Transactions Involving Controlling Stockholder as a Result of Actual or Inherent Coercion are Subject to Entire Fairness Standard of Review
By: Annette Becker and Rich Minice
In In re Tesla Motors, Inc. Stockholder Litigation, C.A. No. 12711-VC (Del. Ch. Feb. 4, 2020), the Delaware Court of Chancery rejected the defendants’ (Elon Musk and the Tesla, Inc. (“Tesla”) board of directors (“Defendants”)) novel position that “inherent coercion” doctrine–as it relates to a controlling stockholder–evaporates when a case for breach of fiduciary duty moves beyond the pleading stage and stockholder ratification exists, and re-affirmed the Delaware principle that entire fairness is the appropriate standard of review. The Court rejected motions for summary judgment by both parties finding that there remained issues of material fact to be determined as to whether stockholder ratification was fully informed and uncoerced, and whether a majority of the Tesla board of directors approving the merger was independent.
Tesla acquired SolarCity Corporation (“SolarCity”) in 2016 by merger (the “Merger”). The plaintiffs, stockholders of Tesla (“Plaintiffs”), brought claims against both Elon Musk (“Musk”), as Tesla’s controlling stockholder, and Tesla’s Board of Directors (the “Board”), for breaches of fiduciary duty in connection with the Merger claiming that the Defendants had wrongly caused Tesla assets to be diverted for a bail out of SolarCity (a company in which Musk had a substantial interest). The Court previously denied Defendants’ motion to dismiss, finding that Plaintiffs had pled sufficient facts to allow a reasonable inference that Musk, despite holding only 22.1% of the voting stock of Tesla, was Tesla’s controlling stockholder based on a theory of inherent coercion, triggering the entire fairness standard of review for transactions involving conflicted controllers.
The parties completed discovery and brought cross motions for summary judgment. Defendants presented three claims for summary judgment: (1) Plaintiffs offered no evidence that Musk, as the conflicted controller, actually coerced Tesla’s stockholders into approving the Merger and thus could not as a matter of law meet the burden of proof; (2) the vote approving the Merger was entitled to business judgment review, because it was both uncoerced and fully informed; and (3) the Merger did not constitute waste. Plaintiffs’ motion asserted that (1) a majority of the Board was conflicted with regard to the Merger; and (2) the stockholder vote approving the Merger was not fully informed.
Defendants’ argument that inherent coercion must be backed by some evidence of actual coercion following the discovery phase of litigation in order to survive a motion for summary judgment presents the practical question of what evidence is required to actually prove (rather than plead) breach of fiduciary duty claims. “While every stockholder with majority voting control is a controller, not every controller is a majority stockholder.” A minority stockholder–such as Musk–may, as a matter of law, be a controlling stockholder if the controller conceivably has the “de facto power of a significant stockholder, which, when coupled with other factors, [such as managerial supremacy], gives that stockholder the ability to dominate the corporate decision-making process.” Musk’s hands-on approach to his role as CEO of Tesla results in significant influence over Tesla decisions, even if he attempts to purposefully distance himself from a decision. Consistent with Delaware precedent regarding the inherent coercion doctrine, the ability to control, rather than the actual exercise of control, is the determinative factor in Delaware controlling stockholder jurisprudence. The Court reiterated that applying the entire fairness standard of review is a necessary protection of minority stockholders, and does not indicate that any fiduciary misconduct occurred. The requirement “is simply a recognition that because conflicted controller transactions have such strong potential for self-dealing, absent replication of an arm’s-length transaction process, an independent judge should thoroughly examine the transaction’s substantive fairness.” The Court denied Defendants’ motion for summary judgment because there remain issues of material fact to be determined at trial as to whether Musk is Tesla’s controlling stockholder.
Additional issues in the motions for summary judgment put forth by both parties were predicated on inadequate disclosures in the prospectus for the Merger, leading to an uninformed stockholder vote. The burden of demonstrating that a stockholder vote was informed falls to the Board. Plaintiffs alleged Tesla made a variety of misrepresentations in its prospectus as to the corporate health of SolarCity, Musk’s involvement in the Merger, and the effect the Merger would have on Tesla. The Court found that genuine issues of material fact existed with respect to SolarCity’s solvency, Musk’s involvement in the Merger vote, and SolarCity’s product development, and denied motions for summary judgment related to those claims. In addition, the Court denied Defendants’ motion for summary judgment as to Plaintiffs’ waste claim, because if SolarCity was in fact insolvent, the Merger may constitute corporate waste. However, the Court granted motions for summary judgment brought by Defendants with respect to claims alleging (1) insufficient disclosure in the prospectus, because a failure to disclose tax assumptions made while calculating a growth rate to use for SolarCity’s valuation is–as a matter of law–immaterial, and (2) misrepresentation of the positive impact of the Merger, because the financial impact projection of an added $500 million in cash to Tesla’s balance sheet as a result of the Merger properly included a qualification that such projections may not come true.
Finally, the Court denied Plaintiffs’ motion for summary judgment as to the conflicted nature of the Board. Plaintiffs alleged that each member of the Board was conflicted, as either a dual fiduciary, benefited from the merger personally, or was conflicted through a relationship with Musk. Defendants conceded that Musk’s brother, Kimbal Musk, was a conflicted director. Each of the remaining Tesla directors that participated in the Merger vote and discussions, except one (Robin Denholm), either served on the board of directors or indirectly held an interest in the success of another Musk company, Space Exploration Technologies Company (“SpaceX”), which held bonds issued by SolarCity. The Court held that whether the interests of SpaceX and Tesla were aligned is best adjudicated at trial. As to the remaining Board member, Robin Denholm, Plaintiffs alleged a conflict because she is friends with Musk and receives substantial compensation as a director of Tesla. In denying Plaintiffs’ motion, the Court applied standing Delaware law, that merely showing a director is well compensated for service or has social relationships with other directors does not extinguish issues of material fact as to independence. Whether the Board was conflicted is more properly adjudicated at trial.