The Delaware Court of Chancery’s April 27 Tesla Motors opinion likens some decisions to “parables”—stories that illustrate important lessons. In the words of presiding Vice Chancellor Joseph R. Slights III, the story of Tesla Motors’ 2016 acquisition of one of Elon Musk’s other companies, SolarCity Corp., is one of “unnecessary peril” from a corporate governance perspective.
However, the court ruled that the $2.6 billion acquisition of the struggling solar power provider SolarCity was fair to Tesla and its stockholders.
But as with all good parables, there are lessons to be learned from the decision.
Financial Fairness Remains the North Star
With Musk on both sides of a transaction that also benefited his relatives, and with objective reasons to doubt that a majority of the Tesla board could exercise independent business judgment, the court was highly critical of Tesla’s decision—unexplained at trial—not to delegate the negotiation and approval of the transaction to a special committee of independent directors.
Assuming that Musk was the controlling stockholder with respect to the transaction, such delegation would have permitted deferential business judgment rule—and a potential early dismissal. That would have saved Tesla, its directors, its stockholders, and other stakeholders, the time, cost, and distraction of a half-decade litigation saga attacking the bona fides of the company’s visionary founder.
The viability of a special committee seemed apparent given that, as discussed below, the court found that the Tesla board generally was well-motivated and able to pursue Tesla’s best interests.
That said, the decision illustrates that a defendant may satisfy the entire fairness standard of review even in circumstances involving a “far from perfect” process.
While the court considers both fair dealing and fair price, despite process flaws, the court may uphold a transaction that is financially fair and therefore results in no harm. That is, the finding that a transaction is financially fair often leads a court to conclude that potential process infirmities did not prevent the board from negotiating a fair transaction.
As the court reasoned, this transaction “had both flaws and redeeming qualities. The linchpin of this case, though, is that Musk proved that the price Tesla paid for SolarCity was fair—and a patently fair price ultimately carries the day.”
Market Indicators Supported Financial Fairness
In so ruling, the court followed recent Delaware decisions that valuations derived from a sufficiently reliable trading market are preferred over experts’ analyses formed in the crucible of litigation. The court followed that precedent in rejecting the plaintiffs’ “all-in” bet that the court would find that SolarCity was insolvent and valueless.
SolarCity was experiencing a liquidity crisis from its business model, which prioritized product development, acquiring market share, and achieving scale—with debt financing—in a long game to become the market leader in a critical industry. But this information was well-known to the investing public, which still valued SolarCity’s equity with a roughly $2.6 billion market capitalization prior to the transaction.
Moreover, contemporaneous documents showed Tesla anticipated synergies above the premium to market that it was prepared to pay. In light of indicia that SolarCity was a valuable, albeit cash-strapped company, the court found plaintiffs’ damages presentation “incredible on its face.”
The court thus found that Tesla “paid a fair price—SolarCity was, at a minimum, worth what Tesla paid for it, and the Acquisition otherwise was highly beneficial to Tesla.”
Independence in Fact Matters
Based on two weeks of trial, the court also concluded that, regardless of objective conflicts of interest, Tesla’s directors—other than Musk—were in fact subjectively well-motivated and pursued Tesla’s best interests. Although Musk “inexplicably was given the opportunity to attempt to influence” the board’s process, he did not dominate it.
In fact, the other directors rejected his proposals throughout the acquisition process. In response, Musk “did not push back against them—there were no threats, fits or fights.” The process also was led by a concededly independent board chair.
The court reasoned that ultimately, “under the direction and influence of a ‘disinterested decisionmaker,’” it was “satisfied that the Tesla fiduciaries placed the interests of Tesla stockholders ahead of their own.” The court also said that each “arguably conflicted director credibly testified (and, in detail explained how) he made his decision consistent with his duty of loyalty.”
This was so despite “facts revealing recognized scenarios where the potential for conflict exists.” (emphasis in original).
Also important was the fact that Tesla engaged an independent financial adviser for the transaction who, free from Musk’s influence, analyzed other potential acquisition opportunities in the same industry, and whose analysis supported that the acquisition price was in the range of, or less than, what would be fair to pay.
After the Fact Vindication, and Proceeding at One’s Own Peril
The court’s decision that the SolarCity acquisition was fair, and thus reflected no breach of fiduciary duty, was fact specific.
In a less certain case, the court may rule differently. In this case, however, years of litigation efforts culminated in an evidentiary record that caused the court to render a favorable judgment, pending any motions for reconsideration or appeals.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Lewis H. Lazarus is a partner at Morris James LLP in Wilmington, Del., and focuses on corporate governance and commercial matters in the Delaware Court of Chancery.
K. Tyler O’Connell is a partner at Morris James LLP and represents companies, members of management, and investors in business disputes before the Delaware courts.