Elon Musk, whose 2012 employment agreement compensation was the largest in US corporate history, is angry that the Delaware Chancery Court invalidated his 2018 employment agreement (also the largest in US business history).
The 2018 agreement is fairly described as being a “performance based, equity compensation plan.” It contained a dozen milestones each of which when attained delivered to Musk approximately 1% of the shares of Tesla.
BTW, Elon Musk does not draw a salary.
Musk enjoying a blunt on Joe Rogan’s pod cast.
In his sophomoric anger, Musk has threatened to move Tesla’s state of incorporation from Delaware to either Nevada or Texas. This would require shareholder approval. Seems wildly childish and small, but, hey, Elon Musk is Elon Musk.
Nevada corporate law is modeled (plagiarized from) on Delaware law and has only a decade of experience whilst Texas has jury trials. You do not want a jury trial if you are a public company.
There is much in the way of emotionally charged fantasy afoot in describing what happened, but allow me to share some actual, verifiable facts.
1. A shareholder, one Richard Tornetta (son-0f-a-gun only owned nine (9) shares of Tesla), filed suit against Tesla, Musk, and the Tesla board of directors in the Delaware Court of Chancery alleging Musk’s compensation agreement was flawed for a number of reasons and should, therefore, be invalidated.
2. The Delaware Chancery Court is a great venue for such disputes — Tornetta v Musk — in this case a shareholder sponsored derivative lawsuit against the company and its board of directors for having failed to discharge their fiduciary duty to the shareholders in several ways.
There are no juries at the DCC and the Chancellor (Chancellor Kathaleen St. Jude McCormick, Notre Dame Law ’04) heard the five day trial herself, whereafter she rendered a 200-page decision.
It is actually modestly funny which must have really irked Elon.
3. The Chancery Court is an attractive venue specifically because there is no jury and the decision is made, therefore, by an experienced, seasoned judge with true business savvy rather than a dozen citizens with a couple of community college semesters amongst them trying to deal with a complex business situation.
You get that, dear reader, right?
I do want to say that the Chancellor’s name — Kathaleen St. Jude McCormick — is a little off putting with the whole “St. Jude” middle name thing. WTF, Kathaleen?
Chancellor McCormick was a Vice Chancellor since 2018 and became the first female Chancellor in 2021. Prior to that she practiced for a decade and a half before the Chancery Court on corporate governance matters. She is considered a solid jurist.
You may recognize her name as she previously handled the Elon Musk acquisition of Twitter litigation and brought that to a successful conclusion. She was fully acquainted with Elon Musk and he with her.
She got high marks for that assignment.
At the top of the stack — the global allegation so to speak — was the allegation that the board of directors failed to discharge its fiduciary duty owed exclusively to the shareholders.
Amongst the specifics are:
1. The agreement was not the result of rigorous, arms length negotiation, but rather Musk proposed the agreement and the Compensation Committee acted as a willing consultant and failed to push back against the agreement’s basic fairness.
The plaintiff did not use the words “lap dogs” but the inference is obvious. The decision used the words “sham negotiations.”
2. The board itself was unduly influenced by Musk in the person of his brother (come on, Elon, your brother?), persons who had received life changing amounts of compensation (the Chairwoman of the Board has benefitted to the tune of $250MM in a 3-year period), close personal friends with whom he had vacationed, and, allegedly, persons with whom he used drugs.
The plaintiff did not allege that the board was high when they approved the agreement.
This board, thusly composed, is alleged to have been incapable of discharging its fiduciary duty to the stockholders by their very make up as they were alleged to be “palled up” with this Musk chap.
This board composition issue appears to be fatal to me. It was not an “independent” board which is the objective and the mandate of the US Securities and Exchange Commission.
3. To make the conflicts more intense, the main quarterback of the agreement for the Tesla company was its general counsel, Todd Maron, an attorney who had previously represented Elon Musk in a divorce.
I swear to God I did not make that up.
4. The contract itself was based on the attainment of certain performance goals that were alleged to be “walks in the park” and not rigorous.
There were 12 such milestones.
