Something Is Rotten in the State of Delaware

Elon Musk is behind proposed legislation that would radically change Delaware law for the worse and give him the pay package he craves.

Resisting Temptation

As I write this, the damage being done to our republican form of government at home, and to the reputation of our country abroad, continue at a breathtaking pace. It’s tempting to address these dispiriting developments.

But I will resist, because the topic here is far more narrow: the attempt, almost surely orchestrated by Elon Musk, to completely gut existing Delaware corporate law, transforming it from a widely admired and respected code that shareholders overwhelmingly prefer into a statutory Wild West in which corporate controllers essentially have free rein to pillage and plunder.

But perhaps today’s topic is not so narrow after all. In the largest sense, what is happening across our country is closely related to the havoc Musk is attempting to wreak on Delaware.

Just as Donald Trump is bent on dismantling the institutions we rely on for our vital rule of law, including the Department of Justice and the Securities and Exchange Commission, Musk is determined to destroy the most important body of law in U.S. corporate governance.

And just as Trump is acting out of a vindictive and spiteful spirit, enraged because the U.S. government dared bring criminal charges against him for his treasonous attempt to steal an election and for his gross mishandling of top secret documents, so too is Musk, who nurses a scorching fury toward Chancellor Kathaleen St. Jude McCormick for her decision in Tornetta v. Musk,¹ bent on retribution.

(Take that, Chancellor McCormick!)

Delaware’s Extraordinary Corporation Law

It is no accident that more than two-thirds of the companies in the Fortune 500 have chosen to incorporate in Delaware. Delaware lawmakers have taken pride in fashioning an intelligent corporate code, and Delaware courts have taken equal pride in developing a deep body of reliable case law.

As important as the law is the way disputes are adjudicated. Delaware chancellors and judges are experienced in corporate law. Moreover, they are appointed rather than elected. Having practiced for decades in Texas, where the judges are elected, I can assure you that elections allow many unqualified people to don black robes.

Further, Delaware’s appointment process is designed to emphasize professionalism over partisanship, as its law requires an equal number of judges from each party.

Disputes over the governance of Delaware corporations are tried in Delaware’s Court of Chancery, which sits without juries and does not award punitive damages. Corporate counsel who remember such celebrated cases as Pennzoil v. Texaco, in which a Texas jury was thoroughly bamboozled by a skilled plaintiff’s lawyer and entered a massive verdict that ended up bankrupting Texaco, welcome having their complex disputes decided by a chancellor who is versed in the nuances of corporate and contract law.

Also, the decisions come quickly in Delaware. By contrast with most states, where there are two layers of appellate courts, appeals from the Court of Chancery go directly to the Delaware Supreme Court. Both the Delaware’s Court of Chancery and its Supreme Court handle cases with admirable speed when speed is required.

The Delicate Balancing Act

Among the reasons why so many corporations choose Delaware is that its law has established a sensible balance between the interests of the corporation’s owners (the shareholders) and the interests of the owners’ agents (the officers and directors).

To describe the balance in simplest terms, Delaware’s business judgment rule insulates the vast majority of business decisions. If corporate managers make a decision in good faith and with reasonable care, then they are immune from liability, even if the decision turns out to be disastrous.

On the other hand, where the corporate managers make a decision that specially benefits one of them in a way that does not similarly benefit other shareholders (a so-called “non-ratable” benefit), then the decision receives a higher level of scrutiny. It must meet the so-called MFW requirements.²

For a non-ratable transaction to be proper, a corporation must, from the start, appoint a truly independent special committee that is free to select its own advisors. That committee must conduct genuine negotiations with the party receiving the benefit, without interference or coercion.

Then, the agreement struck by the special committee must be approved by a majority of disinterested shareholders.

The idea behind the MFW requirements is that a transaction involving a “controller” (think Musk) is inherently coercive because of the enormous influence the controller has over the corporation’s directors. In order to simulate arm’s-length bargaining, those requirements (in the words of the MFW decision) require the controller to “irrevocably and publicly disable itself from using its control to dictate the outcome of negotiations.”

Musk’s Option Grant Fails MFW

In making the 2018 stock options grant at issue in Tornetta, Tesla’s directors ignored the MFW requirements.

Crucial to the Tornetta decision is that Musk controlled Tesla. (Astonishing though it may seem, Musk at trial denied that he controlled Tesla, and he likely will make the same assertion on appeal). Given Musk’s control, it was vital that the board follow the MFW requirements.

However, the special committee that was supposed to negotiate with Musk included several directors who clearly were under his thumb, and who owed to him the vast wealth they suddenly enjoyed. Further, there were no genuine negotiations; rather, Musk essentially set the terms of his options grant and controlled the timing and pace of the committee’s discussions.

