You'll never guess what today's blog post is about

Maybe this is a time when other news has overtaken corporate governance disputes, but governance disputes are we do here, so.

Also, what obviously has my attention right now are two issues: the upcoming Tesla vote on Musk’s pay and redomestication to Texas, and the proposed amendments to the DGCL.  This blog post is a couple of quick notes about both.

On the Tesla vote.

I previously blogged that a good argument could be made that restoring Musk’s pay package now offers no economic benefit to Tesla, and therefore would fall into the legal category of waste – which, under current doctrine (even if subject to challenge in the modern era) would require unanimous shareholder approval.  At the time, I offered the reservation that, from a practical perspective, waste would be difficult to litigate (and yes, if shareholders vote in favor, the effect of the vote will absolutely be litigated, by Tornetta, the current plaintiff, if no one else).  That’s because a court might be hesitant to hold that major institutional shareholders – with a fiduciary duty to maximize value for their beneficiaries – would cast an economically irrational vote.  From there, the court might reason backward and conclude that it couldn’t possibly be economic waste.

I also offered a rejoinder – namely, institutions might vote to approve the package because they were “coerced,” perhaps due to Musk’s threats to develop AI in his private businesses rather than Tesla (which he is using Tesla data to do).  But in my post, I treated that as a difficult argument to make, given that there was no suggestion of a threat in the proxy; the plaintiff would have to reach back to those earlier comments by Musk and ask a court to draw the inference that they were still influencing shareholders in June.

And then, of course, Musk couldn’t quite stay off ex-Twitter and he reaffirmed the threat, which Tesla was then forced to file as proxy solicitation material.  He also hinted at it during an earnings call before stopping himself, which was also filed as solicitation material, and Musk boosters are making the point pretty explicitly on social media:

And all the reporting mentions the threat to develop AI outside of Tesla, so, now, it’s much easier for the plaintiff to argue that any shareholder vote in favor of Musk’s pay is coerced, and therefore without ratifying effect.  It works in tandem with the waste argument, even though they’re also alternatives – why did shareholders vote for waste? Coercion.  How do we know it was coercive?  Because of the lack of (legitimate) economic value for Tesla.  Etc.

And then there’s Texas. I think it would be difficult, legally, for shareholders to challenge reincorporation to Texas as somehow damaging to their rights; leaving aside the uncertain status of TripAdvisor, Texas’s law is similar to Delaware’s, and so formally, reincorporation doesn’t present the same specter of self-dealing.  (I’m not saying no one’s gonna try, who knows what those wacky shareholders might do).  And Tornetta’s legal team probably is going to stay focused on the pay package rather than the Texas issue (except to the extent they’re worried a reincorporation in Texas means a new lawsuit will be filed there that’s res judicata in Delaware).

Nonetheless, the attempt at reincorporation now adds color to the pay dispute.  Because yes, of course, Tesla’s proxy statement makes clear, the states have a lot of formal similarities in their laws.  And academics debate whether there’s any real benefit to incorporating in Delaware, and it might be reasonable for a startup entrepreneur setting up a new company headquartered in Texas to choose Texas as its chartering state.  But Tesla is not a new company – it’s an established public company that has already been operating according to (well, not according to) Delaware law for a while, now contemplating an expensive switch – involving special committee payments, advisors, hours, and expert analysis, not to mention vote whipping – for benefits that even the company itself claims largely are about branding. 

Even then, if Tesla were doing this on a clear day, then, you know, shrug. 

But it’s not a clear day, it’s in the wake of two high profile losses for Tesla – the Tornetta decision, and the earlier settlement over director pay – and one personal one for Musk, namely the Twitter case (which he dropped, because he knew he would lose), and comes only after Musk tweeted his declaration that Tesla would reincorporate in Texas, reincorporated his other companies out of Delaware, and tweeted that he would not acquire Delaware companies.  In the midst of several tweets about Delaware’s perfidy, he even urged other companies to leave.  Given that context – not to mention Chancellor McCormick’s previous findings regarding the Board’s deference to Musk – there is certainly cause to doubt that the Board, or the special committee, was entirely forthcoming about its reasons, and acting entirely in good faith, when insisting that Tesla should move to Texas right now because Tesla is “all-in on Texas,” and not at all acting on Musk’s personal ire.  Which is apparently what ISS said in its proxy recommendation – I don’t have access to the report itself, but it noted that, while the move itself was unobjectionable, “the process undertaken by the board to reach a decision . . . does leave something to be desired.”  And certainly outside observers read the move as an attempt to free the board to give Musk as much compensation as he wants.

