Larry Cunningham held a program on Delaware SB 21 yesterday at the University of Delaware's Weinberg Center. He summarized the speakers on Linkedin.
One speaker was Ed Rock (regular readers will recall he is the Chief Reporter of the ALI's pending Restatement of Corporate Governance).
Professor Rock highlighted that the Musk pay cases (Tornetta I and II) would come out the same way under a pending bill in the Delaware legislature aimed at altering the state's approach to assessing controlling stockholder transactions since the bill doesn't address conflicted CEO transactions, while also observing that the bill seems to respond to pressures from other non-majority controlling stockholders seeking to weaken constraints on their control.
Yale law professor Jon Macey called this summation to my attention and kindly allowed me to take it up on the blog. We're trying to figure out why Professor Rock thinks the cases would come out the same way under SB 21.
I think it's possible that it would come out the same way, but I think it is far from certain and that a strong argument can be made it would come out differently.
I start with the premise that Tornetta v. Musk was the decision that triggered SB 21. After his $50 billion-plus compensation plan was struck down by the Delaware Chancery Court, Musk fired off a now notorious social media post recommending that one should “[n]ever incorporate your company in the state of Delaware.” Tesla subsequently reincorporated in Texas. Subsequently, other controllers started making noises about moving, which triggered Delaware to respond with SB 21 to provide controllers with greater insulation from liability. Presumably the drafters would have ensured that the triggering case would be covered by the statute.
Let's look at SB 21. The first question raised under the statute is whether Musk would be deemed a controlling shareholder. SB 21 defines a controlling shareholder as
any person that, together with such person’s affiliates and associates:
a. Owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors; or
b. Has the power functionally equivalent to that of a stockholder that owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors or for the election of directors who have a majority in voting power of the votes of all directors on the board of directors and power to exercise managerial authority over the business and affairs of the corporation.
According to the Tornetta decision, at the relevant point in time, Musk owned "approximately 21.9% of Tesla's outstanding common stock." Tornetta v. Musk, 310 A.3d 430, 502 (Del. Ch. 2024). As I read SB 21, it is not enough for Musk to exercise de facto "managerial authority over the business and affairs of the corporation," he must also own at least 1/3 of the stock. As the MNAT memorandum on SB 21 explains:
... for non-majority stockholders to be considered controlling stockholders, the functionally-equivalent-to-majority power must be by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote (i) generally in the election of directors or (ii) for the election of directors who have a majority in voting power of the votes of all directors on the board of directors. This change would prevent the existence of controlling stockholder status from being found if the alleged controller does not own a minimum level of stock.
And Musk does not meet that minimum.
Of course, Musk is a CEO. As such, his pay package could be viewed as a related party transaction of the sort traditionally subject to review under DGCL 144. Contrary to what Professor Cunningham reports Professor Rock as stating, it is incorrect to say the bill does not address conflicted CEO transactions. It makes some important changes in former section 144(a) as applied to conflict of interest transactions involving directors and officers.
As revised by SB 21 (assuming it passes), a transaction between the corporation and one of its officers:
may not be the subject of equitable relief, or give rise to an award of damages or other sanction against a director or officer of the corporation if: (1) The material facts as to the director’s or officer’s relationship or interest and as to the contract act or transaction transaction, including any involvement in the initiation, negotiation, or approval of the act or transaction, are disclosed or are known to the board of directors or the committee, and the board or committee in good faith authorizes the contract act or transaction by the affirmative votes of a majority of the disinterested directors, even though the disinterested directors be less than a quorum ....
As I read that statute, Musk's pay package would have been insulated from review if a single member of the Tesla board of directors qualified as "disinterested."
SB 21 defines a disinterested director as "a director who is not a party to the act or transaction and does not have a material interest in the act or transaction or a material relationship with a person that has a material interest in the act or transaction." In turn, material relationship is defined as "a familial, financial, professional, employment, or other relationship that (i) in the case of a director, would reasonably be expected to impair the objectivity of the director’s judgment when participating in the authorization or approval of the act or transaction at issue ...."
Hence, disinterested includes independence. Granted, McCormick found that all of the Tesla directors had relationships with Musk. She basically said none of them were independent, albeit to varying degrees.
But SB 21 adds a wrinkle to the analysis. It provides that:
Any director of a corporation that has a class of stock listed on a national securities exchange shall be presumed to be a disinterested director with respect to an act or transaction to which such director is not a party if the board of directors shall have determined that such director is an independent director or satisfies the relevant criteria for determining director independence under any rules promulgated by such exchange, which presumption shall be heightened and may only be rebutted by substantial and particularized facts that such director has a material interest in such act or transaction or has a material relationship with a person with a material interest in such act or transaction.
Assuming NASDAQ qualifies as a national securities exchange, the directors would get the benefit of this "heightened" presumption. McCormick would have to find "substantial and particularized facts" to rebut that presumption. Obviously, her opinion did not have to resolve that issue, so we have to speculate as to how the analysis would come out under the new presumption.
As to at least two directors--Denholm and Buss--"Plaintiff does not argue that Musk established Buss and Denholm's compensation so as to render them beholden." Tornetta v. Musk, 310 A.3d 430, 510 (Del. Ch. 2024). That's a key factor. After all, if you're not beholden, you're generally regarded as independent.
McCormick nevertheless claimed that Denholm and Buss's lack of independence could be shown by examining how they "acted when negotiating the Grant." Id. There are two problems with that argument, however. First, the part of her opinion analyzing the negotiations makes virtually no mention of Denhold and Buss. Second, McCormick's analysis is premised on her view that establishing Musk was a controller with respect to the transaction at issue is sufficient. See id. at 511 ("There is no greater evidence of Musk's status as a transaction-specific controller than the Board's posture toward Musk during the process that led to the Grant."). It is true that transaction specific control was sufficient under the pre-SB 21 common law. But as we have seen SB 21 says that a minority stockholder can only be deemed a controller if it owns 1/3 of the stock and "power to exercise managerial authority over the business and affairs of the corporation." I read that language as precluding transaction specific control.
In sum, so long as at least one Tesla director qualifies as disinterested, Musk's transaction is cleansed. Given the "heightened" presumption and the narrowed definition of material relationship, I suspect that at least Denholm or Buss would so qualify if the case were tried under the new standard.
Update: Professor Rock sent along some comments, which he kindly allowed me to post:
Larry’s one sentence summary, not reviewed by me, missed a bit of the nuance but was mostly accurate. I’m glad to see that you (mostly) agree with me. While you are right that new 144 would allow a single disinterested & independent director to approve an officer/director conflict transaction (which is weird), surely there was enough evidence in KSJM’s post trial opinion to give her the grist, should she have wanted to use it, to conclude that none of the directors was disinterested. In the litigation context, as you pointed out, she didn’t have to, but it was there. I am enough of a legal realist to think that how a judge justifies his/her decision is not necessarily how he/she arrived at it!