When a negotiation process does not meet the MFW requirements, then the court evaluates the transaction under the so-called “entire fairness” standard.

In Tornetta, the Chancellor found that the transaction was not entirely fair to Tesla. Besides being several magnitudes larger than any compensation award in history, the Chancellor asked a question that Tesla’s directors apparently never considered: given that Musk already owned some 20% of the company before the grant was awarded, why did he need any further incentive at all?³

Musk Attacks the Chancellor

The Chancellor made her ruling invalidating the 2018 stock options grant on January 30, 2024. In that ruling, the Chancellor did not invent any new law. Rather, she carefully hewed to settled Delaware Supreme Court precedent.

Less than an hour after the ruling was published, and before he could possibly have read it in its entirety, Musk complained bitterly about the ruling and told his 200 million followers on X: “Never incorporate your company in the State of Delaware.”

There followed Tesla’s desperate “ratification” gambit by means of a shareholder vote. The Tornetta plaintiff challenged that gambit as legally ineffective.⁴

After extensive briefing and argument, the Chancellor ruled on December 2, 2024 that the ratification vote was indeed ineffective for a host of reasons. Again, none of her reasoning was novel; all of it followed Delaware Supreme Court precedent.

Musk immediately renewed his attacks on the Chancellor, with accusations that were even more vicious, more unhinged, more arrogant, and more unfounded than his earlier efforts. Taking to his X platform, he:

• Accused the Chancellor of “absolute corruption.”

• Claimed the Chancellor is “totally crazy.”

• Claimed the Chancellor is “a radical far left activist cosplaying as a judge.”

• Claimed the Chancellor “is an activist posing as judge.”

• Responded “Absolutely” to a post claiming the Chancellor’s decision was “literal corrupt bullshit.”

• Thanked his friend, Jason Calacanis, for writing, “DELAWARE IS A DISGRACE” and “WE CANT [sic] HAVE THE CORPORATE STANDARD BE A KANGAROO FUCKING COURT.”

• Responded “Lawfare” to a post claiming the Chancellor’s decision was “crazy.”⁴

• Reposted a claim (by the infamous Tesla stock pumper, Cathie Wood) that “Judge [sic] McCormick is an activist judge at its [sic] worst.”

Besides being broadcast to Musk’s followers on X, these attacks were widely reported at various media outlets. Each of the statements he made or endorsed was utterly bereft of any supporting evidence.

Musk Expands His Attacks to Federal Judges

More recently, in accordance with the partnership of malignant narcissism in which he and Trump are engaged, Musk has expanded his snarling attacks to include federal court judges who dare rule that Trump is somehow subject to the laws and to the Constitution.⁵

This is all very dangerous stuff, broadcast as it is to many millions of Musk’s rabid social media followers. If harm should come to any of the judges targeted by Musk, he will bear a full measure of blame.

Now, Musk Seeks To Destroy Delaware’s Law

Several weeks ago came the news that the Delaware law firm of Richard, Layton & Finger (RLF) has drafted proposed legislation, known as Senate Bill 21 (SB 21), to radically amend the Delaware General Corporation Law.

RLF not only represents Musk on various matters, but also was Tesla’s principal Delaware counsel in the Tornetta case. Indeed, one of its star lawyers, Rudolf Koch, took a lead role in arguing key motions in Tornetta, including the ill-fated “ratification” gambit.

While RLF claims its work on SB 21 was not done on behalf of any specific client, I can assure you it is not working for free. One would have to be naive indeed not to strongly suspect that Musk is behind SB 21.

The proposed legislation is radical in its substance. Although its drafters claim that the changes are modest, and will merely “restore conventional rules'“ of Delaware law, that is plainly not so. SB 21 would overturn decades of precedent. Indeed, Professor Eric Talley, a respected Delaware legal expert has identified 33 Delaware Supreme Court decisions that would be overturned or likely overturned by SB 21.

And, surprise, surprise, among those 33 Delaware Supreme Court decisions is MFW. Had SB 21 been the law when Tornetta was decided, then the Tesla special committee would have had no duty to actually negotiate with Musk, but could instead have just accepted his terms. Indeed, SB 21 would have made it difficult even to challenge whether the directors on the special committee were subject to Musk’s control.

A comprehensive analysis of the radical changes SB 21 would effect, and the great uncertainty it would create, can be found here.

If SB 21 passes, then Delaware will become a haven for corporate controllers who want to run roughshod over shareholders, in much the same way that Nevada law now allows (and that Texas law, with Musk’s influence, is now being amended to allow).

