Shifting Gears: Tesla Proposes Move to Texas and Ratifying Musk's Pay.
Boardroom Governance Newsletter #51 | April 18, 2024
It’s hard not to write about Elon Musk when focusing on corporate governance matters. In my newsletter #49 (Feb 2024) I wrote about Chancellor McCormick’s opinion in Tornetta v Musk, where she rescinded his $55.8 billion compensation (now valued at about $46 billion).1 In my last newsletter #50, I wrote about OpenAI’s boardroom saga and Musk’s lawsuit against Sam Altman, Greg Brockman and OpenAI in San Francisco Superior Court.2
The trend continues, because yesterday Tesla filed a Schedule 14(a) Proxy Statement with the SEC for its 2024 annual meeting, including two important proposals that were recommended by a Special Committee of the board: 1) to approve moving Tesla’s state of incorporation from Delaware to Texas, and 2) to ratify Elon Musk’s compensation under the CEO pay package that stockholders previously approved at the 2018 special meeting. Tesla’s annual meeting will take place on June 13, 2024.3
In short, more corporate governance litigation on the horizon.4 The rationale is that while Tesla is still appealing the Tornetta v Musk decision5, a new shareholder vote on the plan would clear up the matter.6
From Robin Denholm, Chair of the Tesla:
“2024 is the year that Tesla should move home to Texas. We are asking for your vote to approve Tesla’s move from Delaware, our current state of incorporation, to a new legal home in Texas. Texas is already our business home, and we are committed to it.”
“Earlier this year, a Delaware Court ruling in Tornetta v. Musk struck down one of your votes and rescinded the pay package that an overwhelming majority of you voted to grant to our CEO, Elon Musk, in 2018. The Tornetta Court decided, years later, that the CEO pay package was not “entirely fair” to the very same stockholders who voted to approve it — even though approximately 73% of all votes cast by our disinterested stockholders voted to approve it in 2018. Because the Delaware Court second-guessed your decision, Elon has not been paid for any of his work for Tesla for the past six years that has helped to generate significant growth and stockholder value. That strikes us — and the many stockholders from whom we already have heard — as fundamentally unfair, and inconsistent with the will of the stockholders who voted for it.”
“We do not agree with what the Delaware Court decided, and we do not think that what the Delaware Court said is how corporate law should or does work. So we are coming to you now so you can help fix this issue — which is a matter of fundamental fairness and respect to our CEO. You have the chance to reinstate your vote and make it count. We are asking you to make your voice heard — once again — by voting to approve ratification of Elon’s 2018 compensation plan.”
Report by the Special Committee of the Board
A special committee of the board of Tesla was charged with determining (i) whether Tesla should remain incorporated in Delaware or should reincorporate elsewhere, and (ii) whether Elon Musk’s 2018 compensation plan should be ratified at the same time as any potential stockholder vote on reincorporation.
“The Committee considered these questions over the course of 8 weeks, meeting 16 times and working extensively with independent legal, academic, and financial advisors. In the Committee’s business judgment, reincorporating in Texas and ratifying Musk’s compensation are in the best interests of Tesla and all of its stockholders, and should be voted for by stockholders at Tesla’s 2024 annual meeting.”
Kathleen Wilson-Thompson was the sole member of the special committee, a “committee of one.”7 Ms. Wilson-Thompson is an outside director who joined Tesla’s Board in December 2018. The Committee was initially constituted with two members, but Joe Gebbia, one of the co-founders of Airbnb and an outside director who joined Tesla’s board in 2022, stepped down from the Committee before any substantive decisions were made.8
The independent counsel to the Committee included Kristen Seeger and John Skakun, from Sidley Austin LLP. The corporate law and governance expert was Professor Anthony Casey (Chicago Law School) and the financial advisor was Houlihan Lokey Capital.
Texas Redomestication
The Committee considered a precise question: “where should this Company be incorporated at this time.” It started from a blank slate, considering all US states as well as the possibility of incorporating outside of the US. It narrowed its focus in stages, first to 10 states9, then 5 (CA, NV, NY, TX and DE) and finally to a binary choice between remaining incorporated in Delaware and reincorporating in one alternative jurisdiction.
“Academic research shows that companies overwhelmingly incorporate either in Delaware or in their home state, and identifies a range of reasons for this. So the Committee determined that the best potential alternative to Delaware was Texas, and resolved to choose between those two states.”
