The Great Tornetta Briefing Battle Has Begun

Defendants have filed their opening briefs on ratification. Their factual story is preposterous, but does Plaintiff have a clean kill on the law without reopening the trial record? (Part 1 of 3)

On June 28, nominal Defendant Tesla, Inc. and the individual Director Defendants¹ in Tornetta v. Musk² filed their opening briefs in the fight over whether the June 13 shareholder vote was legally effective to ratify the Tesla board’s 2018 grant to Elon Musk of a stock options compensation package (the 2018 Grant).

You can find the individual Defendants opening brief here and the opening brief of nominal Defendant Tesla here.

Defendants, of course, contend that the ratification is effective, and that consequently the Chancellor must vacate her January 30, 2024 ruling rescinding that grant (the Rescission Ruling), award nothing to Plaintiff by way of equitable relief or attorneys’ fees, and enter judgment for Defendants.

There are three legal issues I regard as highly significant: (1) statutory ratification, (2) common law ratification, and (3) corporate waste. Here, in this Part 1, I discuss how Defendants have addressed the statutory ratification issue. I hope to discuss the other issues in Parts 2 and 3 later this week.

I. Defendants’ Mendacious Narrative

A large portion of Defendants’ briefing consists of tendentious claims mirroring those made in the proxy materials and the public pronouncements by Musk and the other Tesla directors. I have called these claims “campaign propaganda” because they resemble populist rhetoric more than legal argumentation.

The campaign propaganda begins on the very first page of the individual Defendants’ opening brief on Tesla’s ratification gambit, and continues relentlessly through all 53 pages:

• “Musk did not control Tesla or the ratification itself.”

• Kathleen Wilson-Thompson, the sole member of the Special Committee of One, which “committee” recommended the ratification vote, is “an indisputably independent director.”

• The shareholders were “fully-informed,” and had “full knowledge of the facts.”

• The shareholder vote was “uncoerced.”

Each of these statements, in my view, is provably false. I and my collaborator, a Silicon Valley corporate attorney who has served on the board of several prominent technology companies, have detailed the reasons why these statements are lies here, here, here, and here. In short:

• Musk completely controls Tesla; its directors are Musk’s utterly beholden stooges who allow him to do exactly as he pleases while they wallow in the colossal wealth he has showered upon them; and Musk orchestrated the entire ratification and reincorporation gambits.³

• Kathleen Wilson-Thompson, vastly enriched by Musk for doing exactly as he commands, was merely a puppet on a string. In Part 2 of this series, I’ll expand further on why it is already amply clear that she is not independent.

• The proxy process was deeply flawed and the proxy materials contain many material falsehoods and omissions.

• The vote was coerced by (among other things) Musk’s threat to misappropriate Tesla’s artificial intelligence (AI) and robotics opportunities (which he has already begun doing).

(Image by Microsoft Designer AI)

II. Refuting Musk’s Fiction Would Take Time

Plaintiff’s problem is that demonstrating the truth — that Musk directed the entire process, that Wilson-Thompson lacks independence, that the proxy process was flawed and the proxy disclosures misleading, and that Musk coerced the vote — might require further discovery to introduce evidence that is not now part of the Chancery Court’s “trial record” (documentary evidence, factual testimony, and expert testimony).⁴ Assuming the Court were willing to reopen the case (as Court of Chancery Rule 54 permits), Plaintiff would require several months to gather documents and conduct depositions.

With this case now having passed its sixth anniversary, and the case docket now having reached a staggering 400 entries, the Court might well find it painful to reopen the trial record. Almost certainly, the Court would like to see matters brought to a conclusion soon so that a final order can be entered and the case can become appealable to the Delaware Supreme Court.

Reopening the trial record would be even more painful for Plaintiff’s legal team, which has devoted tens of thousands of hours but not yet seen a pay day.

III. Does Plaintiff Have ‘Kill Shots’ for the Key Issues?

In order to avoid such further delay, Plaintiff needs legal arguments that support its view that the ratification vote was legally ineffective to undo the Court’s ruling rescinding the 2018 Grant. Plaintiff needs, in short, some kill shots (1) that are purely legal and require no further evidence, or (2) that require additional evidence on only one or two narrow issues of very limited scope.

So, let’s see whether Plaintiff has such kill shots.

In its April 17 preliminary proxy statement, Tesla offered its shareholders two reasons why their vote might be legally effective to ratify the 2018 Grant: (1) common law ratification and (2) statutory ratification under Section 204 of the Delaware General Corporate Law:

The Ratification is being sought for any purpose permitted under Delaware law, including but not limited to Delaware common law and Delaware statutory provisions such as Section 204 of the DGCL.

