Saturday, March 31, 2018
Tesla Case Reveals the Poverty of Our Definition of a Controlling Stockholder
Another week, another Delaware Chancery decision in which a powerful, visionary minority blockholder is deemed to have “control” over a corporate board’s decision to acquire a company in which he has an interest.
In In re Oracle Corporation Derivative Litigation, which I blogged about last week, Larry Ellison’s control was enough to show that demand was excused for the purpose of a derivative lawsuit, while the court avoided the question whether Ellison should be formally deemed a controlling stockholder.
In In re Tesla Motors Stockholder Litigation, however, the question could not be avoided. That’s because – unlike in Oracle – the remaining stockholders voted in favor of the acquisition, which led the defendants to argue that the entire deal had been cleansed under Corwin v. KKR Financial Holdings LLC. Since Corwin does not apply to controlling stockholder transactions, Elon Musk’s status became critical.
Briefly, Elon Musk is the Chair, CEO, largest stockholder (22% at the time of the acquisition), and dominant face of Tesla. He was also one of the founders of SolarCity, along with his cousins. When SolarCity neared bankruptcy, Tesla acquired SolarCity at a significant premium to its market price. Though Musk formally recused himself from the Tesla board’s vote, he badgered the board into considering the acquisition (proposing it on three separate occasions within three months), hired the board’s financial and legal advisors, and ran the deal process. Meanwhile, the board voted to approve the deal without forming a special committee. (Sidebar: If the documents are made available under Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, I cannot wait to find out what Wachtell – the board’s deal advisor – had to say about that.) Tesla shareholders sued, alleging that the transaction was a bailout of Musk’s company, paid for with Tesla’s assets.
The court, per VC Slights, concluded that, at least for pleading purposes, plaintiffs had alleged that Musk was a controlling shareholder. Slights rested his decision on Musk’s status as a visionary CEO, his substantial stockholdings, his close business and personal ties to Tesla board members who earned multi-million dollar salaries for their service, his domination of the process which led to the acquisition, the board members’ own ties to SolarCity, and SolarCity’s precarious financial position.
Slights recognized the awkwardness of his holding when compared with the Delaware Supreme Court’s recent conclusion in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd that Michael Dell was not a controlling stockholder of the company that bore his name. Nonetheless, he justified his conclusion on the ground that the buyout in Dell involved several procedural protections (including the use of an independent special committee and Michael Dell’s pledge to cooperate with any buyer) that the Tesla board’s decision lacked.
But that reasoning collapses two separate ideas: whether someone has controlling shareholder status, which requires them to utilize heightened procedural protections to win business judgment deference, and whether a controlling stockholder has, in fact, employed such protections.
What both Tesla and Oracle really illustrate, then, is the inadequacy of pinning the level of judicial scrutiny to a bright line distinction between controlling and noncontrolling stockholder status in the first place. Yes, Musk was a large stockholder, but his stockholdings were the least important mechanism by which he dominated the board (and potentially influenced voting stockholders as well). We can call this yet more Corwin fall out: by heightening the significance of the stockholder vote only for transactions that fall into a specific category, the Delaware Supreme Court wound up placing pressure on the boundaries of that category.
What also stands out about the Tesla opinion – as with Oracle before it – is Delaware’s continued willingness to cast a gimlet eye on the webs of social and business relationships (especially with venture capital firms) that often tie boards together, particularly in tech companies. This is a point that Chief Justice Strine has been pushing, most recently at Tulane’s Corporate Law Institute, and what we are apparently seeing is that such relationships may not only evince a lack of independence, but may even count toward controlling shareholder status, as courts try to grapple with Corwin’s constraints.
Hi, Joan - glad you liked the post! Yes, you're right that the inquiry has always been "shareholding-plus" - which was the court's reasoning as well. The problem is, at what point is the "plus" doing all the work? Because we're now getting close to that point, and if/when we do, should the inquiry be just "controller" minus the stockholder part? The significance of stockholding, as I understand it, is supposed be that there is no way for shareholders to oust that person, if they want to; should the inquiry be more nuanced? Those are the kinds of questions that come to my mind.
Posted by: Ann | Apr 5, 2018 5:43:27 AM
Nice, yes. I quite agree. Thanks for these additional thoughts. I may later want to pick up on this issue from a different angle in teaching or writing. You will be at the top of my list for bouncing off some ideas!
Posted by: joanheminway | Apr 5, 2018 5:49:07 AM
Ann, it's been a long time since I have done a controlling shareholder analysis for purposes of giving legal advice or otherwise. But the concept has always involved a "shareholdings plus" analysis, in my experience. So, this sentence (if I understand it correctly) seems inconsequential: "Yes, Musk was a large stockholder, but his stockholdings were the least important mechanism by which he dominated the board (and potentially influenced voting stockholders as well)." Am I missing something?
Having said that, I totally agree with your main points. Pressure is put on the definition of "controlling shareholder" by the Corwin case. And the results of a "controlling shareholder" analysis are not always clear, since control is in the eye of the beholder based on the facts marshaled.
Posted by: joanheminway | Apr 5, 2018 5:17:45 AM