 3 minutes, until warmed.

Deglaze the skillet with the red wine. Bring to a boil and reduce to a low simmer. Allow the wine to reduce by half. Add 1/2 cup of the soaking liquid. Add bouillon base and stir until dissolved. Add soy and Worcestershire sauces. Add nutmeg, salt, and pepper to taste.

The ragu does not need to braise long as the duck meat is already cooked. Ten to fifteen minutes should be plenty. Add a bit of water if the sauce gets too thick.

When ready, remove skillet from heat, add the crème fraiche, and stir to mix well.

Meanwhile, bring 4 quarts of water to a boil in a large pot. When it comes to the boil add 1 tablespoon kosher salt. Cook the pasta to al dente and drain. Do not rinse.

Plate the pasta. Top with sauce. Top with chives, black pepper, and cheese to taste.

I’ve used both pappardelle and bucatini with success. One of these days I want to try it with gnocchi.

We drank an Orin Swift Eight Years in the Desert (California) 2022, which was a great match. This wine is a blend of Zinfandel, Petite Sirah, Syrah. It's a deep, dark, almost brooding purple-black. Yet, despite its youth, it offered a robust bouquet of raspberry, blueberry, plum, and Indian spices. On the palate, the tannins are already round and soft. Red and black berries, spice, cedar, vanilla. Bright acidity. Very food friendly. Highly recommended.