Elon Musk can cash the largest paycheck in history, the Supreme Court of Delaware has ruled in a narrow and sensible opinion grounded in longstanding principles of equity and contract law.
To catch up: Tesla and Musk entered into an employment contract in 2018, when the company’s market capitalization was about $50 billion. The deal, in rough terms, was that Musk would receive stock options if the value of the company doubled to $100 billion under his watch. He would then receive an additional tranche of options for each $50 billion increase in market value thereafter, up to a maximum payout on the order of $60 billion if Tesla reached a market capitalization of $650 billion within 10 years.
Sure enough, Tesla got there – in much less than a decade – and Musk sought to collect.
Before he could get his hands on the options, however, a shareholder sued Musk and the Tesla directors who approved the plan, arguing that it was contrary to the corporate interest. After all, Musk already owned roughly 20% of the company, giving him substantial incentives to increase Tesla’s stock price regardless. The Delaware Court of Chancery agreed, concluding that the board’s process was compromised and that the deal was unfair to Tesla, and it ordered the contract rescinded.
Musk and the directors appealed to the Supreme Court of Delaware, which took no position on the merits, but unanimously reversed the order of rescission.
Rescission is an equitable remedy that allows a contract to be torn up and the parties sent back to their corners – a return to the status quo ante – and it was the exclusive remedy sought by the plaintiff. Yet rescission ought not to be ordered, explained the state Supreme Court, when it is impracticable or impossible to return the parties to the status quo ante. Plus, there is an equitable element to rescission, and the “party seeking rescission cannot be permitted to derive all possible benefits from the transaction and then, when he is called upon to comply with its terms, claim to be relieved of his obligation.”
Here, it was “undisputed that Musk fully performed . . . and Tesla and its stockholders were rewarded for his work” – the stock price rose more than 1,000%. Who would want to undo that outcome? Moreover, rescission would be “inequitable” in this case because it would leave Musk “uncompensated for his time and efforts over a period of six years.” On those grounds, the Supreme Court held that rescission was unavailable.
The Supreme Court acknowledged that Musk’s pre-existing equity stake provided him with powerful incentives but invoked a basic rule of contract law: past consideration is not consideration. As the court put it, “Musk’s prior compensation arrangements cannot solve the problem of awarding a remedy [rescission] which deprives him of all compensation that he earned for six years under a new contract.”
Andrew A. Schwartz is Laurence W. DeMuth Chair of Business Law at the University of Colorado Law School.