Delaware Court of Chancery Rescinds Elon Musk’s $55.8 Billion Compensation Package in Cautionary Tale About Director Independence and Executive Compensation

On January 30, 2024, the Chancellor of the Delaware Court of Chancery struck down the $55.8 billion compensation plan that Tesla, Inc.’s board of directors had granted to Tesla’s well-known CEO, Elon Musk, finding that the directors breached their fiduciary duties (Tornetta v. Musk). Although fiduciary claims concerning executive compensation are generally reviewed under the deferential business judgment rule, the court found that Musk’s outsized role at Tesla required that the directors show that Musk’s plan was entirely fair. The court, rescinding his compensation, found that Musk’s $55.8 billion pay package was unfair based on Musk’s role in the compensation process and the potential value of the package. This decision, which can be found here, follows a five-day bench trial in the Delaware Court of Chancery.   

As with many things involving Elon Musk, the facts underlying the case were unprecedented. The proposed pay package at issue was “the largest potential compensation opportunity ever observed in public markets by multiple orders of magnitude.” Despite the extraordinary circumstances, the court’s decision addresses issues regularly faced by public companies. It signals the potential for increased scrutiny on CEO and executive compensation. It also serves as a reminder that courts’ analyses of director independence and entire fairness review are fact-intensive exercises. 

Overview 
Tesla is a clean-energy company, known primarily for its line of electric vehicles. Musk joined Tesla in 2004 and led its Series A financing round. In the years that followed, he invested tens of millions of dollars in the company, served as chairman of its board of directors from April 2004 to November 2018, and has served as CEO since 2008. During this time, Tesla has grown exponentially from a startup to a multibillion-dollar public company. As the Delaware Court of Chancery recognized, Musk was “the driving visionary responsible for Tesla’s growth.” By 2017, Musk had a 21.9% equity stake in the company.

In 2012, Tesla’s board approved a performance-based compensation plan for Musk (the “2012 Grant”), which involved 10 tranches eligible to be earned over a 10-year term. By March 2017, seven of the 10 tranches had vested; in those five years, Tesla’s market cap grew by more than 15 times, from $3.2 billion to $53.0 billion. Because Tesla was already nearing the completion of the 2012 Grant milestones, a member of Tesla’s board of directors initiated discussions with Musk in April 2017 regarding his next compensation plan (the “2018 Grant”). 

In June 2017, Tesla’s compensation committee began to discuss Musk’s compensation plan. They hired a compensation consultant and independent counsel, and they created a working group consisting of two members of the compensation committee, Tesla’s general counsel, at least two other in-house attorneys who reported to the general counsel, Tesla’s CFO, their external legal counsel, and another external compensation consultant. Over the next nine months, the compensation committee and Musk formulated the details of his compensation plan. The resulting plan had 12 vesting tranches, each vesting upon satisfaction of one market capitalization milestone and one operational milestone. Each completed tranche would increase Musk’s holdings in the company by 1%. To achieve full vesting, Musk would need to increase Tesla’s market capitalization to $650 billion and satisfy other revenue and EBITDA-based targets. 

On January 21, 2018, the 2018 Grant was approved unanimously by Tesla’s board, with two directors—Musk and his brother—recusing themselves. The 2018 Grant was approved contingent on the approval of a majority of the disinterested stockholders. The company solicited and received approval of the 2018 Grant by a vote of a majority of the minority stockholders. 

The plaintiff, a Tesla stockholder, filed suit in June 2018 challenging the 2018 Grant as a breach of fiduciary duty. The plaintiff alleged that the entire fairness standard of review, Delaware law’s most onerous standard of review, governed the dispute, because the 2018 Grant was (i) a conflicted-controller transaction due to Musk’s control of Tesla and (ii) approved by a majority-conflicted board. If the 2018 Grant was a conflicted-controller transaction, the plaintiff argued that the defendants would have the burden to prove that the transaction was entirely fair unless the transaction was approved by either (i) a committee of independent directors or (ii) a fully informed vote of the majority of the minority stockholders. The plaintiff also argued that the defendants bore the burden of proof because the stockholder vote was not fully informed. 