“The Committee also concluded there is no reason to believe that being incorporated in Delaware increases Tesla’s market value. Of the S&P 500, 35% are domiciled outside of Delaware. Seven of the top 20 by market capitalization are incorporated in their home state: Apple, Costco, Eli Lilly, Johnson & Johnson, Merck, Microsoft, and Proctor & Gamble. Tesla would make 8. Notably, the Committee saw no indication that Microsoft’s earlier reincorporation from Delaware to its home state of Washington had a negative effect on its market value.”
“In the final calculus, the Committee weighed three considerations. First, Tesla’s physical headquarters is in Texas. Second, Tesla is a mission-driven company. And third, the Delaware corporate courts are well-known whereas the Texas business courts have not started hearing cases yet. On balance, the Committee concluded that, for Tesla at this time, these considerations weighed in favor of reincorporating in Texas.”
Why Ratify Musk’s 2018 Compensation Plan?
The Committee’s decision on ratification was grounded in several factors. Per the report: (1) stockholders want to speak for themselves; (2) a ratification vote cures Tornetta’s disclosure criticisms; (3) ratification could avoid further uncertainty regarding Musk’s compensation and motivation; (4) seeking ratification now potentially avoids a criticism of the reincorporation vote; and (5) seeking ratification now potentially avoids other costs.
Some notable quotes:
“In Spring 2018, Tesla’s Board and stockholders voted to award Musk performance-based compensation worth up to $55.8 billion, if approximately $600 billion of stockholder value was created. More than 63 million disinterested shares — 73% of disinterested votes cast — approved the compensation. Adjusted for stock splits, that is equivalent to 945 million shares today. In June 2018, a stockholder with 9 shares filed a lawsuit called Tornetta challenging the compensation in the Delaware Court of Chancery. Five and a half years later, the court invalidated the compensation, finding, among other things, that the 2018 stockholder vote was not fully informed.”
“Holding a ratification vote on Musk’s compensation now may take away one potential criticism of the stockholder vote on reincorporation. The Committee was cognizant of the possibility that its reincorporation decision could be wrongly perceived as being made in direct response to the Tornetta ruling and with the intent to award Musk compensation in a different jurisdiction that he could not get in Delaware. Holding a ratification vote now should preclude such criticism.”
“Since the Tornetta ruling, many stockholders have expressed their support for Musk’s 2018 compensation plan. Dozens of institutional stockholders have, unprompted, told the Company’s Investor Relations team that they think the 2018 compensation plan should be fixed. Seven institutional stockholders — including 4 of the top 10 — felt strongly enough to go straight to the Board Chair to say that.”
I’m interested to hear how BlackRock, Vanguard, StateStreet and other large institutional investors plan to vote, and what will ISS and Glass Lewis recommend to their clients. The report cites support from T. Rowe Price, plus “thousands of retail stockholders representing more than 23 million combined shares — equivalent to the 11th largest institutional stockholder — have sent unsolicited letters and emails to the Board or to the Tornetta court expressing the same sentiment.” If 73% of the disinterested stockholders approved the compensation plan in 2018, what will be the outcome in 2024?
However, getting a new approval from stockholders doesn’t necessarily cleanse the transaction if Musk is considered a controlling stockholder.10
From the Report of the Special Committee:
“Of course, even a favorable ratification vote by stockholders may not fully resolve this matter. The Committee and its advisors cannot predict with certainty how a vote to ratify Musk’s compensation would be treated under Delaware law in these novel circumstances.”
Expect a lot of takes on this vote coming up in June, in the meantime, here is a quick list of readings:
WSJ: Tesla Tries to Revive Elon Musk’s Big Payday After Court Rejected It.
From Matt Levine (Bloomberg): Re-approving Musk’s pay is a bit of unfinished business that Tesla needs to wrap up in Delaware so that it can move to Texas.
From Ann Lipton (Tulane Law School): Tesla and Waste
From Robert Anderson (Arkansas Law School): “This is undoubtedly a significant moment in corporate law history.”
Bloomberg: Mapping Tesla’s Road From Delaware to Texas and Big Musk Payday
Boardroom Governance Podcast 🎙️
Check out my latest episodes:
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Other Relevant Corporate Governance News and Content.
Startup Litigation Digest. The third edition of our UC Law SF Startup Litigation Digest is out. Our goal for this publication is to become a valuable resource for those seeking to understand the litigation backdrop of the tech-driven startup economy. The cases highlighted in this edition include:
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New Enterprise Associates v. Rich. Two important opinions from the Delaware Court of Chancery involving breaches of fiduciary duties and enforceability of covenants not to sue between investors in a private venture-backed company that underwent a recapitalization and later was sold.
