Musk Is Stuck in Delaware

If Musk hoped to escape the gravity of Planet Chancellor McCormick by means of his “ratification” & reincorporation gambits, the Chancellor’s May 28 ruling has extinguished any such possibility.

Jun 06, 2024

I. Introduction

On May 28, Chancellor Kathaleen St. Jude McCormick wrote to the parties’ legal counsel in Tornetta v. Musk to advise that she was denying the emergency motions filed by Plaintiff on April 23. She grounded her denial in Defendants’ representation that they had no “current intention” of engaging in the conduct that prompted Plaintiff to file those motions.

Some people following the case immediately expressed concern that the Chancellor’s letter created a loophole for the Defendants, at some future date, to change their “current intention” in the devious manner outlined in those Plaintiff’s motions. The consequence would be that Defendants would be able to move the case to a Texas court which would, by hook or by crook, undo the January 30 ruling that rescinded the 2018 stock options grant (the 2018 Grant) and thereby restore to Musk the ability to buy 304 million shares of Tesla for $23.34 per share.

In this post, I explain why those concerns are unfounded and why I believe the Chancellor’s May 28 letter was, in fact, a brilliant way to rule on the disputes over the “ratification” effort now afoot in the wake of Tesla’s April 17 preliminary proxy statement.

When it comes to the 2018 Grant, Elon’s cemented to Delaware. (gencraft.com image)

II. Where We Are Now, and How We Got There

[Those already familiar with the background of the Tornetta v. Musk case, including the January 30 ruling that rescinded the 2018 Grant, the subsequent dispute over Plaintiff’s legal fees, Tesla’s surprise effort to have its shareholders “ratify” the rescinded grant, and Plaintiff’s April 23 motions, can skip to Part III of this post.]

