Delaware Chancellor’s Ruling Could Have Broader Implications for Corporate America

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A recent ruling by Delaware Chancery Court Chancellor Kathaleen McCormick has raised concerns for the rest of corporate America, as it nullifies Elon Musk’s $55.8 billion pay package. In response to a shareholder’s lawsuit against Tesla, McCormick sided with the plaintiff, claiming that Musk’s compensation plan from 2018 was the result of manipulated negotiations. The lawsuit accused Tesla’s directors of breaching their fiduciary duty in awarding Musk his compensation.

In a decisive and comprehensive 201-page document, McCormick acknowledged the potential precedent her ruling could set in Delaware, where the majority of U.S. corporations are incorporated. She stated, “Delaware courts have previously avoided definitively resolving this question, but this decision dares to ‘boldly go where no man has gone before,’ or at least where no Delaware court has tread.”

The main issue at hand, as emphasized by the plaintiff, was whether Musk truly controls Tesla. McCormick’s ruling affirmed that he does maintain significant control. Alongside his 21.9% equity stake at the time, Musk, often regarded as a “Superstar CEO,” had influential connections with the directors responsible for negotiating on behalf of Tesla. He dominated the entire process that led to the board’s approval of his compensation plan. During the trial, Musk’s extensive ties and relationships with each member of Tesla’s compensation committee came to light, including his former divorce attorney who also served as Tesla’s former general counsel, Todd Maron.

Maron’s emotional deposition revealed his deep admiration for Musk, raising concerns about his impartiality in the negotiation process. As McCormick noted, Maron acted as a primary intermediary between Musk and the committee, leaving doubts about which side he truly aligned himself with.

This significant ruling has far-reaching implications that extend beyond just Elon Musk and Tesla, potentially reshaping corporate governance practices across the United States.

The Issue of Musk’s Ties to Tesla’s Board

The issue of Elon Musk’s close ties to Tesla’s board has been a topic of concern and scrutiny. In 2016, investors filed a lawsuit over Tesla’s acquisition of SolarCity, alleging that Musk coerced board members into accepting an overpriced buyout of the solar company, which happened to be run by his cousins.

Last year, Delaware’s Supreme Court ruled that the deal was fair to shareholders and that negotiations were conducted independently. However, this recent ruling raises important questions that other boards need to take note of.

Implications for Other Boards

According to Carl Tobias, a professor at the University of Richmond’s School of Law, this case sets a precedent that should grab the attention of other boards. Board members may now be concerned about similar situations occurring within their own companies and the potential lack of protection for shareholders or the corporation itself.

Limited Impact on Tesla’s Current Board

Although this ruling may not greatly impact Tesla’s current board due to changes in its composition, Stephen Diamond, an associate professor of law at Santa Clara University Law School, believes that it will make future negotiations regarding Musk’s compensation seem more adversarial. Furthermore, the decision has implications for Delaware corporate law by suggesting that CEOs can be seen as having control over a firm even without owning a majority of outstanding stock. This could result in closer scrutiny of board behavior.

Potential Effects on Musk’s Attempts for More Control

It is uncertain at this point how this ruling may affect Musk’s ongoing efforts to gain more control or influence over Tesla. Musk has expressed his intentions in various public forums, including his tweets and the company’s conference call with analysts. Presently, Musk holds just under 13% of the company’s shares.

Regardless, Tuesday’s ruling marks a rare instance where Musk’s power has been checked.

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