In April, the Delaware Chancery Court cleared Elon Musk, CEO of Tesla Motors, Inc. for breach of fiduciary duties in connection with Tesla’s 2016 acquisition of SolarCity Corporation. However, Musk and his board of directors were found to have incurred unnecessary risks by not adopting certain best practices for addressing director conflicts of interests.
What does this mean for business leaders trying to absorb the outcome of this case? In short, although a fact-specific analysis would be required, shareholders generally must meet a high threshold before corporate directors are held liable for breach of fiduciary duties under either the “entire fairness” doctrine or the “business judgement” rule.
The “entire fairness” doctrine allows the court’s decision to focus on whether, in the absence of arms-length bargaining, the transaction, viewed objectively, is fair and reasonable. The “business judgement” rule is considered more lenient and assumes management is acting in the interests of the corporation and its stakeholders, allowing them to make responsible decisions without the fear of being held liable.
The alleged conflicts created by Musk’s ownership and leadership of both companies was the initial basis of the lawsuit. Musk was the Chairman of the SolarCity Board of Directors and the company’s largest stockholder. He was also serving as CEO and a director of Tesla and owned 22% of Tesla’s stock. Tesla chose to approve the merger by “affirmative vote of a majority of the minority of Tesla’s disinterested stockholders.” The Board recused Musk from certain discussions regarding the acquisition. Regardless, the plaintiffs claimed that Musk led Tesla’s Board to approve the acquisition at an unfair price, following a highly flawed process, in order to bail out Musk’s failing investment in SolarCity.
Plaintiffs brought claims against Musk and members of Tesla’s Board seeking $13 billion of damages. All defendants except Musk settled with plaintiffs. Musk proceeded to trial in July 2021.
The trial wrapped up after 11 days. The post-trial decision by the court started off by determining the level of scrutiny used to evaluate the breach of fiduciary duty claim. The court established a basis for assuming that entire fairness is the governing standard of review, rather than the more lenient business judgement rule.
The court found that the acquisition was entirely fair even though there were some questionable issues in the selling process. By “fair,” the court referred to the price Tesla paid for SolarCity. If there were attempts by Musk to control the process, that was neutralized by Tesla’s Board and its independent directors. However, Musk did press the Tesla Board to consider the acquisition in the first place. Musk also communicated with SolarCity’s management about the acquisition and engaged in other discussions.
Ultimately, the court was persuaded by evidence that Musk presented to show that the price paid for SolarCity was fair. The court focused on market evidence that supported the price Tesla paid and SolarCity’s current and future cash flows. The court found the transaction to be entirely fair and that Musk had not breached his fiduciary duties. Plaintiff’s other claims also failed.
Although this case was decided under an “entire fairness” governing standard of review, as stated earlier, this case showed it can also be difficult for shareholders to meet their burden of proof under the more lenient business judgement rule.
The case is In re Tesla Motors, Inc. Stockholder Litigation, Consol. C.A. No. 12711‑VCS (Del. Ch.).
Photo by Daniel Oberhaus (2018)