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Legal Challenge to Tesla Mega-Grant

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October 01, 2019 | Barbara Baksa

Legal Challenge to Tesla Mega-Grant

A Delaware court has allowed a lawsuit over a massive grant issued to Elon Musk to proceed. As I’m sure many of you know, I am not a fan of mega-grants, so I am intrigued by this development. For today’s blog entry, I summarize the decision.

What Mega-Grant?

In 2018, Tesla’s board granted a stock option to Elon Musk for shares equal to 12% of Tesla’s common stock outstanding. Vesting in the option is contingent on a series of market cap, revenue, and adjusted EBITDA targets. The option was valued at $2.3 billion for SCT purposes, could result in a payout of over $50 billion if all the targets are met, and resulted in a CEO pay ratio of over 40,000 to 1 for Tesla.

While not required, Tesla held a special shareholder vote to allow shareholders to approve the grant. Musk recused himself from the vote.

What Lawsuit?

A shareholder has filed a lawsuit against Tesla alleging that the award constitutes a breach of fiduciary duty on the part of Musk and Tesla’s board, and that it constitutes unjust enrichment and corporate waste. The court dismissed the waste claim but has allowed the claims of breach of fiduciary duties and unjust enrichment to proceed.

What About the Business Judgement Rule?

Lawsuits over executive compensation often don’t get very far because of the business judgement rule, the essence of which, for our purposes, is that it’s the board’s job, not the shareholders’, to set executive pay. The opinion of the vice chancellor (the proceeding was brought in the Delaware Chancery Court, which is presided over by chancellors) notes: “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.”

In this case, however, the court decided that the business judgement rule does not apply; consequently, the lawsuit can proceed. The vice chancellor’s primary reason for this seems to boil down to the fact that Musk is a controlling shareholder and therefore may have influenced both the board and the shareholders, even though he abstained from the shareholder vote (and is not a member of Tesla’s compensation committee). From the vice chancellor’s opinion:

Had the Board ensured from the outset of “substantive economic negotiations” that both of Tesla’s qualified decision makers—an independent, fully functioning Compensation Committee and the minority stockholders—were able to engage in an informed review of the Award, followed by meaningful (i.e., otherwise uncoerced) approval, the Court’s reflexive suspicion of Musk’s coercive influence over the outcome would be abated. Business judgment deference at the pleadings stage would then be justified. Plaintiff has well pled, however, that the Board level review was not divorced from Musk’s influence. Entire fairness, therefore, must abide.

It will be interesting to see what happens with this case.

- Barbara

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