The most complex issue, and the one on which I believe Defendants have made their strongest case, is common law ratification. As I noted at the outset, I’ll turn to that issue in Part 2. In this Part 1, I will address only the more simple statutory ratification issue.

IV. The Statutory Ratification Arguments

In assessing whether the shareholder vote was legally effective for purposes of statutory ratification under Section 204 of the Delaware General Corporation Law, I will do what the Court might do: assume for purposes of argument that Defendants’ rhetoric about the independent, fully informed, non-coercive proxy process is accurate, and ask whether, even accepting that narrative, Defendants’ arguments can withstand Plaintiff’s responses.

But how can I know what Plaintiff’s responses will be until I see their responsive brief on July 12? As fortune would have it, we already have an informative preview of Plaintiff’s arguments from two sources: (1) the amicus curiae (friend of the court) brief from Professor Charles Elson, which he sought permission to file on May 13, and (2) Plaintiff’s June 21 reply brief on the legal fees issue, which included a short summary of Plaintiff’s ratification arguments.

I will detail, one-by-one, the arguments Plaintiff has made, and examine the way in which Defendants in their opening briefs have attempted to parry those arguments.

Warning: The large legal teams on each side of this case include experts on Delaware law, which is not my legal specialty. Moreover, those large teams can engage in extensive legal research that is well beyond my capacity. Consequently, Plaintiff is all but certain to make additional arguments that I fail to anticipate in this post. As for the arguments I do discuss, Plaintiff will surely make them in a far more complete and informed fashion than I can.

A. The Statutory Language

Plaintiff has emphasized that the Chancellor ordered rescission of the 2018 Grant “as a remedy for Defendants’ fiduciary breaches”⁵ rather than “a failure of authorization.” Here, it is worth recalling that Section 204 deals with defective corporate acts that are void “solely as a result of a failure of authorization” (emphasis added).

Nominal Defendant Tesla devotes only one paragraph in its brief to arguing why the shareholder vote was legally effective under Section 204. Tesla contends that the argument that ratification cannot cure a breach of fiduciary duty is “a diversion.” Why? Because, as the Chancellor wrote in her Rescission Ruling, the rescission remedy “flow[s] from the disclosure deficiencies.”

That argument is going nowhere. The language in the opinion reads, “Although rescission does not automatically flow from the disclosure deficiencies, it is nevertheless an available and appropriate remedy.” So, for starters, the Chancellor did not say that the rescission remedy flows from the disclosure deficiencies. To the contrary, she said that remedy does not automatically flow from those deficiencies. This argument is so fatuous that it’s difficult to fathom why Tesla made it.

Did the individual Defendants do any better? No, they did even worse. Indeed, they positively embarrassed themselves. They rely heavily on a case called Harrison Metal Cap. III v. Mathe.

The individual Defendants’ reliance on this case is simply bizarre. The Vice Chancellor dismissed the case because the plaintiff⁶ had failed to demand that the board of directors bring the lawsuit before filing its derivative action while also failing to plead facts showing such demand would have been futile. The Vice Chancellor’s order never reaches the merits of whether the shareholder ratification at issue would have been invalid because the shareholder vote was uninformed. Indeed, the order never even mentions Section 204.

B. The Legislative History

The Elson amicus brief cites legislative synopsis to Section 204, stating that the provision is designed to remedy problems of the “technical validity of the act or transaction,” but

is not intended to modify the fiduciary duties applicable either to approval or effectuation of a defective corporate act or transaction or any ratification of such act or transaction. Defective corporate acts, even if ratified under this section, are subject to traditional fiduciary and equitable review.

How do the Defendants deal with this legislative history? Not convincingly.

Nominal Defendant Tesla ignores it completely.

The individual Defendants are a bit more clever. They include a citation to the legislative synopsis, but do not mention the language quoted by Elson. Instead, they quote from a portion of the synopsis stating that “the doctrine of ‘shareholder ratification’ . . . continue[s] to be an effective mode of ratification.” What they fail to make explicit is that the portion of the official synopsis they are quoting explicitly applies only to common law ratification, not statutory ratification under Section 204.⁷

C. The Applied Energetics Decisions

The Elson brief also cites a 2020 Delaware Court of Chancery case called Applied Energetics, Inc. v. Farley for the proposition that defective corporate acts, even if ratified, remain “subject to traditional fiduciary and equitable review.”⁸

Additionally, Elson notes that of 32 judicial decisions citing Section 204, “not one holds, suggests, or even considers the possibility that Section 204 could ratify a fiduciary breach.”

