Saturday, May 7, 2022
Tesla and Delaware
As everyone knows by now, in In re Tesla Motors Stockholder Litigation, VC Slights refrained from engaging all the meaty doctrinal issues. He did not decide whether Elon Musk is a controlling shareholder of Tesla; he refused even to decide whether a “controller” is a different thing than a “controlling shareholder,” see Op. at 81 n.377. He didn’t decide whether the Board was majority independent, going so far as to raise the possibility that even a board that operates under serious conflicts may nonetheless “prove” their independence at trial, see Op. at 81 n.378. He did not decide whether passive investors’ stakes on both sides of a merger may render them not disinterested for cleansing purposes, see Op. at 63 n.311. Instead, he found it easier to conclude that Tesla’s acquisition of SolarCity was entirely fair, rather than engage with all the thorny legal questions the case raised.
That was sort of a surprise (though you can’t help but wonder how much of that was hindsight, see Op. at 126-27). Yet in many respects, it was ultimately a very Delaware sort of decision.
It has long been observed that while liability is rarely imposed on Delaware fiduciaries, the Delaware judicial system has its own method of discipline, namely, through reputational sanctions. Ed Rock described this phenomenon in Saints and Sinners: How Does Delaware Corporate Law Work?; as he tells it, Delaware decisions are parables of good managers and bad managers, and operate as a kind of “public shaming” for those who violate these norms. See also Omari S. Simmons, Branding the Small Wonder: Delaware’s Dominance and the Market for Corporate Law (discussing the Disney case; “even where a decision does not result in liability for board members, embarrassing details of corporate dysfunction may tarnish a company's reputation. Reputational risk is another salient reason for boardrooms to pay attention to Delaware court pronouncements.”).
That’s not a bad description of the Tesla decision. Though VC Slights had apparently a great deal of admiration for Elon Musk’s strategic vision and business expertise, he also offered harsh criticism over Tesla’s refusal to adopt an independent process for negotiating the deal. See Op. at 86-87. He even explicitly acknowledged Delaware law as functioning through parable, see id., and, as punishment for the board’s laxity, he refused to award Musk costs. See Op. at 131. These criticisms should strike fear into the hearts of corporate managers (or their insurers) everywhere: all of these litigation expenses, from the motion to dismiss through discovery through summary judgment to trial, could have been avoided had the Tesla board simply adopted cleansing measures from the outset. And that’s supposed to be the takeaway for future boards.
But will that work?
In his article, Ed Rock acknowledged that celebrity managers might not care about Delaware’s opprobrium, not when they stand to earn riches by ignoring it. Instead, he pointed out that most public corporations have a bureaucratic set of directors, who will be responsive to Delaware’s censure even when particular managers are not. As he put it:
MBOs, overnight, provided the opportunity for the senior managers to become very rich, to go from being bureaucrats to entrepreneurs . Under such circumstances , one can expect that some managers might rather quickly become indifferent to the criticism of the judges. The possibility of becoming seriously rich sometimes has that effect.
How did the courts respond? In the MBO cases, one sees a subtle shift of attention from the managers to the special committee. Although the potential gains to managers in MBOs might lead them to develop resistance to the deterrent effect of public shaming, the members of the special committee had no such prospects. They were not getting rich. They were simply trying to do their best as outside directors. One would predict that such actors are likely to be far more susceptible to the kind of influence that Delaware opinions exert than the managers. The Delaware courts, perhaps sensing this, focused much of their attention-both in the opinions and in extrajudicial utterances-on influencing the conduct of the special committees.
Note, now, a surprising implication of this analysis. If the success of Delaware's method for constraining or encouraging managers to act on behalf of shareholders depends critically on a separation of ownership and control , with the greater susceptibility to reputational effects that agents have in comparison to principals, then the system is likely to be less suitable for corporations not characterized by this separation, such as closely held corporations.
If that’s right, Tesla – and Elon Musk – are particularly poorly suited for the “Delaware way.” Not only is Musk himself indifferent to Delaware’s criticism, but his public board – stacked with allies and close associates – is structured very much like his private ones, making it more akin to the structure of a closely-held company. See, for example, this New York Times article about how Musk retains tight control over his companies, including by populating boards and managerial positions with his allies.
One could obviously argue that in the end, it hardly matters so long as Musk is benefitting his shareholders. But leaving aside the problem of counterfactuals (what if a more independent board would have improved shareholder returns even more?) another possibility is that other CEOs take Musk as a role model – especially in a time when companies are staying private for longer, as founders are feted as auteurs, as most IPOs feature dual-class stock, as even ostensibly “independent” directors are compensated with millions of dollars’ worth of stock – and not all of these stories will end happily for shareholders. There is a real question whether Musk is simply an outlier, or whether the model public company on which the Delaware ethos is built is transforming into a different kind of institution that requires different policing.
Such a great question at the end of this post--something to truly watch. I have worked with public company boards that are led and controlled in a way similar to the Tesla board as publicly described. A specific one comes to mind. But they were rare and not led by celebrities/public figures. It strikes me that is an important component here. Musk's actions are so public and so much more of an attractive nuisance. They may, indeed, be sufficient to change the regulatory reaction. Time will tell.
Posted by: joanheminway | May 9, 2022 7:43:05 AM