Why the Tesla shareholder vote won’t be the end of Elon Musk’s Delaware fight

Tesla shareholders will vote on Thursday on whether to restore the mammoth pay package for chief executive Elon Musk that was struck down by a Delaware judge this year. But that is not expected to close the book on a legal saga that has consumed the electric-car maker and the leading US business law court that dared to defy Musk and his overseers on the company’s board.

In asking shareholders to approve of the same 2018 pay package that was nullified by the Delaware Court of Chancery in January, Tesla is relying on a legal principle known as “ratification”, in which the validity of a corporate action can be cemented by a shareholder vote. Ratification, the company told shareholders in a proxy note earlier this year, “will restore Tesla’s stockholder democracy”.

This instance, however, is the first time a company has tried to leverage that principle after its board was found to have breached its fiduciary duty to approve the deal in the first place.

Even Tesla admits it does not know what happens next. “The [Tesla board] special committee and its advisers 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,” it said in a proxy statement sent to shareholders.

The outcome of the vote is far from certain. The large proxy advisers, Institutional Shareholder Services and Glass Lewis have recommended voting against the pay, even as many large shareholders have voiced support. The result will send an important message on how investors feel about rewarding successful visionary CEOs — even those who come with baggage.

Each side has offered divergent views on what Thursday’s vote will mean in a more practical sense. Should the referendum pass, dissident shareholders could sue again or amend their original case to attack the new pay vote. They could claim paying Musk for past performance is itself a “waste” of corporate resources and yet another breach of fiduciary duty.

Tesla had awarded a share grant that ultimately was worth 304mn shares of stock, which at the company’s price today is worth about $54bn.

For its part, Tesla has taken steps to avoid winding up in a similar situation as 2018 — when, according to the Delaware court ruling, the company’s board was too intertwined with Musk to exercise independent judgment, ultimately resulting in approving pay terms that were unfair to shareholders.

A new independent director, Kathleen Wilson-Thompson, has approved the same terms as in 2018: 304mn shares, which equates to roughly a tenth of outstanding Tesla shares, if multiple stock price and operating performance targets are hit. Wilson-Thompson hired her own legal, financial and academic advisers, spending more than 200 hours on her deliberations, according to the proxy.

The company has argued that without a sizeable pay package, Musk could lose focus on the carmaker given his other ventures ranging from social media platform X to SpaceX and his artificial intelligence start-up, xAI. The proxy sent to shareholders spelt out the billionaire had found the pay deal “motivating” and he had confirmed “that ratification of it would motivate him to continue devoting his time and energy to Tesla”.

Thursday’s vote will leave unresolved the question of how much the lawyers who sued and won over the 2018 deal will take home. In March they asked the court to grant them 29mn Tesla shares — now worth more than $5bn — as a payment for their work. A court hearing is set for July.

Tesla has strongly opposed that request. Apart from airing its views in the shareholder proxy statement, it has added four powerhouse law firms to represent it in the pay case: national firms Sullivan & Cromwell and DLA Piper as well as two titans of the Delaware bar, Richard Layton and Morris Nichols.

Tesla says shareholders who easily approved the pay package six years ago still support the stock grant — and Thursday’s vote may prove it right. If the shares are restored to Musk, they could argue, then plaintiffs attorneys cannot argue that they achieved any benefit for the remaining shareholders and must be denied their fee request.

It could also prompt the judge who overturned the pay package, Kathaleen McCormick, to reconsider her original decision.

Lawrence Hamermesh, a law professor at Widener University, said: “In theory, the chancellor could say that with the stockholders having approved it on a fully informed basis that is an effective ratification, and the product of appropriate stockholder action, and in a way my previous ruling is moot.”

Delaware’s identity crisis

Musk’s pay is not the only item on the ballot on Thursday: so is Delaware itself, as shareholders will be asked to approve the move of Tesla’s legal domicile to Texas, where its corporate headquarters are, from Delaware, a move the billionaire first floated in the aftermath of the ruling.

Musk’s fury led him to move two of his other private companies to Texas and Nevada. Others have not yet rushed to join his exodus. Nevertheless, top lawyers have become concerned about companies with large controlling shareholders such as the Tesla CEO that increasingly are facing tough scrutiny from Delaware judges on M&A or other strategic actions.

The Musk pay decision is just one of a series of recent rulings that has dealt setbacks to corporate boards, a trend that has unsettled its corporate law establishment.

The decision that has elicited the most controversy is a March ruling that invalidated a contract that investment bank founder Ken Moelis struck with directors of his eponymous firm that forced the board to give him veto power over key corporate decisions.

Delaware’s legislature has sprung into action to consider changes to the state law in the coming weeks that would swing the pendulum back towards companies. The amendments under consideration would give businesses more freedom to strike contracts such as the Moelis arrangement with a small shareholder or group of shareholders. But professors and shareholder lawyers are worried that the basic idea of corporations, that boards must retain flexibility to make such decisions, is being threatened. 

The judge who wrote the Moelis decision, Travis Laster, shared his own concern on LinkedIn, calling the proposed changes “major surgery”.

Rick Horvath, a California-based partner at Dechert, said: “Both public and private companies have expressed concerns over perceived uncertainty from the Delaware courts. There is a growing perception that decisions are results-based, and a minor mis-step could result in significant legal exposure. The discussion around alternative domiciles is at its highest point in a generation.”

The same judge who struck down Musk’s pay package has also inserted herself into the brewing debate about whether the Delaware court has become excessively hostile to companies and boards of directors.

In May, McCormick wrote a letter to the state’s bar association that recommends changes to the Delaware corporate law, arguing that historically changes to the law resulting from court decisions did not happen hastily.

“None of the hallmarks of Delaware’s tradition are present this year. The proposal was not the product of a cautious and deliberative process . . . quite the opposite.”

The Musk and Moelis decisions have demonstrated how strict Delaware corporate law can be for companies that have large shareholders who want to exercise power, a common occurrence in private equity and venture capital-backed enterprises. Advisers told the Financial Times they are quietly counselling those companies that have controlling shareholders to consider alternatives to Delaware.

Ann Lipton, a law professor at Tulane University, said: “These companies went public with these existing stockholder agreements [giving power to large shareholders] and for the first time were tested legally, the court said not they are not OK. It has scared a lot of companies.”

The Delaware court has received roughly 1,500 letters and emails in total from ordinary Tesla shareholders asking McCormick to respect their wishes if they again vote in favour of Musk’s pay package.

One self-described “small investor in Tesla”, Steve Lindenmuth of Union City, California, wrote: “I only invested in Tesla for one reason. That reason was because Elon Musk was then CEO. For years I told people I would invest in Musk if he had stock in himself.

“It is undeniable he is the greatest CEO of our lifetime.”

Additional reporting from Tabby Kinder