Musk Controlled Tesla in This Transaction 
The court’s analysis first addressed the “gating issue” of which standard of review applied to the 2018 Grant. Following a heavily factual analysis, the Delaware Court of Chancery concluded that because the 2018 Grant was a transaction between Tesla and a controlling stockholder, entire fairness applied. To reach this conclusion, the court considered the following facts pertaining to Musk’s control: 

• Stock Ownership: The court found that Musk wielded significant influence over Tesla through his 21.9% ownership of Tesla’s outstanding common stock. This fact was not dispositive, but the court did find that Musk’s stock ownership gave him a “leg up” because the company also had a supermajority voting requirement for any amendment to the bylaws governing stockholder meetings, directors, indemnification rights, and the supermajority voting requirement itself.
• Boardroom and Managerial Supremacy: More important than Musk’s stock ownership in Tesla was his “outsized influence” in the boardroom, which heavily weighed in favor of a finding of control. In addition to his deep personal involvement in Tesla, the court found that Musk exercised unusually expansive managerial authority and operated as if free from board oversight. In so finding, the court seemed to establish a new category of “superstar CEOs” under Delaware law whose presence at a company changes the traditional dynamics of corporate decision-making. In the words of the court: 

CEO superstardom is relevant to controller status because the belief in the CEO’s singular importance shifts the balance of power between management, the board, and the stockholders. When directors believe a CEO is uniquely critical to the corporation’s mission, even independent actors are likely to be unduly deferential.

• Relationships with the Board: The court also analyzed Musk’s relationships with the eight active members of the board during the relevant time, ultimately determining that the majority of the board was beholden to Musk, including the four members of the compensation committee. The court noted:
  • Two of the compensation committee members had both extensive business ties (having invested tens of millions of dollars in Musk-led entities) and personal ties with Musk (including spending vacations together and attending family birthday parties, which the court viewed as indicating a lack of independence).
  • The two other members of the compensation committee were beholden to Musk because of the importance of their Tesla director compensation. One director described this money as “life-changing,” and the other director admitted it was a large portion of his personal wealth.
  • Only one director was found to be independent, because she had no ties to Musk and had allowed the Tesla options she earned while a director to expire without exercising them.
  • The remaining directors were Musk himself, his brother, and one of Musk’s long-time friends.
  • The working group also included management members “who were beholden to Musk, such as [the] General Counsel . . . who was Musk’s former divorce attorney and whose admiration for Musk moved him to tears during his deposition.” 

The Stockholder Vote Was Not Fully Informed
The defendants argued that, even if it was a controller-conflicted transaction, the entire fairness burden of proof should be shifted to plaintiff because the 2018 Grant had also been approved by a majority of the minority of Tesla’s stockholders. But the Delaware Court of Chancery found the vote ineffective because it was not fully informed. Specifically, the court found that the proxy failed to disclose the following material information:

• “[T]he financial or personal connections between the members of the compensation committee and Musk.” 
• “[T]he level of control that Musk exercised over the process—e.g., his control over the timing, the fact that he made the initial offer, the fact that his initial offer set the terms until he changed them six months later, the lack of negotiations, and the failure to benchmark, among other things.” 
• The conversation that Musk had with a director in early April 2017, during which “Musk established the key terms of the 2018 Grant.”

Application of Entire Fairness 
After determining that it was the defendants who bore the burden to prove that the 2018 Grant was entirely fair, the court applied the two elements of the entire fairness standard of review: fair process and fair price. Based on the following considerations, the court determined that the defendants failed to meet this burden and thus the transaction was not entirely fair:

