Tornetta v. Musk: The Tesla Compensation Case
Trial begins November 14th. What will this "new" old case bring?
Day is done, gone the sun.
From the lake, from the hills, from the sky,
All is well, safely
rest prep thyself for the next case. 🎶
October 28th at 5:00pm Eastern has come and gone, and there is one email that Chancellor Kathaleen St. Jude McCormick will not be receiving—one that says, in an alternate universe, that the Twitter deal did not close, and the trial is back on.
Here, in this universe, on this—perhaps the weirdest—timeline, the deal did close, on its original terms. $54.20 per share. $44 billion or so in cash, equity, and debt—the combination of which precisely, we may never quite know.
Casey Newton has taken over the role of Chief Outside Information Officer for all the tweeps wondering what will become of their jobs in the post-acquisition landscape, and The Chancery Daily reverts to nerding out over legal documents.
So, shall we go … onwards! Or, perhaps, in some ways, backwards! To a complaint originally filed in 2018 that is finally wending its way toward trial in less than two weeks.
As we did for the Twitter v. Musk complaint, it’s time to create a reference document for the upcoming lay of the trial land and take a deep dive into the particulars of Richard J. Tornetta v. Elon Musk, et al., which will be going to trial in front of Chancellor McCormick starting on November 14th.
This case will certainly be different from the Twitter matter, which—as I’ve said on many occasions—was fairly banal from a legal point of view, though it was capacious in size. The Tornetta case concerns (according to Plaintiff’s allegations) “the largest compensation grant in human history (the Grant)” which was:
“paid to a part-time executive who conceived of and dictated its fundamental terms”
“approved by a conflicted Committee and supine Board with none of the traditional ‘benchmarketing’ that is grist for the mills of all executive compesnation consultants”
“secured with a materially misleading and omissive proxy statement, and”
“demanded for the avowed purpose of colonizing Mars (the planet)”
[I’m still trying to figure out that last parenthetical. Is there another Mars, perhaps the clarification was required to show that Musk wasn’t trying to take over the candy company in some weird modern-day take on Willy Wonka and the Chocolate Factory?] In any case, Plaintiff prays for the requested relief of the Grant’s invalidation.
In the Delaware Court of Chancery, pre-trial briefs outline the arguments that will be proven at trial. Trial is—in the main—a serial presentation of live witness testimony. There is little extemporization by the attorneys (or at least less than in your average jury trial, for certain). In this sense, trials feel much more fact and testimony-heavy than Hollywood depictions of trials, which are mostly just lawyers pontificating about points of law in ways that would rarely, if ever, happen in reality.
The place for legal arguments, and tying together the meat of the relevant law is in pre-trial and post-trial briefing (and sometimes, post-trial oral argument). So, we can see from reviewing these pre-trial briefs what arguments will be made through the witness testimony at trial.
Let’s look at what the plaintiff is alleging in this case to support the proposition that the compensation grant should be invalidated. There’s a lot to unpack here about how these things work and the state of corporate law with respect to challenging board and corporate actions, so stick with it even if it doesn’t make much sense. We’re going to address these issues from various angles, and we have to start somewhere.
The Chancery Daily is a reader-supported publication. Consider becoming a free or paid subscriber because you’re awesome.
Plaintiff here lays out several avenues for its own success on the merits of the case. Defendants will have their say in their own pre-trial brief, which you can be assured will read like it was written in an entirely different universe. Such is life in the law.
Plaintiff says, no matter which path you take through the legal requirements, the answer is invalidation of the grant, according to precedent. They even filed summary judgment (arguing that there were no disputed facts, that the case could be decided simply by applying the law), which Chancellor McCormick declined to rule on pre-trial.
The two paths to invalidation are as follows: either the grant fails because it wasn’t approved by fully-informed stockholders (proxy disclosure claims), or, if the grant was validly approved, it’s subject to the entire fairness review by the Court (because Musk is allegedly a controller) and it fails under the applicable standard of review.
There’s so much implied even in that short summary, for example, the rationale for why they have to prove that Musk is a controller to get to a standard of review under which the transaction is not blessed. That’s because in Delaware, corporations and contracts reign supreme. If this is just an average, everyday company with an independent board of directors and no controller calling the self-interested shots, then this case doesn’t see the light of trial. Why not? Because in the same way that Delaware centers the primacy of contractual obligations, it similarly gives great deference to folks running businesses. In a normal, everyday situation, a little thing called the Business Judgment Rule applies to review the actions of companies and their boards of directors, and under BJR, the business nearly always wins, well before the eve of a trial.