And if that’s right – that no matter how thorough the proxy statement is about describing the Board’s reasoning and the special committee’s diligence, it’s impossible to escape the doubts raised by the context in which this is occurring – then even if the Texas proposal is not directly challenged by Tornetta, the fact of its existence supports the argument that all of the Board – including the special committee – is beholden to Musk.  Therefore, none of the Board’s actions – including the recommendation that the pay package be restored – can be trusted.

Point being, it adds heft to any legal challenges to the pay vote.

BUT!!  Given that it is, frankly, politically awkward for one state – Delaware – to claim there’s anything wrong with incorporating in another state, I wouldn’t be surprised if Chancellor McCormick didn’t want to engage with the Texas issue directly.  But it could still affect her thinking (and the thinking of the Delaware Supreme Court on appeal).

On Proposed Amendments to Delaware Law

Prior posts in reverse chronological order here, here, here, and here.

VC Laster has been active on LinkedIn, highlighting various ambiguities in the proposed DGCL 122(18).  But he’s doing more than poasting; in Columbia Pipeline Merger Group Litigation and in Wagner v. BRP Group, Inc., his legal reasoning reads as a direct challenge to the synopsis to those amendments, by demonstrating the fiduciary “outs” they propose are ephemeral.

For example, the DGCL 122(18) synopsis says:

even the enforceability of a claim for money damages for breach of the covenant may be subject to equitable review, and related equitable limitations, if the making or performance of the contract constitutes a breach of fiduciary duty…

New § 122(18) does not relieve any directors, officers or stockholders of any fiduciary duties they owe to the corporation or its stockholders, including … with respect to deciding whether to perform, or cause the corporation to perform, or to breach, the contract, whether in connection with their management of the corporation’s business and affairs in the ordinary course or their approval of extraordinary transactions, such as a sale of the corporation

However, in both Columbia Pipeline and BRP, Laster extensively discusses how fiduciary obligations cannot require corporations to break contracts, or free them of consequences (including damages or equitable remedies) when they do so.  The synopsis suggests contracts might be set aside when directors’ actions are reviewed under “enhanced scrutiny”; Laster takes that one on as well in both cases, concluding that it’s a misreading of Paramount Commc’ns Inc. v. QVC Network Inc., 637 A.2d 34 (Del. 1994).

Additionally, the synopsis says:

New § 122(18) does not relieve any directors, officers or stockholders of any fiduciary duties they owe to the corporation or its stockholders, including with respect to deciding to cause the corporation to enter into a contract with a stockholder or beneficial owner of stock….

In BRP, Laster highlights that fiduciary duties are only owed to current – not future – shareholders.  Which means, if fiduciary obligations are the only thing that protects shareholders when boards adopt these contracts, anyone who was not a shareholder at the time of contracting will have no claim.  In practical effect, a contract adopted pre-IPO could not be challenged by public stockholders.

Additionally, in Moelis, Laster held that the improper provisions of a stockholder agreement might be replicated via a preferred share issuance, though reserving the question just how far preferred shares might go.  In BRP, he elaborated on that point, arguing that some restrictions on board authority must be contained in the charter “proper,” and cannot even be included in preferred shares.  As he put it:

A counterparty also would not be able to secure covenants that bind the board through a preferred stock issuance. A certificate of designations can set forth “the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions” of the class or series of stock that the board authorizes using blank check authority. 8 Del. C. § 102(a)(4). That list of features does not include imposing covenants on the board. To constrain or mandate action by the board under Section 141(a) requires a charter provision directed to the board, not a charter provision limited to the “the designations and the powers, preferences and rights, and the qualifications, limitations or restrictions” of a class or series of shares.  That type of provision could appear in the original charter. It also could be implemented through charter amendment duly approved under Section 242, or through a merger or comparable transaction where the DGCL authorizes amendments to the charter of the surviving corporation. A covenant binding the board could not be imposed through a certificate of designations. Under current law, it also cannot be imposed through a governance agreement.

Proposed DGCL 122(18) would authorize contracts that:

covenant that the corporation or one or more persons or bodies will take, or refrain from taking, actions specified in the contract

The implication being, DGCL 122(18) would authorize contracts that go further than what could be accomplished in a preferred share issuance.  Assuming that’s right, it just further demonstrates how DGCL 122(18) would more than authorize governance contracts, but actually encourage a shift of governance from the corporate form and into personal contracts.