On January 4, 2024, the Court of Chancery of Delaware struck down the largest potential compensation plan in the history of public market – Elon Musk’s $55.8 billion compensation plan from Tesla. Can Musk override the Court’s decision with a subsequent stockholder vote?

Background

A board of directors’ decision on the appropriate compensation for a company’s CEO is a crucial business determination that is typically subject to great judicial deference. However, in Delaware, the law recognizes the inherent risks in a corporation’s transactions with a controlling stockholder. A defendant bears the burden of proving that the compensation plan is entirely fair. But that burden can shift to the plaintiff when the transaction is approved by a fully informed vote of the majority of the minority stockholders. In this case, despite the transaction being approved by a vote of the majority of minority shareholders, Musk was unable to prove that the stockholder vote was fully informed because the proxy statement was found to contain inaccurate and misleading information.

The January 2024 Decision

Here, the plaintiff, a minority stockholder, brought a direct and derivative action against Tesla, Elon Musk and other members of the board of directors, seeking to rescind Musk’s compensation plan due to alleged  disclosure deficiencies. Because Musk is a controlling stockholder, the Court found that the most onerous standard – entire fairness – applied to assessing whether the board had complied with its fiduciary duties. The entire fairness standard requires the board to prove that the transaction is inherently fair to the stockholders by demonstrating both fair dealing and fair price.

The Court found that the defendants failed to meet their burden.

To show that the vote was fully informed, the defendants had to establish that stockholders had “all material information” related to the transaction. An omitted fact is material only where “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote”. Examples of such information include a director’s actual or potential conflict with a transactional counterparty and the steps in a board or committee process that resulted in the approval of the transaction. In this case, there were two categories of material information that were undisclosed: conflicts and process. First, the defendants failed to disclose any of the compensation committee members’ actual or potential conflicts with respect to Musk, describing them instead as fully independent in the proxy statement. That description was ultimately proven untrue. Second, the proxy statement did not disclose the level of control that Musk exercised over the process (e.g. his control over the timing, the fact that he made the initial offer, the fact that his initial offer set the terms, the lack of negotiations, and the failure to benchmark). As a result, the Court found the proxy statement materially deficient in those respects and ordered recission of the compensation plan.

In response to the Court’s decision, the defendants put the rescinded compensation plan – the exact same plan that the Court deemed a breach of the duty of loyalty – to a stockholder vote for the purpose of “ratifying” it.  Following a successful stockholder vote, the defendants moved to “revise” the trial decision, effectively asking the Court to reverse its own decision and enter judgment in their favor.

The December 2024 Decision

On December 2, 2024, the Court denied the motion to revise its January decision.

The Court found four fatal flaws with the defendants’ attempt to ratify the compensation package following the trial decision:

1. The defendants had no procedural ground for reversing the outcome of an adverse trial decision based on evidence they created after trial.
2. Common law ratification is an affirmative defense that must be raised promptly, which means that, at a minimum, it cannot be raised for the first time after the trial opinion.
3. A stockholder vote standing alone cannot ratify a conflicted-controller transaction.
4. Even if a stockholder vote could have a ratifying effect, it could not do so here due to multiple, material misstatements in the proxy statement.

Can a Shareholder Vote Overrule the Court?

The answer thus far is no.

The central argument in this case was grounded in agency law, i.e., that stockholders hold the power to adopt any corporate acts they deem to be in their own best interests because they are the principals of the corporation. Delaware law applies transaction-specific rules that limit the effect of a stockholder vote when conflicts threaten the decision-making process. As the standard of review increases when conflicts become more direct and serious, the effect of a fiduciary ratification diminishes. The Court recognized the inherent risks with a conflicted-controller transaction and found that despite the defendants’ creativity, they did not meet the entire fairness standard and therefore, the motion to revise was denied. 

This case is the first of its kind in the U.S. While Canadian courts have not yet faced a similar scenario, the Delaware decision and analysis may inform how Canadian courts would address a similar question.