On October 15, the Delaware Supreme Court heard arguments in In re Tesla, Inc. Derivative Litigation, more commonly known as Richard J. Tornetta v. Elon Musk, et al. and Tesla, Inc., the stockholder derivative action rescinding Elon Musk’s $55 billion pay package. On appeal are two separate decisions by Chancellor Kathaleen St. Jude McCormick: the post-trial decision rescinding the pay package and a subsequent decision denying Tesla’s request to revise the post-trial decision after a second stockholder vote and granting $345 million in attorneys’ fees to the plaintiff’s counsel.

Eight questions were raised by three groups of appellants — the director defendants, Tesla itself, and two objectors who sought to intervene in the case below and the appeal – most of which focused on whether the Court of Chancery properly applied the entire fairness standard of review to the decision to grant the pay package, whether that transaction was actually unfair, whether ratification was a viable legal path, and whether rescission was the appropriate remedy.

Without making divination-based predictions, we would argue that complete reversal of either decision seems unlikely. The trial record paints a damning picture of the defendants where they willingly abdicated much of their control to a man who was their long-time friend, former client, or even brother.

How We Got Here

In Tornetta v. Musk, Chancellor McCormick concluded that Musk exercised control over the board during negotiations. At trial, witnesses testified that they considered themselves as “not on different sides of things” than Musk, that the process was “cooperative” with Musk, and that there was no “positional negotiation.” The court found that Musk “dictated the timing of the process [and] ma[de] last-minute changes to the timeline or altering substantive terms” and the transaction was a conflicted-controller transaction.

Musk’s status as a controller led the court to apply Delaware’s stringent entire fairness standard of review, under which the burden shifts to defendants to affirmatively prove that the transaction was fair in both process and price, unless the transaction was approved by a fully informed vote of the majority of the minority stockholders. The chancellor concluded that a 2018 vote by Tesla stockholders approving the package was not fully informed because it failed to disclose the same conflicts of interest that resulted in Musk being deemed a controller during negotiations.

After the post-trial decision, Tesla held a vote in June 2024 purportedly attempting to restore the package through a fully informed vote, going so far as to include the post-trial decision attached to the proxy. When this vote approved the package again, Tesla moved to revise the post-trial decision. The chancellor denied this request, finding that the defendants offered no procedural or precedential grounds for reversing a post-trial decision based on evidence created after trial and that, even if there were such a basis, the subsequent vote still involved “multiple material misstatements” and did not cleanse the defects from the 2018 vote.

The Arguments on Appeal

At arguments, the defendants focused on both the control finding and the recission remedy, arguing that there was insufficient evidence of Musk’s control to apply the entire fairness standard and that, even if there were, rescission would not be the appropriate remedy – given that Tesla has benefitted from Musk’s six years of work and that Tesla achieved all of the performance metrics necessary for issuing the grant in full. For control, the defendants pointed to a previous derivative action about an acquisition that benefitted Musk and nonetheless survived under entire fairness review. There, the Court of Chancery determined, despite an assumption that Musk was a controller, Tesla’s board operated independently. The defendants argued that the 2018 vote was fully informed and was sufficient to return the standard of review to business judgment and that the 2024 vote was “likely the most informed stockholder vote in Delaware history.”

The plaintiff, in response, argued that the entire fairness standard was appropriately applied based on an enormous record showing Musk’s exercise of control. The plaintiff also argued that rescission was appropriate, and any alternative remedy would have had to have been raised by defendants below. They did not offer one and therefore waived these arguments. As for attorneys’ fees, counsel noted that despite this being the largest award in Delaware history, it represented 0.6 percent of the benefit derived from rescission.

Chief Justice Collin Seitz and Justice Gary Traynor pushed defense counsel on the issue of transaction-specific control, with the chief justice going so far as to pointedly ask: “It’s pretty clear from the record that you did not argue that transaction specific control was not a viable theory in the Court of Chancery, correct? . . . [W]here did you preserve that other than some general statement about “he was not a controller?””

Justice Karen Valihura asked counsel for both sides whether they could identify a case where “a court has equitably rescinded an executive’s compensation after years of work,” and seemingly disagreed that the plaintiff’s cited case, Valeant Pharmaceuticals International v. Adam Jerney, sufficiently answered her question, prompting a debate on the difference between rescission as a remedy and disgorgement. She noted that the Court of Chancery said “it had no record before it” to provide any remedy other than rescission and that if the Supreme Court concluded rescission was not appropriate, nominal damages might be the only thing left for the plaintiff, given that “equity isn’t a license to make stuff up.”

Justice Abigail LeGrow also asked whether Musk had an argument under quantum meruit if the Supreme Court affirmed the chancellor’s decisions below and whether the justice should consider this point when determining if full rescission was appropriate.

SB21 and What to Expect

While the Supreme Court’s decision is not expected soon, Delaware has already responded to criticism of the chancellor’s decisions. In March, the Delaware General Assembly passed Senate Bill 21, amending Section 144 of the DGCL to limit the definition of controller and make it easier for boards to escape entire fairness review in the now strictly-limited circumstances where a controller can be found to exist. Under the new definition, Musk would have been statutorily precluded from being considered a controller, and entire fairness would likely not have been on the table. These changes are also being challenged constitutionally, with arguments set for November 5 before the justices.

As warned in “Delaware Beware” and “Incorporating Unicorns,” Delaware’s brand of corporate law – once synonymous with stability – now risks becoming a victim of its own success. The Tesla litigation is not just about one pay package. It’s a referendum on whether Delaware’s system still commands the trust of its most dynamic companies.

Of course, regardless of the outcome here, it may all be academic. Tesla, at Musk’s urging, reincorporated to Texas in June and has already publicly stated that it intends to restore the pay package under a separate compensation plan if the appeal is unsuccessful. And that’s even before the company considers its new proposed pay plan which could make Musk the world’s first trillionaire. $55 billion may shortly become pocket change for the world’s richest man.

This post comes to us from Anat Alon-Beck, John Livingstone, and Sophia Fisher at Case Western Reserve University School of Law.