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.
