Tornetta v. Musk: The 2018 Grant Is Wasteful, but Is It Waste?
A strong case can be made that restoring Musk's options package would be "corporate waste." But there are better arguments for ruling that the shareholder vote was legally ineffective. Part 3 of 3.
We deal again with Tornetta v. Musk1, in which the Chancellor has already heard final arguments on legal fees, and will now consider the ratification issue that first arose with Tesla’s filing of its April 17 preliminary proxy statement.
As those following along know, we are examining whether Plaintiff has legal arguments that conclusively refute the assertions by Tesla, Elon Musk, and Musk’s co-defendants (all current or former Tesla directors) that the June 13 shareholder vote was legally ineffective to ratify the Tesla board’s 2018 grant to Musk of a stock options compensation package (the 2018 Grant).
In Part 1, we looked at Defendants’ assertion that the ratification vote was legally effective under Section 204 of the Delaware General Corporation Law. In Part 2, we covered Defendants’ common law ratification arguments. In this final Part 3, we examine the separate argument that restoring the 2018 Grant would amount to corporate waste, also invalidating the June 13 vote.
I. What Is Corporate Waste?
The origins and development of the corporate waste doctrine track, to a large extent, the rise in incidence of the stratospheric compensation of corporate executives. Professor Harwell Wells at Temple Law School has written a fine law journal article, a link to which you can find here.
Delaware courts define corporate waste (often just called “waste”) as follows:
If the value of the compensation to be paid [by a corporation to an executive or other party] is so out of all proportion to the value of the services which he would be expected to render that no reasonable person would consider that the corporation would receive a quid pro quo, then the contract would constitute a gift of corporate funds and would be illegal.
In Tornetta, the waste argument would proceed as follows:
The Chancellor’s January 30, 2024 ruling rescinded the 2018 Grant (the Rescission Ruling).
At that point, Tesla had no further legal obligation to compensate Musk with the stock options at issue in that grant.
Consequently, a restoration of the 2018 Grant by means of the attempted “ratification” would amount to an immense payment (based on the Tesla share price as I write this, almost $80 billion) for services already performed, and consequently would constitute an illegal gift of corporate funds.
Only a unanimous shareholder vote can ratify what would otherwise constitute corporate waste. In Tesla’s case, as in the case of almost any publicly-held corporation, achieving such unanimity would be impossible.
II. Will Plaintiff Even Argue Waste?
Plaintiff has not yet filed its answering brief on ratification; that brief is due this Friday, July 12. Plaintiff has offered an abbreviated preview of its arguments, however, near the end of its reply brief on the legal fees issue. While Plaintiff there took direct aim at the common law and statutory ratification arguments, corporate waste went unmentioned.
Defendants spend several pages of their opening briefs attempting to parry the waste claim. Which raises the question: if Plaintiff has not yet seemed inclined to make the waste argument, then why have Defendants taken care to offer their counterargument?
III. Professors Elson & Lipton on Waste
Defendants have taken such care for a very good reason: because Professor Charles Elson, whose first amicus curiae brief was cited in the Rescission Ruling, has sought the Court’s permission to file a second amicus brief on the ratification issue. In that second brief, Elson not only argues that the ratification vote was legally ineffective under both statutory and common law, but also devotes a two paragraphs to asserting that restoring the 2018 Grant would amount to corporate waste.
A. The Formidable Lipton Blog
Elson cites a legal blog post by Professor Ann Lipton of Tulane Law School in which she writes:
[A]warding back pay in this instance looks like — a gift. A sheer gift to Musk out of gratitude for his part work to Tesla.
The Lipton blog post is brilliant, insightful, and thought-provoking, and is especially impressive for having been written and published within one day after the April 17 publication of Tesla’s proxy statement. I find Lipton’s blog post even more persuasive than the argument in Elson’s brief (though, in fairness, Lipton enjoyed freedom from the constraint to observe an economy of words that was forced upon Elson).
Lipton notes that under Delaware law, Tesla could have awarded Musk backpay to assure his future services. However, that is decidedly not what happened here. The Chancellor has already found, based on Musk’s own testimony, that he had no intention of leaving Tesla at the time of the 2018 Grant.
Yes, as Lipton also notes, corporate boards regularly reward people for their past work even absent any contractual obligation to do so. In those instances, Delaware courts have rejected corporate waste attacks by pointing to the benefits accruing to the corporation from such rewards, including assistance from retiring employees with succession planning, or motivating both the rewarded employees and their colleagues to hope for similar beneficent future treatment. Alas, those cases don’t help Musk.
None of that is relevant here. Tesla is not arguing the award is necessary to secure Musk’s future services and it’s not like there are comparable Tesla employees out there looking to Musk’s compensation as a model for themselves. Plus, McCormick already concluded that the amount was unreasonable.
Lipton then proceeds to dismantle each of the justifications for the ratification offered in the proxy statement by the Tesla board and special committee (of one).
