On January 30, 2024, the Delaware Court of Chancery struck down Tesla CEO Elon Musk’s $55 billion performance-based stock option package, ruling that Tesla’s directors did not satisfy the stringent “entire fairness” standard in approving his compensation. This case comes on the heels of a $735 million settlement in which Tesla directors disgorged previously-received compensation following shareholder claims of unjust enrichment and breach of fiduciary duty.[1] The court applied the entire fairness standard because of Musk’s enormous control over the transaction, referring to him as a “Superstar CEO”[2] who wielded maximum possible influence over the board. While the compensation package was approved by a majority of disinterested shareholders, the court concluded proxy disclosure was deficient and therefore shareholders were not fully informed.[3] Ultimately, the Tesla board was not able to prove the benefit received from Musk’s leadership was worth the $55 billion Tesla paid for it.

This case voids the largest compensation package in corporate America, yet will likely prove exceptional for a number of reasons. In her opinion, Chancellor McCormick was unabashedly critical of Tesla’s board, highlighting with pointed language their repeated failures to properly approve Musk’s compensation. The Tesla board fell short on many – seemingly, all – levels: directors were not independent, their process was flawed in terms of timeline, negotiation etiquette, and a failure to conduct appropriate benchmarking, they did not fully inform their shareholders, and did not properly justify the scope of Musk’s staggering compensation. Chancellor McCormick’s opinion, rehashing each of these errors, reads as a guidebook for how not to approve executive compensation. In this article we will highlight key takeaways from the decision and draw contrast to standard practice for Delaware public companies. While the prospect of a judge overturning the business discretion of a board and compromising the retention and incentive structure of key leadership is understandably alarming, we hope to show the extreme circumstances specific to Tesla that prompted this result. Delaware issuers should take comfort that McCormick is not setting a new standard of corporate governance; she is holding one issuer accountable for woeful failures.

Board independence: At its core, Tornetta v. Musk reflects the power of shareholders to challenge the actions of an interested board and controlling stockholder. Had truly independent and disinterested directors granted a non-controlling stockholder a $55 billion compensation package, their decision would have been protected by the “business judgment rule” and legal challenge would largely be limited to assessing the approval process, not the resulting substance. [4] While independent and disinterested board or committee approval alone would not have been sufficient in Tornetta, it was necessary, and McCormick found it lacking. At Tesla, members of the board had strong business and personal relationships with Musk: members owed their generational wealth to investments made in Musk’s private companies, members vacationed with Musk and were friendly with his extended family, members used their connection to Musk to fundraise for their own businesses resulting in massive profits. One member of the board, Kimbal Musk, was Elon Musk’s brother. The strong ties between Musk and members of the board rendered them beholden to his decision-making and compromised their ability to participate in meaningful negotiation. Tornetta found that Musk had transaction-specific control over the approval of his compensation package, in part because of these relationships with board members. The board also lost its independence through Musk’s broader influence over managerial decisions. Chancellor McCormick notes that the “avalanche of evidence” surrounding Musk’s authority at Tesla is “so overwhelming that it is burdensome to set out in prose.”[5] Tesla and Musk are “intertwined, almost in a Mary Shelley (“You are my creator…”) sort of way.”[6] Musk’s “CEO superstardom,”[7] stemming from his occupation of high-status roles (at relevant times, including CEO, chair, and founder) contributed to this impartiality: “When directors believe a CEO is uniquely critical to the corporation’s mission, even independent actors are likely to be unduly deferential.”[8] This case underscores the importance of maintaining independent directors, especially when it comes to compensation decisions, and especially in the face of such a singularly powerful executive.