In January of 2018, Tesla Inc.’s Board of Directors awarded Elon Musk the 2018 Grant under which he could be awarded stock options for up to 304 million shares by achieving certain market capitalization milestones in combination with various financial performance goals. Two months later, Tesla shareholders voted to approve the grant.
Over the next four years, all the milestones were met. (Since then, however, several of the market capitalization milestones have melted away as Tesla’s share price has dropped, and several of the financial performance goals could no longer be met today. However, the 2018 Grant contained no “clawback” for such a circumstance.)
Richard J. Tornetta, acting on behalf of Tesla Inc. in a so-called derivative action, filed his lawsuit in June of 2018, challenging the 2018 Grant as a breach of fiduciary duty by Tesla’s directors and seeking to restore the 304 million shares to Tesla.
By the time the matter came to trial in November of 2022, the Defendants included Elon Musk, Robyn M. Denholm, Antonio J. Gracias, James Murdoch, Linda Johnson Rice, Brad W. Buss, and Ira Ehrenpreis. Further, because the lawsuit was a derivative action, Tesla was a so-called “nominal Defendant,” permitted to appear and argue why it disagreed with Tornetta.
In a 200-page Post-Trial Opinion handed down on January 30, the Delaware Court of Chancery rescinded the 2018 Grant. The Chancellor found that Musk was a controlling shareholder, that the directors approving the grant were beholden to Musk, and that the proxy materials were materially misleading. Applying the so-called entire fairness test, the Court found that the transaction was not fair to Tesla or its shareholders. Consequently, the Court restored to Tesla the 303,960,630 shares underlying the voided options, thereby increasing the percentage ownership of all non-Musk shareholders by about 10%. The Chancellor instructed the parties (1) to confer on the form of a final order and (2) to propose a briefing schedule for any remaining issues, including legal fees.
Plaintiff submitted its petition for costs and legal fees on March 1. On March 18, the parties agreed on a briefing schedule for the legal fees issue, which they amended on April 11. The schedule now has Defendants’ opposition due on June 7 and Plaintiff’s reply on June 21. The schedule also calls for submission of a proposed Order and Final Judgment by June 26, with the hearing on the legal fees motion to occur on July 8.
Meanwhile, unbeknownst to either the Court or Plaintiff, Tesla’s directors (including Musk) had begun meeting in early February to devise a plan to undermine the Court’s rescission ruling. The meetings continued through April 16, though Defendants’ lawyers never mentioned what their clients were planning while they were negotiating the briefing schedule that, conveniently for them, pushed the date for entry of any final order well past the date of the shareholder vote Tesla intended to announce.
Defendants sprung their surprise on April 17 with the filing of the preliminary proxy statement, which solicits shareholder votes at a June 13 annual meeting on proposals to, among other things, (1) “ratify” the 2008 Grant and (2) move Tesla’s state of incorporation from Delaware to Texas. Simultaneously with filing the proxy materials, Tesla advised the Court that it believed the “ratification” and reincorporation proposals “would materially impact” the January 30 Post-Trial Opinion as well as “the substance and status of” Plaintiff’s petition for legal fees.
Plaintiff Tornetta’s lawyers reacted quickly, filing motions on April 23 designed (1) to stop Defendants from attempting to litigate the 2018 Grant outside of Delaware, (2) to make clear that the Court’s ruling on rescission is “final” even if the legal fees have not yet been ruled upon, and (3) to place under the Court’s protection the 304 million Tesla shares at issue.
The parties completed briefing those issues on May 21. In a May 28 letter ruling, the Chancellor denied Plaintiff’s motions “without prejudice to re-raise the requests if events warrant.” (That letter is the subject of this post.)
On June 14, Tesla counsel wrote a letter to the Court, reporting that the ratification and reincorporation proposals had received affirmative votes, stating that “the Ratification is now effective,” and suggesting that the parties meet and confer about a revised scheduling order to accommodate briefing on the parties’ “respective positions.” Plaintiff immediately responded, taking issue with the assertion that any ratification was effective, indicating a willingness to agree to more briefing, but stating its view that the July 8 date for the final hearing should be maintained.
On June 20, Defendants filed a motion asking the Court to delay the final hearing date until after further briefing on “ratification.” Defendants proposed to conclude that briefing on July 19, with the final hearing at the Court’s convenience thereafter.
On June 21, in addition to filing its reply brief on legal fees (which also laid out numerous arguments why the “ratification” was legally ineffective), Plaintiff opposed Defendants’ request to amend the scheduling order. Plaintiff indicated it was amenable to further briefing, but said such briefing should be completed before the scheduled July 8 final hearing. Plaintiff also argued that the opening briefs on ratification should have a 3,000-word limit, rather than the 14,000 words proposed by Defendants.
On June 26, both parties filed their proposed final order. While the Chancellor had instructed the parties to “confer on a final order implementing this decision” (that is, the January 30 rescission ruling), Defendants instead turned in a form of final order that awarded judgment for Defendants.
On June 27, the Chancellor granted the amended scheduling order sought by Defendants, but retained the July 8 hearing on the legal fees issue. She instructed the parties to argue only the legal fees issue at the July 8 hearing, without reference to the ratification issue. Defendants’ motion and opening brief on the legal effectiveness is due on June 28, Plaintiff’s answering brief on July 12, and Defendants’ reply brief on July 19. The Chancellor instructed the parties to contact her chambers to set a hearing on the Defendants’ ratification motion for “late July or the first week in August.”
On July 8, the Court heard argument on legal fees, and took the matter under advisement rather.
On July 11, the Court set a hearing date of August 2, 2024 for the ratification issue.
On July 19, with Plaintiff’s filing of its reply brief, the parties completed their briefing of the ratification issue.
On August 2, the Court heard argument on ratification, and took the matter under advisement.

III. The Genius of the May 28 Letter Ruling

Chancellor McCormick’s May 28 letter concisely describes the case’s history. It explains that, because the issues of attorney’s fees and costs had not yet been adjudicated, the January 30 ruling rescinding the 2018 Grant was not yet a final, appealable judgment.

