(Reuters) - Does Elon Musk, who owns just 22.1% of Tesla’s shares, control the company he founded and continues to lead? If so, according to a summary judgment ruling issued Tuesday by Vice-Chancellor Joseph Slights of Delaware Chancery Court, Delaware law presumes that he wielded coercive influence over Tesla shareholders who voted to approve the company’s $2.6 billion acquisition of the Musk startup SolarCity in 2016.
Tesla shareholders, represented by Grant & Eisenhofer, Kessler Topaz Meltzer & Check and Robbins Geller Rudman & Dowd, contend that Musk pushed Tesla to rescue SolarCity from insolvency, breaching his fiduciary duty and wasting Tesla assets. Tesla directors, including Musk, have argued throughout the long-running litigation that the SolarCity acquisition process was unconflicted and that the deal was approved by shareholders in a fully informed, non-coerced vote. (All of the directors except for Musk agreed last month to a $60 million, insurance-funded settlement of shareholders’ claims.) Vice-Chancellor Slights is scheduled to oversee a 10-day trial of shareholders’ claims next month.
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The key to the case is the standard of review that the Chancery judge will apply to shareholders’ claims. Shareholders have a vastly better chance of tagging Musk with liability if they can persuade the vice-chancellor to evaluate the deal’s entire fairness, rather than deferring to the board’s business judgment – a standard that pretty much dooms shareholders’ M&A claims.
Musk’s alleged control of Tesla is, in turn, the critical factor in determining which standard should apply. When there’s no controlling shareholder, Delaware law gives wide latitude to boards’ decisionmaking. Under the state Supreme Court’s 2016 decision in Corwin v. KKR Holdings, directors of companies that have no controlling shareholder are entitled to business judgment deference even if the sales process was flawed, as long as the deal ended up being approved by a majority of shareholders. But Corwin doesn’t shield directors of companies that are under the sway of a controlling shareholder. To protect minority shareholders from the controller’s potentially conflicting interests, those deals are subject to judicial review of their entire fairness.
Vice-Chancellor Slights already ruled, back in 2018, that Tesla shareholders plausibly alleged Musk’s control in their complaint. The judge denied Tesla directors’ motion to dismiss the case at the pleading stage, concluding that shareholders’ allegations about Musk’s voting interest, outsized influence at the company and domination of the SolarCity deal process added up to an inference that Musk wielded the power of a controlling shareholder.
But that 2018 decision only entitled shareholders to move ahead with discovery. Last summer, the board’s lawyers at Cravath Swaine & Moore and Ross Aronstam & Moritz told the judge that investors had failed to establish in discovery that they’re entitled to entire fairness review. In a motion for summary judgment, the board’s lawyers argued (among other things) that the case record showed no evidence that Musk somehow coerced independent shareholders to approve the SolarCity acquisition. So, according to the board’s brief, the business judgment standard must apply to a deal that was conditioned upon – and subsequently approved in – an uncoerced, fully-informed shareholder vote.
“There is nothing in the record that could support a finding that the sophisticated institutional investors here were willing to risk breaching their own fiduciary duties to their clients out of fear of some alleged ‘potent retributive capacity’ on the part of Musk,” the board’s brief said.
Shareholders argued in their summary judgment brief that Vice-Chancellor Slights must apply the entire fairness standard regardless of Musk’s control because the board was hopelessly conflicted and shareholders were duped into backing an acquisition that was misrepresented in Tesla’s proxy disclosures.
In Tuesday’s decision, the vice-chancellor mostly denied both sides’ requests for summary judgment, concluding that he needs to delve more deeply into the facts to decide which standard of evaluation to use.
Importantly, though, he held that shareholders don’t have to come up with specific evidence that Musk coerced independent shareholders to approve the SolarCity deal. Delaware law, he said, presumes that controlling shareholders have “inherently coercive” power over their fellow investors.
“A conflicted controller has strong incentives to engage in transactions that benefit him to the detriment of the corporation and its other stockholders,” Vice-Chancellor Slights wrote. “And, as an 800-pound gorilla in the board room and at the ballot box, the controller has retributive capacities that lead our courts to question whether independent directors or voting shareholders can freely exercise their judgment in approving transactions sponsored by the controller. In these circumstances, shareholders are entitled to an independent review where the controller is made to explain why the transaction’s process and price were fair.”
Defense lawyers had argued that Delaware precedent on controlling shareholders’ inherently coercive power only addresses pleading-stage litigation. Once a case moves past discovery, they argued, shareholders have to provide proof that the controlling shareholder swayed the vote. Otherwise, their brief said, the shareholder vote should be treated as uncoerced – and the deal should be reviewed under the business judgment standard.
Vice-Chancellor Slights hailed that “ingenious” argument – but rejected it. Delaware courts developed their precedent on the coercive power of controlling shareholders because they understand how the world works, he said: The ability to control is self-fulfilling. And though the vice-chancellor conceded that even some of the Delaware jurists who originated the theory have subsequently questioned it in a law review article, the presumption that a controlling shareholder has inherently coercive power remains good law.
Of course, Slights said, to invoke the entire fairness standard of review, investors must still show that Musk was, in fact, a controlling shareholder by dint of his outsized influence at the company. And even if shareholders clear that hurdle, Musk can still prove at trial that the SolarCity deal was fair, which is exactly what defense lawyers have been arguing since the case began.
I emailed Evan Chesler of Cravath and shareholder counsel Christine Mackintosh of Grant & Eisenhofer for comment on Vice-Chancellor Slights’ decision but didn’t hear back.
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