B. What’s Old Is New Again
The classic corporate waste decision in Delaware is the 1952 decision in Fidanque v. American Maracaibo Co. There, a corporation paid consulting fees to a 70-year-old former executive even though the executive had been incapacitated by a stroke. Legal commentators in Delaware, arguing that corporate waste was a doctrine ready for the legal graveyard, have for years made great hay in pointing out how rare is such a circumstance.
As Lipton notes, though, a nearly identical circumstance recently arose involving the late Sumner Redstone. Even after the 91-year-old Redstone’s declining condition left him unable to speak, the CBS board refused to terminate his $1.75 million annuyla contract as Executive Chair. Later, when Redstone finally resigned, the board awarded him a $1 million annual salary as “Chairman Emeritus.”
Chancellor Andre Bouchard declined to dismiss a lawsuit alleging waste, writing:
This court has commented many times on the difficulty of pleading a viable claim for waste against a corporate director under our law. But the particularized allegations of the complaint here depict an extreme factual scenario—one sufficiently severe so as to excuse plaintiff from having to make a demand on the CBS board of directors to press claims concerning certain (but not all) of the challenged payments, and to permit plaintiff to take discovery so that an evidentiary record may be developed before the court adjudicates whether those payments were made in accordance with the directors’ fiduciary duties.
So, per Lipton, the corporate waste doctrine still has legs.
C. Ann v. Andy
Indeed, Professor Lipton has tangled on CNBC television with the always unctuous (and deeply-devoted-to-Elon) Andrew Ross Sorkin on that very point. Worth a watch. (If time-pressed, start at 2:40.)
(My instructions to Microsoft Designer AI: “A business television news anchor giving adoring glances to the executive he is interviewing. The executive is wearing black jeans and a t-shirt, and is slightly overweight. Both are seated in a television studio.” Yes, AI has a ways to go…)
IV. Defendants: The People (and Giants) Have Spoken
Plaintiff first argues that the Court in Tornetta has “already ruled” that the 2018 Grant “is not waste.” Plaintiff cites to a 2019 ruling by Vice Chancellor Slights, who handled the case before his retirement, dismissing Plaintiff’s corporate waste claim. Slights wrote:
While Plaintiff has adequately pled the Award is unfair, "[t]he pleading burden on a plaintiff attacking a corporate transaction as wasteful is necessarily higher than that of a plaintiff challenging a transaction as ‘unfair.’ " This is especially so with respect to the Award given that the majority of disinterested stockholders voting at the special meeting approved the Award, and our law recognizes as axiomatic, even on the pleadings, "that stockholders would be unlikely to approve a transaction that is wasteful." The well-pled facts fail to support a reasonable inference that no person of "ordinary sound business judgment" would have granted the Award, a fact made even more clear in the light of the informed stockholder vote that approved it. Defendant's motion to dismiss Count IV is granted.
I think the circumstances have changed considerably since that ruling. Tesla now seeks to award Musk munificent compensation for services he has already performed. So, it does not appear to me that the 2019 ruling at the pleadings stage precludes an argument today that the doctrine of corporate waste bars the revival of the 2018 Grant by means of a ratification vote.2
That said, the fact that Tesla shareholders have now twice voted to approve the compensation package speaks loudly against waste, even accounting for the proxy deficiencies undergirding both of those votes.
Moreover, Defendants make much of the fact that several institutional shareholders voted in favor of the pay package. (“After all, are we claiming that giants like BlackRock and T. Rowe Price are voting to give away corporate assets?”) There is, as both I and Professor Lipton have noted, a case to be made that Musk coerced those shareholders with an implicit threat to punish them by withholding future business from them if they failed to vote in favor of ratification. But proving such coercion, along with other coercive acts directed at both retail and institutional investors, would involve reopening the record to develop a great deal more evidence.
I find the remainder of Defendants’ arguments on waste unpersuasive. Those arguments rely either on the business judgment rule, whose application here in place of the entire fairness standard amounts to wishful thinking by Defendants (see Part II of this Substack series), or on the rationale of cases that Professor Lipton has capably explained are inapplicable here.
V. Conclusion
All things considered, I understand why Plaintiff has not yet attacked the June 13 shareholder vote on the basis of waste, and why, even if it determines to include a waste argument in its answering brief to be filed this Friday (July 12), it might choose to relegate it to a last-ditch pitch.
My sense is that, if the Chancellor decides to rule that as a matter of law, the June 13 vote was ineffective to revive the 2018 Grant (and as Parts I & II of this series make clear, I think such a ruling would be entirely correct for several independent reasons), such a ruling based on the doctrine of corporate waste is an unlikely candidate.
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.
The same warning I offered in Parts 1 & 2 is equally important in this Part 3: 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 more complete and informed fashion than I can.
Dear Mr Rossi (corrected - Fossi), I'm hoping justice will be served. Thank you for this three part in-depth explanation of what is going on.