Neither of the Defendants’ briefs cites Applied Energetics or otherwise attempts to grapple with Professor Elson’s points. Given that Defendants received Elson’s brief six weeks before they had to file their own briefs, their allergy to Applied Energetics is instructive.

D. Law Journal Articles

Elson also cites a 2016 law journal article about Section 204 in which the author writes that the ratification processes “do not eliminate or immunize any breach of fiduciary duty that may accompany the defective corporate act.”

Then, Elson sticks the knife in deeper by quoting from publications by lawyers at two of the law firms now representing Tesla in Tornetta. In the first such publication, the writer plainly states that Sections 204 and 205 “do not affect fiduciary duties or any equitable claims against such [technically defective] acts.” The writer of the second legal publication states that while an act “properly ratified under Section 204 may be given retroactive legal effect from a technical standpoint,” it “would not be insulated from an equitable challenge.”

And how do the Defendants respond to these powerful points?

I think you’ve already guessed. Both the brief of Nominal Defendant Tesla and the brief of the individual Defendants completely ignore them.

V. Conclusion

I think Defendants are unlikely to prevail on their argument that, under Section 204, the June 13 shareholder vote was legally effective to ratify the 2018 Grant.

As noted earlier, the common law ratification argument is more complex, and the waste argument is intriguing as well. Stay tuned.

[Post-publication note, July 8, 2024: in the original version of this post, I wrote that the individual Defendants had referred to the same case, Harrison Metal Cap. III v. Mathe, using two different citations. I was wrong; one of the citations was to the order in the case and the other was to another document in the case. My error does not affect my conclusion that the case does nothing to advance Defendants’ Section 204 argument.]

1. Those individual director defendants, who approved the 2018 Grant, are Robyn Denholm, Antonio Gracias, James Murdoch, Linda Johnson Rice, Brad Buss, and Ira Ehrenpreis. Denholm, Murdoch, and Ehrenpreis continue to serve on the board today.

2. Readers not already familiar with the background of Tornetta v. Musk, or wanting a refresher on some points, can find a summary in Part II of this Substack post.

3. Did Musk ask the Tesla directors to approve his radical shift in strategy, from being an EV manufacturer to instead focusing on artificial intelligence and robotics? Did Musk seek approval from those directors before forming his own AI company last March? Did he seek their approval before diverting the Nvidia chips? If the trial record is reopened in this case, the directors will be asked to answer those questions. Under oath.

4. As I will detail in Part 2 of this series, I believe there is already more than sufficient evidence that Wilson-Thompson lacked independence. Revealing the truth on the other points likely would require reopening the record.

5. The quoted language is from the Rescission Ruling at page 192.

6. The individual Defendants mention the “plaintiffs” in their first citation, but there is only a single plaintiff.

7. From the official synopsis:

Subsection (i) provides that the procedures in §§ 204 and 205 are not intended to preempt or restrict other valid means of ratifying any corporate act or transaction, including any defective corporate act, that would otherwise be voidable but not void. Thus, for example, the general doctrine of ratification, as recognized by the Court of Chancery in Klig v. Deloitte LLP, 36 A.3d 785 (Del. Ch. 2011), and Kalegeorgi v. Victor Kamkin, Inc., 750 A.2d 531 (Del. Ch. 1999), aff’d 748 A.2d 913 (Del. 2000) (unpublished table decision), and applied to a board’s adoption of acts taken by officers who may not have had the actual authority to take such acts, would continue to be an effective mode of ratification and there is no obligation to follow the procedures set forth in § 204 to ratify such matters.

8. Professor Elson is not guilty of taking that quote out of context. Here is the full paragraph:

Validating the contract itself will not lead automatically to its enforcement, because validation "only removes the taint of voidness or voidability that stems from the ‘failure of authorization.’ " Restoring Equity, supra, at 414. Defective corporate acts, even if ratified or validated, "are subject to traditional fiduciary and equitable review." H.B. 127 syn., 147th Gen. Assem. (2013) ("Ratification of a defective corporate act under § 204 is designed to remedy the technical validity of the act or transaction; it is not intended to modify the fiduciary duties applicable to either the approval or effectuation of a defective corporate act or transaction or any ratification of such act or transaction."). Nevertheless, assuming Farley prevails on his claim to validate his authorization of his salary and proves that the self-interested compensation was entirely fair, then he can pursue his claim for non-payment. The Company's motion for summary judgment on this count is denied.