Lack of process: The entire fairness test requires a board to engage in “fair dealing”[9] on behalf of the company, which was compromised by the glaring lack of process prior to the approval of Musk’s grant. Chancellor McCormick was disturbed by Musk’s manipulation over the timeline of the approval process, that no true negotiations occurred, and that the board failed to conduct a traditional benchmarking analysis. Initially, Musk proposed a “recklessly fast approach”[10] that would have resulted in approval of his grant within less than three weeks. Though the process ultimately took nine months, the pace was unilaterally set by Musk, who “artificially [compressed] the work into short bursts that took place when he wished to move forward”[11], prompting the court to note “Time spent only matters when well spent.”[12] Musk would often make last-minute proposals prior to board or Compensation Committee meetings, which the court found made it “tough for the committee and its advisors to be prepared.”[13] Beyond the timeline of events leading up to approval, the “negotiations” that took place during that timeline were woefully insufficient. The court found that the board, rather than negotiating against Musk, cooperated with him, working alongside him “almost as an advisory body.”[14] Neither Musk nor the Compensation Committee had independent legal counsel—both seemingly relying on Tesla’s General Counsel in the process. Musk’s initial proposal was the only one seriously considered until Musk’s second proposal, which he unilaterally offered. Musk completely dictated the terms of his grant and faced no pushback as to its size or difficulty of achievement. Musk himself even approved the projections of his grant that would be presented at the meetings, and the Compensation Committee did not include valuations for any other alternatives. Lastly, the board failed to engage an independent compensation consultant or conduct a traditional benchmarking analysis, even though the extraordinary nature of Musk’s grant makes the benchmarking process more critical, not less, because it could have called attention to the orders of magnitude between Musk’s grant and market comparables. By all metrics, Tornetta concluded the Tesla board failed to engage in uncompromised, arms-length negotiations to arrive at Musk’s compensation plan; they operated on Musk’s erratic timeline, participated in a collaborative process that served to advance Musk’s interests ahead of Tesla’s, and included no benchmarking from advisors, as is standard in a negotiation of this nature and magnitude.

Faulty disclosure: In the face of an interested or non-independent board, the board’s discretion will generally prevail if a fully informed and uncoerced vote of disinterested shareholders approves the compensation offered to the controlling stockholder. Although Musk’s compensation package was approved by a majority of disinterested shareholders, Tornetta found that vote ineffective because Tesla failed to disclose the board’s potential conflicts and repeatedly described directors as independent despite their close relationships with Musk. Further, the proxy omitted material information on the process that led to board approval of Musk’s compensation. Shareholders were not told that Musk dictated the timeline, terms of the initial offer, and subsequent changes to the initial offer (as Musk himself admitted, he was “negotiating against [himself]”[15]). The proxy also did not mention the striking lack of negotiation between Musk and the board, and failed to disclose that the board did not engage in traditional benchmarking analyses against peer companies. In cataloguing these issues, Chancellor McCormick highlights that merely disclosing director compensation or director investment in particular entities is insufficient in situations where there are such deep personal ties between board members and executive officers; companies must disclose relevant relationships in the proxy for full transparency. Further, companies must take care to disclose more than the “key terms”[16] of a compensation package when seeking a shareholder vote (i.e., more than economic details). Shareholders are entitled to a full and accurate description of all material steps in the process, including, sometimes, extra disclosure to ensure that the necessary information presented is in no way misleading. A materially deficient proxy simply cannot save an interested board from the court’s scrutiny.