Deference under the business judgment rule says that compensation of executive officers is precisely the kind of thing that (in an ordinary situation) deserves to be handled with the lightest touch by the court. As then-Vice Chancellor Slights said in an earlier opinion in this case: “A board of directors’ decision to fix the compensation of the company’s executive officers is about as work-a-day as board decisions get. It is a decision entitled to great judicial deference,” citing See Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000) (“[A] board’s decision on executive compensation is entitled to great deference. It is the essence of business judgment for a board to determine if a particular individual warrant[s] large amounts of money. . .”).
The business judgment rule is why cases brought by stockholders (whether directly, or derivatively on behalf of the corporation) frequently face an uphill battle, one which I would say aligns more with the position that Musk was in for the Twitter case, fighting to jump over steep hurdles — in that case, to get around the presumptions of contractual obligations, here, to overcome the presumption of deference. Here, Musk is on the smoother side of the law. As a director, he is entitled to the presumption of deference, as are his co-directors. That’s why you’ll hear people speaking very differently about this case than the prior one. This is why businesses love Delaware! And that’s why the plaintiff has to prove various facts to make a legally-winnable case that isn’t just dismissed out of hand.
So, Plaintiff argues that the grant was subject to and contingent upon the approval of non-Musk shareholders (by its own design), but that the vote that was held should be nullified because it was based on a materially misleading and omissive proxy statement. If Plaintiff can prove the materially misleading and omissive bit, stockholders should be entitled to judgment in their favor, because Tesla chose to condition the grant on stockholder approval. If the vote is invalidated, the Grant is invalidated.
Plaintiff lists four areas where the disclosure fell short:
Failure to disclose committee members’ potential conflicts
Failure to accurately disclose the grant milestones’ achievability
Failure to accurately disclose the grant process
Failure to disclose Musk’s competing interests
Second, plaintiff claims to have an alternative path to victory, even if the disclosure is found to be sufficient and therefore, the stockholder approval valid. Remember here, if the business judgment rule were to apply, there’s no way we would be facing a trial in less than two weeks. These claims would not have survived a motion to dismiss under the deference of the BJR. So, what does plaintiff have to prove to have kept the claims alive? Plaintiff must show that the business judgment rule does not apply here. Instead, that the “entire fairness” standard of review is applicable.
This is where the argument about Musk being a controller of Tesla (despite not being literally a controlling stockholder by percentage). If Musk is not found to be a controller in one of the three ways that the plaintiff alleges, the business judgment rule applies, and if the disclosure claims fail, so likely will plaintiff.
So, the arguments for applying the entire fairness standard are as follows:
Musk controlled Tesla, in general
Musk controlled Tesla, with respect to the grant
Musk controlled the committee
Musk dictated the grant terms
Musk shaped the grant’s timing
Musk negotiated against (only) himself
At least half the directors who approved the grant were conflicted
But even if Musk can prove that the entire fairness standard applies, that’s not an immediate win for plaintiff. The burden under entire fairness is high and the burden of proof shifts to the defendants to show that the grant is entirely fair.
Now we have a bit of argument inception here, because in preempting defendants’ likely arguments for entire fairness, plaintiff reiterates the inadequacy of the disclosures, noting that the grant was not approved by fully-informed stockholders, and that the grant was not approved by an independent, well-functioning committee. If the grant had been validly approved by fully-informed stockholders, it would likely be “cleansed” of its conflicts and defaulted back to review under the BJR. So, a lot is riding on whether or not the disclosure claims succeed or fail.
But even if the disclosure claims fail, the plaintiff still has a path to victory: the approval of a majority of the minority (non-Musk) stockholders is only one factor (although an important one) in the analysis. If the plaintiff could prove that the entire fairness should still apply due to the lack of a functioning, independent committee, defendants would still have to prevail on their defense that the grant was entirely fair, which means that it has to have been “the product of both fair dealing and fair price.”
Again, in the arguments about fair dealing, we see the arguments about Musk’s control and conflicts with the members of the board of directors arise. We even get another level of inception on the disclosure claims, as one of the arguments is that the board breached its disclosure duties by securing grant approval via a materially deficient proxy, rendering the process unfair.
If plaintiff passes the hurdle of getting past the deference of the business judgment rule, and the entire fairness standard is found to apply here, then defendants have to prove both that the deal was—as stated above—”the product of fair dealing and fair price.” Fail on either one, and the transaction would not be considered fair under the standard.
Plaintiff lays out four reasons why defendants cannot establish fair dealing:
The grant was unnecessary
The grant’s design deified its purported goal of focusing Musk on Tesla
The grant provides outsized payouts for probable results
The grant is the largest compensation plan ever, with no comparables
Plaintiff seeks invalidation of the grant, and equitable recission of all options issued under the grant.
I think that’s enough class for today. Tomorrow, we’ll dive into the factual and legal particulars and summarize Defendants’ response to Plaintiff’s arguments laid out above.
Until then, my friends!