Elon Musk vs Delaware battle puts spotlight on value of shareholder votes

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Elon Musk’s seemingly unbreakable bond with Tesla shareholders may be his superpower. That special relationship may very well be compelling enough to get him his $56bn pay deal which was rejected by the Delaware Court of Chancery for a second time last week. 

Musk has easily won two votes over the pay package, the second time this June even after an original scathing ruling in February from a trial court that held the Tesla board process around the original 2018 approval was tainted. Tesla’s board has insisted that those successful votes cure any corporate governance defects. Vox Populi, Vox Dei indeed, as inscribed on a cake Musk said he was sending to the Delaware courts as a “parting gift”, reminding them that “the voice of the people is the voice of the gods”. Love him or hate him, Musk has offered Tesla shareholders a voice, even if the Delaware judiciary is unimpressed so far with those efforts.

Elon is, however, an increasingly rare proponent of shareholder democracy at big public companies with dominant shareholders. In another high-profile situation this year, Hollywood group Paramount decided that shareholders not affiliated with the Redstone family would not get the chance to weigh in on a merger with studio Skydance Media — the deal approval could close with the control stock the family held. Shareholders of Endeavor similarly got no vote in this year’s go-private deal led by Silver Lake and Ari Emanuel. In both cases, the companies said independent directors negotiated a fair deal for minority shareholders. But undoubtedly some of those shareholders will sue, claiming the directors sold the company too cheaply in a sweetheart deal and that their denial of a vote is evidence of bad faith.

For years, companies successfully used the shield of successful shareholder votes to win such lawsuits. But the votes for most companies prove nail-biters that generate painful shareholder litigation anyway. And more importantly, the companies that eschew votes in order to force through deals quickly are increasingly winning in Delaware’s court, anyway.

Paul Graham and Cathie Wood were among the prominent investors who last week complained that Delaware judges were inappropriately intruding on the prerogatives of shareholders and boards, citing the latest Musk pay decision. In fact, corporate law is quite hands-off on corporate decision-making.

The exception to that deference arises when there are companies with directors beholden to dominant shareholders — thus putting smaller shareholders at risk of being steamrollered. Self-interested transactions, like “squeeze-out mergers” where minority shareholders can be forced to sell, had long been subjected to tough judicial scrutiny, arising from the inherent risk of coerced deal terms.

But a decade ago, the billionaire Ron Perleman had an idea. When buying out minority shareholders in his conglomerate, Perleman first let independent directors set the deal terms and then the minority shareholders vote up or down on the deal. After that was approved by the Delaware Supreme Court, this has been a way to conduct transactions with dominant shareholders.

For the canny plaintiffs lawyers who sue companies, the game since has been to show the directors are not really independent or find some fact from the negotiations that was excluded from the proxy filing sent to shareholders before the vote. At the same time, hedge funds can buy up shares to muck up the vote in the hopes of securing a price bump.

However, more recently, companies have shifted course after Delaware courts let conflicted transactions that lacked shareholder protections, go forward without penalty. One case involved Howard Lutnick, the billionaire Donald Trump ally. “Lately many controllers have decided not to take advantage of the shareholder vote, preferring to take the risk of judicial review,” said Dorothy Lund, a law professor at Columbia University. 

One other big winner in recent years from that trend? None other than Musk. Dissident shareholders had challenged Tesla’s 2016 buyout of SolarCity, another Musk company, alleging it was a bailout of a company that was approaching bankruptcy. The Delaware judge in the case harshly criticised the independence of the Tesla board. But ultimately, he decided that the price paid was reasonable and that Tesla and Musk should face no sanction. 

For all of the recent complaints Musk and friends have about Delaware, plenty of messy controller deals are surviving intense legal challenges. In the current pay deal fight, Musk has tried harder than many other tycoons to be friendly towards shareholders. There is a decent chance that is going to pay off for him when the Delaware Supreme Court considers his appeal.

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