The letter recounts how the Plaintiff, on March 1, filed its papers detailing what it sought by way of legal fees, and how the parties then stipulated to a briefing schedule culminating in a July 8 hearing.

A. The ‘Plot Twist’

“Then,” wrote the Chancellor, “came a plot twist.”

The letter ruling details Tesla’s April 17 filing of its preliminary proxy statement by means of which Tesla’s Directors asked the shareholders (1) to “ratify” the 2018 Grant “under Delaware common law or statutory law” (which the Court calls the Ratification Proposal) and (2) to approve moving Tesla’s state of incorporation to Texas (the Court calls this the Texas Proposal).

B. Putting the ‘Rat’ in ‘Ratify’

Let’s pause here to note two important drafting touches. First, in the proxy statement, the word “ratify” does not appear in quotation marks. The Chancellor herself wrapped the word in those quotation marks. I read that to mean that the Chancellor is by no means convinced that Section 204 of the Delaware General Corporation Law (on which Tesla has premised the ratification vote) is available to cure material breaches of fiduciary duty rather than mere technical defects in statutory authorization.

Second, related to the first, the Chancellor quoted directly from the proxy statement in stating that the Ratification Proposal is “under Delaware common law or statutory law.” In other words, Tesla’s proxy statement may be making the claim that ratification is available under Delaware common law or statutory law, but by explicitly quoting from the proxy, the Chancellor wants to make clear that she is making no such suggestion.

C. Defendants’ Doublespeak

Next, the Chancellor details the way in which the Defendants appear to have been talking out of both sides of their mouth. On the very day Tesla filed the proxy statement, three new Delaware law firms entered the case on behalf of nominal defendant Tesla. One of those firms wrote to the Court stating that the impending shareholder votes “would materially impact” the Post-Trial Opinion as well as “the substance and status of” Plaintiff’s petition for an award of legal fees. (The letter does not mention additional language in the proxy statement indicating that Musk still has the right to the 304 million shares underlying the options that have been rescinded, and that either the Delaware court “or another court” could make further rulings in the case.)

The Chancellor reviewed how, concerned that Defendants were seeking to evade judgment if Tesla moved its state of incorporation to Texas, Plaintiff filed motions asking the Court (1) to enjoin Defendants from litigating the 2018 Grant outside of Delaware, (2) to protect that 304 million shares at issue by means of sequestration or a constructive trust, and (3) to enter a final “implementing” order on the rescission of the 2018 Grant to foreclose any argument that the lack of a final, appealable order means that the recission is unenforceable.

D. Laying the Groundwork for Textbook Judicial Estoppel

The Chancellor then detailed assurances – contrary to Tesla’s April 17 statement that the shareholder vote “would materially impact” the Delaware proceedings – made by Defendants in an April 25 letter and in May 7 briefing. To a lawyer, these assurances are crucial. They form a solid bedrock of promises that will “judicially estop” Defendants from taking a different position later, so it is worth repeating some of the assurances (that phrases in quotation marks are taken directly from the Defendants’ April 25 and May 7 papers):

“Tesla would still be a Delaware corporation at the time of [the shareholder vote].”
Success on the Ratification Proposal “will not affect any obligations or liabilities of [Tesla] incurred prior to the conversion or the personal liability of any person incurred prior to the conversion, nor will it affect the choice of law applicable to [Tesla] with respect to matters arising prior to the conversion.” [The Court added the emphasis.]
A final implementing order is unnecessary because it would be “redundant” and “superfluous” and would “serve[] no substantive purpose.”
Neither the Ratification Proposal nor the Texas Proposal would “interfere with this [c]ourt’s jurisdiction over the . . . [f]ee [p]etition or this [c]ourt’s ability to enter a final judgment so that the case may be appealed.”
The threat of the Texas Proposal is “entirely illusory.”

