Richard J. Tornetta v. Elon Musk
(2019)
Rule of Law:
When a board grants executive compensation to a controlling stockholder, the transaction is subject to entire fairness review, even if approved by unaffiliated stockholders, unless the MFW dual protections (an independent special committee empowered to say no and an informed, uncoerced majority-of-the-minority vote) are implemented from the outset of substantive negotiations.
Facts:
- In January 2018, Tesla, Inc.'s board of directors (the "Board") approved an incentive-based compensation plan for its chief executive officer, Elon Musk, called the 2018 Performance Award (the "Award").
- At the time the Award was approved, Elon Musk was Tesla’s largest stockholder, owning approximately 21.9% of its common stock, and served as Tesla’s Chairman, CEO, and Chief Product Architect.
- Musk also served as the majority shareholder, Chairman, CEO, and Chief Technology Officer of Space Exploration Technologies Corporation ("SpaceX"), which was alleged to be one of the world’s most valuable private companies.
- The 2018 Award was a 10-year grant of stock options that would vest in twelve tranches, contingent upon Tesla achieving both market capitalization and operational milestones (total revenue and adjusted EBITDA).
- Each market capitalization milestone required a $50 billion increase in Tesla's market capitalization, and if all milestones were reached, the Award had a maximum potential value of $55.8 billion, though Musk would earn nothing if milestones were missed.
- The Board conditioned the implementation of the Award on the approval of a majority of the disinterested shares voting at a March 21, 2018, special meeting of Tesla stockholders.
- Tesla's proxy statement for the meeting expressly conditioned approval on receiving a majority vote of shares not owned by Musk or Kimbal Musk, clarifying that failure to vote would have no effect.
- At the special meeting, 73% of disinterested shares present and entitled to vote cast in favor of the Award.
Procedural Posture:
- Plaintiff, Richard J. Tornetta, a Tesla stockholder, demanded to inspect certain books and records relating to the 2018 Performance Award pursuant to 8 Del. C. § 220.
- Upon receiving responsive documents, Plaintiff filed a Complaint in the Court of Chancery of the State of Delaware.
- The Complaint asserted four claims: (1) a direct and derivative claim for breach of fiduciary duty against Musk, (2) a direct and derivative claim for breach of fiduciary duty against the Director Defendants, (3) a derivative claim for unjust enrichment against Musk, and (4) a derivative claim for waste against the Director Defendants.
- Defendants filed a motion to dismiss the Complaint under Court of Chancery Rule 12(b)(6).
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Issue:
Does stockholder ratification of an executive compensation plan for a controlling stockholder shift the standard of judicial review from entire fairness to the business judgment rule, in the absence of the MFW dual protections?
Opinions:
Majority - Slights, Vice Chancellor
No, stockholder ratification of an executive compensation plan for a controlling stockholder does not shift the standard of judicial review from entire fairness to the business judgment rule, in the absence of the MFW dual protections. While board decisions on executive compensation are generally entitled to great deference, and stockholder approval usually enhances this deference, this case is atypical due to Elon Musk's status as a controlling stockholder and the extraordinary size of the Award. Delaware law harbors reflexive suspicion toward conflicted controller transactions because the controlling stockholder, as an "800-pound gorilla," can exert coercive influence over the board and unaffiliated stockholders. Thus, stockholder approval alone is insufficient to justify business judgment deference in such cases, as minority stockholders may fear retribution if they vote against the controller's interests, a concern equally present in compensation settings as in transformational transactions. To neutralize this presumptively coercive influence and earn business judgment deference at the pleadings stage, fiduciaries must implement the dual protections established in In re MFW Shareholders Litigation from the outset: the transaction must be conditioned on the approval of both an independent, fully-functioning special committee and an informed, uncoerced vote of a majority of the minority stockholders. Although MFW originated in the squeeze-out merger context, its dual protections can serve as potent safeguards in other conflicted controller transactions, like executive compensation. Here, Plaintiff has adequately pled that the Board and Compensation Committee processes were not divorced from Musk's influence, failing to satisfy the 'fully functioning, independent special committee' condition of MFW. Therefore, the entire fairness standard of review applies to the Award. Regarding the waste claim, the pleading burden is significantly higher than for unfairness, and the court notes the unlikelihood of stockholders approving a truly wasteful transaction. The well-pled facts did not support a reasonable inference that no person of 'ordinary sound business judgment' would have granted the Award.
Analysis:
This case significantly extends the application of the MFW dual protections framework beyond its original context of squeeze-out mergers to executive compensation for controlling stockholders. It clarifies that, for any transaction where a controlling stockholder stands on both sides, the stringent entire fairness standard will apply unless the rigorous procedural safeguards of MFW (an independent special committee and a majority-of-the-minority vote) are adopted from the outset of negotiations. This ruling provides a clear roadmap for fiduciaries seeking to secure business judgment review for conflicted controller transactions, incentivizing them to establish truly independent committees and ensure uncoerced minority stockholder votes. Its practical impact will likely be an increase in the use of these MFW-type procedural protections by boards dealing with controlling stockholders, and a reduction in pleadings-stage dismissals of breach of fiduciary duty claims when those protections are not properly implemented.
