Elon Musk is inescapable these days. The richest man in the world is buying Twitter. He runs the largest car manufacturer — by market cap — in the world. He sends rockets to space and digs tunnels underground. He’s in a never-ending fight with the Securities and Exchange Commission. Ford Motor Company has a new ad campaign where it takes not-so-subtle swipes at Tesla’s founder.
Even the Delaware Court of Chancery is getting in on the action. In late April, Vice Chancellor Slights ended six years of hard-fought litigation, issuing a 132-page post-trial opinion to conclude In re Tesla Motors, Inc. Stockholder Litigation, C.A. No. 12711-VCS (Del. Ch. Apr. 27, 2022). Despite serious reservations about Musk’s involvement and conduct in the transaction, the court concluded Tesla’s 2016 purchase of SolarCity Corporation was “entirely fair.”
Summarizing a 132-page opinion in 800 words is not easy, but we will try. The image evoked after reading the court’s decision is of a judge pinching his nose, being slightly disgusted by the whole circus, but still giving the deal a thumbs up.
When Tesla decided to buy SolarCity, Musk owned 22% of both companies. Two of Musk’s cousins ran SolarCity. Six of the seven members of Tesla’s board of directors were either SolarCity shareholders, directors, or officers. Despite SolarCity being in danger of a “major liquidity crisis,” Tesla agreed to purchase SolarCity for $2.1 billion in an all-stock offer valued at approximately $20 per SolarCity share. Delaware law did not mandate Tesla shareholder approval, but Tesla chose to obtain their approval anyway. Eighty-five percent of Tesla’s shareholders approved the deal.
Numerous Tesla stockholders promptly filed class and derivative actions challenging the acquisition. Those separate actions were ultimately consolidated, and the defendants moved to dismiss, arguing the SolarCity acquisition was subject to the business judgment rule. In turn, plaintiffs argued that Musk functioned as Tesla’s “controlling stockholder.” Vice Chancellor Slights denied the defendants’ motion, concluding that Musk likely exerted actual control over Tesla’s board and that the “entire fairness” standard applied to Tesla’s acquisition. In re Tesla Motors, Inc. Stockholder Litigation, C.A. No. 12711-VCS (Del. Ch. Mar. 28, 2018). Plaintiffs ultimately settled out with every defendant — except Musk — for $60 million. The plaintiffs and Musk had an 11-day trial to determine if Musk breached his fiduciary duties.
To reach its ruling, the court punted on the difficult legal questions of whether Musk was a “controlling shareholder” and whether the business judgment rule or entire fairness standard should apply. Instead, the court “assumed” the entire fairness standard applied and analyzed plaintiffs’ claims under that standard.
The court observed that “entire fairness” has “two basic aspects: fair dealing and fair price.” Fair dealing looks at how the transaction “was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Fair price, on the other hand, involves “the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company's stock.” The court concluded that the process followed and the price paid satisfied the entire fairness standard.
Price. On price, two items stood out to the court:
(1) Tesla’s stock performance post-acquisition, and
(2) The deal’s approval by 85% of its shareholders.
The court noted the “astronomic rise” in Tesla’s stock price as evidence of fairness. As the court noted: “although the relevant inquiry in an entire fairness analysis is whether the acquisition target was worth the price paid when the deal was consummated, hindsight suggests that Musk is right when he asserts that, once valued as a car company, Tesla is now valued as a first-of-its-kind, vertically integrated clean energy company.” The court also found that the deal was approved by a majority of Tesla’s disinterested stockholders, which amounted to “compelling evidence that the price was fair.” The court also gave credence to Tesla’s financial advisors’ fairness opinions and concluded that the market was “sufficiently informed to reach a reliable assessment of SolarCity’s value.”
Process. The court found almost as much wrong with Tesla’s process as was right. On the positive side of the ledger, the court noted Tesla’s board conditioned SolarCity’s purchase on the approval of a majority of Tesla’s disinterested stockholders. Tesla’s board could also point to its cadre of “top-tier” financial and legal advisors. Tesla’s board forced Musk and another director to recuse themselves from the final decision making on price and approval. Finally, the court found “strong evidence of fairness” in the fact that an independent board member led both due diligence and the negotiation processes.
But the court took time to also chastise many of Musk’s actions: “The process flaws flow principally from Elon’s apparent inability to acknowledge his clear conflict of interest and separate himself from Tesla’s consideration of the Acquisition.” The court recognized that “Elon was permitted to participate in the deal process to a degree greater than he should have been.” Among other shortcomings, the court highlighted:
(1) Musk’s numerous undisclosed conversations with SolarCity’s management during the deal;
(2) Musk’s promises of a bridge loan to shore up SolarCity’s financials;
(3) Musk’s selection of outside deal counsel;
(4) Musk’s significant involvement in pricing, timing, and due diligence conversations, and
(5) Musk’s public demonstrations — during the deal negotiations — of SolarCity’s products and promises about those products’ launch when they were actually inoperable and far from being ready to go to market.
- Should Tesla’s post-acquisition stock performance really be probative of whether the price it paid for SolarCity was fair? It is anticipated that much ink will be spilled in legal academia analyzing that question. Many things impacted Tesla’s stock value in the years since it acquired SolarCity. Tesla solved the early problems that plagued its production, launched new vehicles, and enjoyed an extended stretch of a booming economy. Put another way, what if Tesla had acquired SolarCity in November 2021, at the height of the market? Tesla’s shares are down about 40% from their highs just six months ago. This seems like a problematic rationale and one that may have a chilling effect on shareholder suits.
- Musk owes a couple hundred million of his fortune to the financial and legal advisors Tesla retained for this deal. The court ascribed major weight to the heavyweight caliber of those outside professionals. And those professionals created a major advantage for Tesla when they chose to put the SolarCity acquisition up for shareholder vote. Delaware law didn’t require it, but the fact that 85% of Tesla’s shareholders voted to approve the transaction was a major factor in the court’s decision. Three cheers for excellent outside counsel!
- Delaware’s “entire fairness” standard has been described as the most stringent and onerous test available of a board’s decision-making authority. But between last week’s update and this decision, the standard has lost some of its luster. Both cases involve numerous instances of just-plain-bad corporate process and inequitable purposes, but both transactions were deemed entirely fair. Maybe a new name is appropriate — “mostly fair” or “good enough” standard of review?
- Even the court seemed to have second thoughts about its decision. How damning is this quote from the court? “Elon likely could have avoided the need for judicial review of his conduct as a Tesla fiduciary had he simply followed the ground rules of good corporate governance in conflict transactions. He declined to do so. For that reason, I decline to award him prevailing party costs.” In the end, it seems, that no one prevailed in this case.