5. As a then 21.6% shareholder, it was alleged Musk did not require such a high motivation as he was in effect, a “control shareholder.” This turn of a phrase — control shareholder — has huge legal significance as we shall see.
6. When the employment agreement was run by the shareholders for approval — which they did approve by a huge margin in the 73% range (excluding the shareholding of the Brothers Musk, Elon and Kimbal) — the board of directors failed to disclose the history of the agreement, how it was “negotiated,” and the low bar status of the performance milestones.
7. The size of the agreement — in excess of $56,000,000,000 — was alleged to be unconscionable and far beyond what was either necessary or prudent. Apparently, size matters.s
The biggest and most damaging finding by the Chancellor was that Elon Musk was a “control shareholder” meaning he had complete control of the negotiation of his own compensation.
Essentially, Judge McCormick ruled that Musk had control of the negotiations through his former divorce attorney acting as the primary contact person with the otherwise conflicted and compromised board of directors and its feckless compensation committee.
Given the above, this is not a huge leap of faith.
What this did was trigger a legal standard of what is called “entirely fair” meaning that the burden of proof that the deal was “entirely fair” now fell to the board of directors of Tesla who, in the Court’s opinion, failed to meet that burden.
The Court speaking through its Chancellor said, “In the final analysis, Musk launched a self-driving process, recalibrating the speed and direction along the way as he saw fit. The process arrived at an unfair price.”
You have to see the humor in that utterance even if it was lost on Elon Musk.
It appears the future holds the following:
1. Tesla, its board, Musk can appeal the ruling. Good luck with that.
2. The Tesla board has to re-negotiate its agreement with its CEO; but, first, it has to reconstitute itself in a manner that will pass muster as to its independence whilst the Chancellor, the Chancery Court, and the US Securities and Exchange Commission are looking over their shoulders.
Wise counselors appear to agree that means at least 3 new independent directors have to replace some of the most conflicted board members before they can conduct negotiations. This will take time.
3. Brother Kimbal probably has to leave the board.
4. Now, the new board has a very difficult task as they can hardly reward Elon Musk for performance that has happened in the past. No contract can influence that performance, and, thus, it would be a waste of corporate assets to give Musk a reward for his past performance.
Seems wildly unfair, but that is what the law says.
Why do I think it’s unfair? Because when this negotiation began, the market cap of Tesla was $50B. In 2021, it briefly hit $1T — yes trillion. Today it is approximately $800B.
So, yeah, Musk performed and created massive value for the shareholders.
5. Musk recently said he wanted to own “at least 25%” of the voting control of the company if he was going to stick his AI and robotics entrepreneurial endeavors inside Tesla rather than developing them elsewhere.
Seems a little blackmaily to me, but what do you think?
Given this debacle, it seems highly unlikely any board is going to hand Musk another 12% of the company and expect it to pass muster. Further, those endeavors are, arguably, already the property of Tesla.
6. Just to be clear:
a. Musk owned 21.6% of Tesla when the 2018 agreement was in play.
b. Musk used some of his Tesla stock to swing the Twitter/X deal.
c. After the Twitter/X deal, Musk owned 13.4% of Tesla.
d. Now, Musk wants to own “at least 25%” of Tesla to feel inspired and motivated to stuff his AI and robotics endeavors under the Tesla mantle.
The Tesla – Musk compensation agreement was done with crayon and Musk controlled the entire operation subject only to the scrutiny of persons who were unable to be objective.
The Chancellor caught Tesla, the board, and Elon with their knickers around their ankles and called them out on it in a modestly humorous 200-page opinion that seems damning.
Musk performed though the hurdles were likely overstated in difficulty even by the Russian judge.
This story is not over yet.
This is not a story about how the government penalized entrepreneurial endeavor; this is a story of how Musk and his buddies got sloppy and failed to follow the rules and betrayed their own bloody greed and arrogance.
It is also about a guy with 9 bloody shares who charged the Gates of Hell with half a thimble of tonic water and put out the fires. Damn good lawyering.
Having said all of the above, I would not bet against Elon Musk and he is a great entrepreneur.
But, hey, what the Hell do I really know anyway? I’m just a Big Red Car.