Magnitude of compensation: “An unfathomable sum,”[17] writes Chancellor McCormick in describing Musk’s $55 billion compensation plan, the largest ever observed in the public markets. Musk’s plan was 250 times larger than median peer compensation, and over 33 times larger than his plan’s closet comparison: Musk’s prior compensation plan.[18] The entire fairness test requires a board to negotiate a “fair price”[19] on behalf of the company, which was challenging in light of the magnitude of Musk’s compensation. In justifying this compensation as fair, defendants made numerous arguments – to compare what Tesla “gave” versus what Tesla “got”; that the milestones set were ambitious and difficult to achieve; that the shareholder approval proves the price was fair; and even that the grant was fair because it worked – Tesla thrived during the time of Musk’s enormous grant. Chancellor McCormick devotes ample space to debunking each of these arguments, but ultimately takes issue with two central themes. First, given Musk’s sizeable 21.9% equity stake in Tesla and his public declaration that he had no intent to leave the company, such a large grant was unnecessary to drive his performance and retention; Musk was naturally aligned with shareholder interests and the plan’s goals. Second, though the board claimed to be concerned about keeping Musk fully engaged at Tesla, they made no effort to condition compensation upon Musk providing a set amount of time or attention to Tesla over his other projects. Essentially, as Chancellor McCormick points out, there was no relation between what Tesla got out of Musk via the $55 billion compensation package and Tesla’s stated goals – they could have “gotten” the same result from “giving” much less. The opinion also highlights that although the board claims to have set ambitious milestones that would be difficult to achieve, by their own conservative accounting metrics, some milestones were 70% likely to be achieved soon after the grant was approved. To be clear – the $55 billion on its own is not the issue. Tornetta states that there is “no absolute limit on the magnitude of a compensation grant that could be considered fair.”[20] However, the issues identified in Musk’s compensation make it clear that, regardless of amount, compensation must be tailored to specifically drive achievement of the board’s goals, not to provide compensation for an executive already financially motivated to maximize company profit. Companies must be able to justify their compensation decisions in light of the particular facts and circumstances, both in terms of quantity of compensation and difficulty of achieving milestones, in a more cogent and convincing manner than Tesla.

Tesla’s failures provide a near-textbook case of worst practices when it comes to board approval of executive compensation. At every turn, companies, regardless of how much they’d like to pay their executives, have the opportunity avoid Tesla’s fate. Insisting directors approving non-controlling stockholder compensation remain disinterested and independent and following appropriate process will shield the board from most judicial scrutiny. Even in the case of an interested or non-independent board and/or a controlling stockholder, following an appropriate compensation approval process and seeking a proper shareholder vote, with full disclosure around both conflicts and process, can provide significant protection to the approved transaction. Directors should ensure the board retains control over the entire process of approval – including the timeline (e.g., ensuring that the appropriate members of management and external advisors are preparing helpful materials and providing the board with ample time for review and discussion), properly documenting and memorializing its deliberations and decisions, the sufficiency of negotiations, the engagement of independent legal advisors and compensation consultants, and the use of benchmarking analyses. Lastly, directors must design compensation plans to actually drive the board’s goals. The exceptional set of circumstances that led to the ruling in Tornetta can be avoided simply by adhering to industry best practices in compensation setting.

[1] Julia Petty, Michael Gao & Michael Albano, $735M Tesla Settlement Drives Home Lessons For Boards, Law360 (Aug. 30, 2023, 11:24 AM), https://www.law360.com/articles/1714134.

[2] Tornetta v. Musk, C.A. No. 2018-0408-KSJM at *120 (Del. Ch. Jan 30, 2024).

[3] Whether either (a) independent and disinterested board or committee approval or (b) a fully informed and uncoerced vote by a majority of disinterested stockholders would have been sufficient, by itself, to “cleanse” a controlling stockholder transaction like the Musk grant, thereby lowering the standard of review from entire fairness to the deferential business judgment rule, is an issue currently before the Delaware Supreme Court. See In re Match Gp., Inc. Deriv. Litig., C.A. No. 368, 2022, order at 2 (Del. May 30, 2023). In this case, the Court of Chancery applied the roadmap developed in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014), requiring approval of both an independent and disinterested special committee and informed and uncoerced approval of holders of a majority of the disinterested shares in order to invoke the business judgement rule.

[4] In addition, a compensation package of this quantum may also be subject to a corporate waste claim.

[5] Tornetta v. Musk, C.A. No. 2018-0408-KSJM at *117 (Del. Ch. Jan 30, 2024)

[6] Id.

[7] Id. at *121.

[8] Id.

[9] Id. at *159.

[10] Id. at *129.

[11] Tornetta v. Musk, C.A. No. 2018-0408-KSJM at *133 (Del. Ch. Jan. 30, 2024).

[12] Id. at *5.

[13] Id. at *133.

[14] Id. at *129.

[15] Id. at *66.

[16] Id. at *156.

[17] Tornetta v. Musk, C.A. No. 2018-0408-KSJM at *180 (Del. Ch. Jan. 30, 2024).

[18] Id. at *1.

[19] Id. at *171.

[20] Id.