• Unfair Process. Despite multiple board, compensation committee, and working group meetings discussing the 2018 Grant, the court held that there was “barely any evidence of negotiations” of the 2018 Grant “at all” and that “neither the Compensation Committee nor the Board acted in the best interests of the Company when negotiating Musk’s compensation plan.” In reaching this conclusion, the court considered the following facts: 
  • Musk’s Control of the Timing of Negotiations: Despite the nine months of discussion of the 2018 Grant starting in April 2017 and ending with the January 2018 approval, most of the work occurred during “small segments” of that time and under significant time pressure from Musk.
  • Lack of Negotiation over the Size and Terms of the 2018 Grant: The most “striking omission” from the negotiation process was the “absence of any evidence of adversarial negotiations regarding the size” of the 2018 Grant. 
    • In the court’s view, Musk made the original proposal, and even when he lowered this proposal during the course of discussions, this was simply a unilateral decision on his part. Musk had testified during his deposition that he was “negotiating against [himself].”
    • As evidence of negotiations, the defendants argued that the compensation committee had extracted concessions from Musk, including a five-year holding period for the shares acquired upon exercise of the 2018 Grant, an M&A adjustment, and a 12-tranche structure requiring Tesla to increase market capitalization by $100 billion more than Musk had initially proposed to earn the full amount of the 2018 Grant. But the court flatly rejected this argument: “It is not accurate to refer to these terms as concessions” because “the holding period was adopted in part to increase the discount on the publicly disclosed grant price, the M&A adjustment was industry standard, and the 12-tranche structure was reached in an effort to translate Musk’s fully-diluted-share proposal to the board’s preferred total-outstanding-shares metric.”
  • Lack of Benchmarking Analysis: The court also considered the fact that even though the compensation committee had received guidance from two compensation consultants, the process lacked a benchmarking analysis comparing the 2018 Grant to compensation plans at comparable companies.
• Unfair Price. The court looked at whether the economic and financial considerations of the transaction were substantively fair. At the outset, the court noted that the $55.8 billion maximum value of the plan “is the largest potential compensation opportunity ever observed in public markets by multiple orders of magnitude—250 times larger than the contemporaneous median peer compensation plan and over 33 times larger than the plan’s closest comparison, which was Musk’s prior compensation plan.” 
  • The court rejected the defendants’ framing of the economic terms of the transaction as “6% for $600 billion in growth” (i.e., Musk was required to increase Tesla’s market cap from $50 billion to $650 billion to increase his own holdings from 21.9% to 28.3% as well as hitting other operation milestones tied to revenue and EBITDA). The court recognized the appeal of this argument but ultimately determined that because Musk (i) already had an incentive to improve Tesla’s performance due to his large ownership stake in the company and (ii) had no intention to leave Tesla, this was not the “fair price” that the directors and company should have negotiated. 

Takeaways for Companies and Their Compensation Committees
While this decision involved outsized facts and personalities, there are some key takeaways to keep in mind when considering executive compensation as well as board conflicts generally. 

As an initial matter, this case signals a potential for increased scrutiny on CEO and executive compensation. While ordinarily reviewed under the deferential business judgment standard, compensation plans for CEOs or executives with large shareholdings, deep relationships with the board, a “celebrity” personality, or other “X factors” may prompt entire fairness review—or even the threat of entire fairness review. The Delaware Court of Chancery’s 200-page decision is an important reminder that entire fairness is a highly factual analysis that considers both process and price and that litigation under this standard is often protracted and expensive. That said, this case provides some important guidance on steps that companies can take to help protect executive compensation decisions, especially when any of these risk factors exist. Among other things, companies should consider: 

• The independence of the compensation committee or other board group making executive compensation decisions, and whether any of the directors involved have close or disabling ties to the executives;
• Whether to exclude the executives from board-level discussions about the terms of new compensation plans;
• Who originates the initial proposal on compensation, and what role the executives should have in developing that initial proposal;
• Whether the directors are determining the price and terms of compensation and not simply adopting an executive’s terms without consideration and negotiation; 
• Whether any board discussions with executives over the price and other terms of their compensation are conducted at arm’s length, and whether there are meaningful concessions or give-and-take by both parties if there is a negotiation;
• Whether the value of the compensation is fair to shareholders, and whether the board could secure the continued leadership of the executive for a price that is more fair;
• Whether to engage independent compensation consultants and obtain benchmarking or other analyses of the potential compensation plan to determine how the compensation package compares to other similarly situated companies and executives; and
• Whether a sufficient conflict exists such that the compensation ought to be approved by a majority of the disinterested stockholders and, if so, whether the existence of the conflicts and process are adequately disclosed.

More broadly, the case also reconfirms that director independence is fact-intensive. Delaware courts will carefully scrutinize both business and personal relationships between purported controlling stockholders and the company’s directors. When determining independence: 

• Courts will consider whether personal ties such as vacationing together and attending family weddings or birthday parties, when coupled with extensive business connections, may undercut director independence.
• Director compensation, when it provides “life-changing” money to independent directors, may also undermine director independence.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.