The Chancellor then summarized. First, she noted that Defendants have represented they had no “current intention” of engaging in the evasion feared by Plaintiff. Let us pause there. Does the “current intention” language create a loophole, allowing Defendants to attempt the evasion later and to claim that the formulated that intention only after May 28?

No, it does not. There follow some powerful statements in which the Court offers further interpretations of what Defendants have represented. Notably, those statements do not have any “current intention” qualification. Among them are these two:

[A]ny litigation related to the effect of the Ratification Proposal, if it is successful, would be subject to the Delaware forum selection provision in Tesla’s bylaws.
[T]he defendants will not file a state or federal action collaterally attacking the Post-Trial Opinion.

E. A Shot Across the Bow…

After listing these representations, the Chancellor’s letter reminds the Defendants’ lawyers that as “officers of the court” they are “duty-bound” to correct any error in her interpretation of their clients’ positions.

This is an extraordinary warning. The Chancellor is, in effect, signaling that she will not abide any monkey business. Any lawyer for Defendants who is aware that his or her client is planning an action contrary to the Court’s understanding of Defendants’ representations, and who fails to alert the Court immediately (or to seeking without explanation to withdraw from representing Defendants, which is a quiet way of telegraphing such information) risks disciplinary action and, indeed, possible disbarment.

F. …And a Finishing Flourish

Based on the “great comfort” she derived from Defendants’ representations, the Chancellor denied the Plaintiff’s motions, “albeit without prejudice to re-raise the requests if events warrant.”

In other words, were any Defendant to take any action inconsistent with those representations, then the Court would not hesitate to respond with a firm order, which could well include granting some or all of the relief sought by Plaintiff in the April 23 motions.

IV. Conclusions

As a legal matter, no state or federal court in the United States, properly applying the law, could have wrested away from the Delaware courts jurisdiction over Tornetta v. Musk. If Musk or his lawyers had hoped that might happen, then it could only be because they were hoping to locate a crooked court in the land of Judge Roy Bean.

Because it was already the law that Delaware would retain jurisdiction over the Tornetta case, the statements made by Defendants in opposing Plaintiff’s motions, so carefully detailed by the Chancellor, are simply more quick-drying cement that glues to Musk to Delaware as regards all disputes arising out of the 2018 Grant.

In all events, if there were any doubt before, the May 28 letter ruling makes clear beyond peradventure that Tornetta v. Musk, filed in Delaware, will remain in Delaware. It also makes clear that all disputes relating to the 2018 Grant will be adjudicated in Delaware.

Regardless of the outcome of the shareholder votes, the schedule for deciding the legal fees issue will stay on course, culminating in the July 8 hearing and, I would guess, a ruling on that issue within a few weeks of the hearing.

What about entry of a final, appealable order in the case? When such an order might be entered could well depend on the outcome of the June 13 ratification vote (and, given that the proxy statement states that such a vote is merely advisory, on whether the Tesla Board decides to “ratify” the 2018 Grant notwithstanding a negative result from the shareholders).

If the “ratification” occurs, then there is no doubt that Plaintiff will challenge its legal effect. Will that dispute be decided as part of the existing case, or will there be a new proceeding, with the existing rulings becoming immediately appealable? The answer is far beyond my zone of expertise. Perhaps the Court of Chancery has the discretion to steer the boat in either direction.

Of this I am certain, though: if the shareholders or Board vote to “ratify” the 2018 Grant, then the fight over that gambit will continue, in Delaware, for many months to come.

[Note on 6/6: howardoark at Threads, a careful reader of my posts, has helped me correct an error in this one (as he has done in the previous posts). I advised those “not” familiar with the background facts to skip to Part III when I meant to advise those “already” familiar with the background to do so. Thanks, Howard!]

[Note on 6/23: I have added to the bullet point chronology. All posts describing events after May 28 have been added since the date I originally published this post.]