Slync and Christopher Kirchner. The founder of Slync, a Texas-based supply-chain management software startup, was convicted of defrauding investors out of at least $25 million. Separately, the SEC charged Christopher Kirchner with fraudulently offering and selling more than $67 million of securities to multiple investors, more than $28 million he allegedly misappropriated for personal benefit.
OneTrust Governance Dispute. A Co-Chairman and early investor in a Georgia-based data security company sued the CEO and co-founder in Delaware Chancery Court for violating the company's LLC agreement with “improper actions” that the CEO allegedly took without board approval. The case was eventually dismissed after a board reshuffle and sale of interests in the company.
U.S. v. Sean Grusd. A California man was charged with wire fraud in federal court in Chicago for defrauding multiple investors out of more than $23 million as part of a fake investment scheme.
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Onward and upward.
Sincerely,
Evan Epstein
The comp package gave him options to buy up to 304 million shares at a preset price of $23.34, and the current price per share is about $152 (Tesla is now valued at $495 billion). Interestingly, the current valuation is below four of the tranches of the compensation plan that had set milestones up to $650 billion. Of course, Tesla reached a peak valuation of $1.2 trillion in November of 2021.
Tesla also asked shareholders to re-elect two directors, Kimbal Musk and James Murdoch, to the board. The company’s directors serve staggered three-year terms.
On the reincorporation question, a recent opinion in Palkon v. Maffei (involving TripAdvisor seeking to reincorporate from Delaware to Nevada), the Delaware Court of Chancery concluded that this outcome could produce a “non-ratable” benefit for a controlling shareholder from reincorporation in Nevada.
The judge scheduled a July 8 hearing to decide whether lawyers for the Tesla shareholder who brought the case should get $5.6 billion in Tesla stock as their legal fee award for their successful challenge to Musk’s compensation plan. An appeal would proceed after that decision.
From the report from the Special Committee: “As the Delaware Court of Chancery has recently noted, ‘Delaware law offers solutions for missteps.’ One such solution is ratification — essentially, a re-approval of a prior action. The Committee concluded that Musk’s 2018 compensation plan should be put to a new stockholder vote. This will give all of Tesla’s stockholders their voice back. They will get to decide Musk’s compensation, with full knowledge of everything criticized in Tornetta.”
“The Committee and its counsel discussed with the Board Chair, the Nominating and Governance Committee Chair, and management the possibility of accelerating the in-process search for new independent directors, and adding any new director(s) to the Committee. The timing of the ongoing director search ultimately did not fit with the Committee’s work, and the Committee determined there was no reason to delay its work based on the possibility that additional directors would be added to the Board at some point in the future.” The Report also cited SolarCity, where the Court of Chancery provided the following guidance to Tesla:
“This point cannot be emphasized enough. There was a right way to structure the deal process within Tesla that likely would have obviated the need for litigation and judicial second guessing of fiduciary conduct. First and foremost, Elon should have stepped away from the Tesla Board’s consideration of the Acquisition entirely, providing targeted input only when asked to do so under clearly recorded protocols. The Tesla Board should have formed a special committee comprised of indisputably independent directors, even if that meant it was a committee of one.”
“Gebbia explained that he was stepping down out of an abundance of caution because of the potential for unfair attacks based on perceived conflicts of interest [he raised the fact that he has a personal relationship with Elon Musk, as well as a potential business transaction through Samara with him (which is currently on hold)].”
The ten states included California, Delaware, Florida, Maryland, Nevada, New York, Ohio, Pennsylvania, Texas, and Virginia “because each has a significant number of major public companies incorporated in them, and because Tesla’s most significant US operations are in California, Nevada, New York, and Texas.” The Committee concluded that “the corporate law of each of the 10 US states under consideration is, on the whole, substantially similar.”
Three potentially relevant differences were noted in particular: 1) Florida, Maryland, Nevada, New York, Ohio, Pennsylvania, and Texas have constituency statutes, which expressly permit directors and officers to take into account a company’s mission or broader stakeholder considerations when discharging their fiduciary duties, 2) Nevada was the only state under consideration without a heightened standard of judicial review for interested transactions or that allows exculpation for certain duty of loyalty claims, and 3) There was some variation in anti-takeover protections, with Delaware having one of the most management-friendly approaches. The Committee viewed this factor as not especially relevant to Tesla at this time, including because of its market capitalization.
Technically speaking, a stockholder could still challenge the compensation package, but the plaintiff will have the burden of proving by a preponderance of evidence the lack of fairness, rather than the defendant controller proving fairness.