SB 21’s Suspicious Process

Historically, any amendments to Delaware corporate law happen after an annual review by the state’s Corporation Law Council, which is a committee comprised of experienced transactional and litigation lawyers. If the Corporation Law Council believes the corporation code needs to be changed to adapt to new issues, then it recommends an amendment to the Delaware Legislature.

But not this time. SB 21 completely bypassed the Corporation Law Council. The law firm taking the lead in the drafting, with close ties to Musk and Tesla, and the bill’s sponsors, are attempting to ram the amendments through the legislature in record time. They want to assure that institutional shareholders, such as pension funds and insurance companies, who care deeply about shareholder rights, have no time to organize in opposition to this abomination.

The legislation is being pushed hard by Delaware Senate Majority Leader Bryan Townsend:

In the wake of the report, the sponsor of SB 21, Senate Majority Leader Bryan Townsend, said his legislation had nothing to do with Musk, and that he has “no reason to believe it has any impact” on his billion-dollar pay package dispute.

“This legislation applies equally to every Delaware corporation, and it’s not retroactive, so it’s not about affecting any kind of pending litigation,” Townsend said in a reference to Musk’s pay dispute, which is currently pending before the Delaware Supreme Court.

Well, Senator, with respect, that’s bullshit. This is all about about Elon Musk. (What does Musk have on Senator Townsend, one wonders.)

Alas, it gets worse. . .

Not Retroactive, Senator Townsend?

Lo and behold, those clever drafters of SB 21, who of course did not even have Musk or Tesla on their mind when they were busy doing an end run around the Corporation Law Council, just added this new language to the bill’s synopsis:

Brian JM Quinn, a respected law professor, has this to say about this new language (in a blog post called, appropriately, “Corporate vandalism”):

And there it is. The whole game. This legislation is not retroactive, but the lack of retroactivity shall not affect the ability of a court to reach an outcome consistent with one that would be dictated by this Act.

What does that mean?

Well, don't forget the Musk pay package is up on appeal. This legislation - the whole thing - appears to be about dictating an outcome for the Tornetta appeal. Not content to sit by and wait for the Delaware Supreme Court to reach that outcome on its own, which it very well could have done on its own, the sponsors of this bill appear to want to ensure the court comes to this conclusion. The Synopsis clarifies the question of retroactivity in a way that signals to the Court how it should decide on a pending case. Wow. I mean, seriously? Wow.

Again, one must ask just what kinds of strings are being pulled to make Senator Townsend tie himself in such knots, and to make Delaware’s new governor, Matt Meyer, genuflect to Elon Musk.

By the way, folks, the governor, secretary of state, and attorney general of Delaware are Democrats. The Delaware Senate is controlled by Democrats. The Delaware House of Representatives is controlled by Democrats.

But this is all perfectly normal, right?

Just Let Them Leave

If Elon Musk wants to take Tesla to Texas, good riddance. If he wants to encourage his other oligarch buddies to move their companies out of Delaware so they can abuse their shareholders much as Musk abuses Tesla shareholders, then Delaware should happily bid them farewell.

Allowing controllers to abuse shareholders is why God made the corporate codes of Nevada and Texas.

I have news for you, Governor Meyer and Senator Townsend: the many, many corporations that enjoy responsible governance, and appreciate the sound and reliable law Delaware offers, will stay put.

Trump and Musk, Musk and Trump: the tag team sponsoring blatant corruption and a determined assault on the rule of law that has been vital to our prosperity.

[Post-publication note: March 5, 2024. The original version of this article stated that the law firm of Wachtell, Lipton, Rosen, and Katz, which along with the RLF firm participated in the drafting of SB 21, represented Musk in the Twitter v. Musk litigation. That was incorrect; Wachtell represented Twitter. My apologies for the error.]

1. I have written extensively about the Tornetta case, with a deep admiration for the work of Chancellor McCormick. Part II of this post summarizes the facts and rulings in the case. This post details the remarkable final hearing in the case, and this post reviews the final opinion.

2. The name derives from a 2014 Delaware Supreme Court case, Kahn v. M&F Worldwide Corp.

3. The Chancellor mentioned the examples of Mark Zuckerberg, Bill Gates, and Jeff Bezos. “In each instance, the CEO’s board recognized that the executive’s preexisting ownership stake provided sufficient incentive to grow the companies that they had built.”

4. The shareholders also approved Tesla’s reincorporation in Texas, which occurred immediately after the vote.

5. From the Reuters story: “Musk, the world's richest person, has lambasted judges in more than 30 posts since the end of January on his social media site X, calling them ‘corrupt,’ ‘radical,’ ‘evil’ and deriding the ‘TYRANNY of the JUDICIARY’ after judges blocked parts of the federal downsizing that he’s led. The Tesla CEO has also reposted nearly two dozen tweets by others attacking judges.”