Delaware Chancery Court Chief Judge, Kathaleen McCormick, has ruled to void Tesla CEO Elon Musk’s extravagant $55.8 billion compensation package, stating that it was excessive and marred by an insufficiently independent process.
The court found that Musk’s significant influence over Tesla, combined with the lack of independence in the decision-making process, rendered the compensation plan invalid.
“This decision dares to boldly go where no man has gone before, or at least where no Delaware court has tread. The collection of features characterizing Musk’s relationship with Tesla and its directors gave him enormous influence over Tesla,” Judge McCormick remarked in her ruling.
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The judge highlighted Musk’s multi-faceted role as the CEO, Chairman, and founder, coupled with his substantial equity stake of 21.9%, as factors that contributed to his dominance in the decision-making process. She noted that Musk controlled the Board of Directors (BOD), and the directors who approved the compensation plan were not truly independent. Importantly, shareholders were not adequately informed of this controlled relationship.
“The primary consequence of this finding is that the defendants bore the burden of proving at trial that the compensation plan was entirely fair. Delaware law allows defendants to shift the burden of proof under the entire fairness standard where the transaction was approved by a fully informed vote of the majority of the minority stockholders,” Judge McCormick explained.
However, the defendants failed to prove the stockholder vote was fully informed, as the proxy statement inaccurately described key directors as independent and omitted crucial details about the process. This left the defendants attempting to justify the fairness of the largest potential compensation plan in the history of public markets.
“Further, the shareholders who approved the compensation plan weren’t made aware of this controlled relationship. Hence, the $55.8B comp plan is voided,” McCormick ruled.
Musk’s compensation package, approved by around 80% of Tesla shareholders in 2018 when the company’s valuation was approximately $60 billion, required him to achieve significant market cap growth and meet ambitious revenue and profit targets. The milestones ranged from a $100 billion valuation to a final milestone of $650 billion. If Musk successfully reached these milestones, he would be entitled to the full $55 billion compensation package.
Remarkably, Musk achieved all the milestones, contributing to a substantial increase in Tesla’s market valuation, which currently stands at around $600 billion. The company’s financial success during this period has been characterized by robust revenue growth, profitability, and the creation of significant shareholder value.
However, shareholder Richard Tornetta filed a lawsuit in 2019, claiming that the compensation package was excessive and the board had not acted in the best interest of shareholders.
In the broader context of Musk’s compensation, it’s essential to note that his controversial compensation plan raised eyebrows when it was first proposed. Approved by the majority of shareholders in 2018, the plan set ambitious targets, tying Musk’s compensation directly to the company’s market valuation and financial performance.
However, the result of this legal challenge mounted by Tornetta, who held a mere 9 shares of Tesla, has held many in bewilderment.
“Rarely, if ever, does a Delaware court rescind a compensation agreement,” said Charles Elson, a corporate governance expert at the University of Delaware. “To my memory, it hasn’t happened.”
Now, Tesla finds itself at a crossroads. The company can choose to appeal the court’s decision, potentially escalating the legal battle to higher courts, including the Delaware Supreme Court and even the U.S. Supreme Court. Alternatively, Tesla may opt to develop an alternative compensation package for the contentious 2018 agreement.
Dan Ives, a Wedbush Tech analyst, views the court ruling as a potential turning point.
“Delaware Court ruling a shocker ruled against Musk/Tesla BUT this now clears the path for the Board to create a new pay package and incentives that could supersede this and could solve a lot of the Musk ongoing frustrations. Also could further lock Musk into Tesla,” he said.
Musk’s response to the court ruling included a recommendation to fellow entrepreneurs. He posted on Twitter, “Never incorporate your company in the state of Delaware,” emphasizing a dissatisfaction with the legal implications of the state’s jurisdiction. He followed up with a suggestion to incorporate in Nevada or Texas, especially if one prefers shareholders to have a more decisive role in company matters.
Musk even conducted a poll on his social media platform X, asking users whether Tesla should change its state of incorporation to Texas, where the company’s physical headquarters are located. An overwhelming 87% of respondents voted in favor of the move. Musk promptly declared that Tesla would initiate a shareholder vote to transfer the state of incorporation to Texas.
The public vote is unequivocally in favor of Texas!
Tesla will move immediately to hold a shareholder vote to transfer state of incorporation to Texas. https://t.co/ParwqQvS3d
— Elon Musk (@elonmusk) February 1, 2024
The court’s ruling has cast a shadow over Musk’s fortune, threatening his position in the centi-billionaire league. Musk was recently dethroned as the world’s richest man by the French Businessman and CEO of LVMH, the world’s largest luxury goods company, Bernard Arnault.
Arnault’s fortune now stands at $207.8 billion, following a substantial increase of $23.6 billion on Friday, surpassing Musk’s $204.5 billion, per Forbes’ real-time billionaires list.