ProfessorBainbridge.com

California versus Delaware on Advancement

From my friend Francis Pileggi:

A recent gem of a short letter ruling from the Delaware Court of Chancery in Goldman v. LBG Real Estate Company LLC, C.A. No. 2023-0426-KSJM (Del. Ch., Feb. 26, 2024), provides important insights, with citations to authority, on three noteworthy topics of widespread relevance to corporate litigators ...

He goes on to offer a bulleted summary. useful.

Guest Post: Every Billionaire Lawyer is a Policy Failure—Ten Ways to Think About the Tornetta Fee Request

Herewith a guest post from Anthony Rickey:

Three law firms filed papers last Friday seeking fees for their victory in rescinding Elon Musk’s $55.8 billion pay package at Tesla.  The law firms—Bernstein Litowitz Berger & Grossman LLP, Friedman Oster & Tejtel PLLC, and Andrews & Springer LLC—want the Court of Chancery to award them 29,402,900 freely tradeable shares of Tesla common stock, along with over $1.12m in expenses.  According to Reuters, this would not only be the largest fee in Delaware history, it may be the largest fee in the history of stockholder litigation, dwarfing the $688 million fee in the Enron securities fraud case.

Some comparative statistics may help to wrap one’s head around this mammoth request.  This is not legal advice:  most of the numbers below are legally irrelevant under the factors that govern Delaware fee awards.  Instead, they offer some amusing perspective on an attempt to make multimillionaires out of attorneys.  (These figures use the $202.64 closing price of Tesla stock on March 1, 2024, the day of Tornetta’s fee application.  The stock fell considerably after the announcement.)

The Basic Figures

1. An award of 29,402,900 shares would be worth $5,958,203,656. The law firms spent 19,499.95 hours on the case, so the stock would be worth $305,549.69 per hour, or a lodestar multiplier of 437.32x to the attorneys’ hourly rates.  That does not include time spent preparing the fee application or to be spent on appeal.  With numbers that high, the appeal won’t move the needle much.
2. The award would amount to $622,022,628.44 for each of the nine shares of Tesla stock owned by plaintiff Richard Tornetta.
3. In comparison, it’s a mere $94.55 for each of the 63,014,339 disinterested shares voted in favor of Musk’s compensation package. The opinions of those shareholders are functionally irrelevant because the Court of Chancery held that the vote was not fully informed.  Under Delaware law, plaintiffs do not need to prove that any stockholder would have changed their mind had they known the supposedly material information, let alone that the vote would have come out differently.
4. The requested fee is 19.6 times larger than the current record in the Delaware Court of Chancery set by the $304,742,604.45 granted to plaintiffs in Americas Mining Corp. v. Theriault.

Compared to the Delaware Economy

5. The fee would be only slightly smaller than the $6.07 billion general fund operating budget proposed by Delaware Governor Carney for FY2025. Alternatively, it represents 6.6% of Delaware’s estimated GDP in 2022.
6. Assuming (unrealistically) that the entire fee were subject to Delaware’s 8.7% corporate income tax, the state would receive $518,363,718.07. For perspective, that is 15.64% of all business tax revenue collected by Delaware in fiscal year 2022.

Compared to Texas

7. Elon Musk has proposed reincorporating Tesla in Texas. By statute, class action fees in Texas are limited to four times lodestar.  Under a similar rule, Tornetta’s attorneys could receive no more than $54,497,851.00. 
8. That would still represent a return of $2,794.77 per hour for each timekeeper. In other words, Texas plaintiffs could have secured a much smaller recovery while still achieving the same net benefit for Tesla stockholders.

Other Entertaining Figures

9. According to Calculator.net, there are 2,974,015 minutes between the time that Tornetta filed his complaint and the Court of Chancery reached its decision. If awarded, Tornetta’s attorneys will collectively earn $2,003.42 per minute between those two events
10. According to Pollstar, Taylor Swift’s “Eras Tour” grossed $1,039,263,762 as of December 2023. The Tornetta attorneys would thus earn 5.7x more than the world’s most successful musical tour.

While I’ve tried to keep these lighthearted, I can’t end without expressing disbelief at this fee application.  Elon Musk’s pay was meant to incentivize him to build a company; the lawyers prosecuted a complaint.  No attorney deserves six figures in compensation per hour, no matter how complex or risky the litigation, and the concept that this level of incentive is necessary to motivate contingency lawyers is incredible.  One can only hope that the Delaware courts channel Dorothy Parker’s perhaps apocryphal comment and do not toss this application aside lightly.  It should be hurled with great force.

New Wave Stockholder Agreements: VC Travis Laster Cites Yours Truly in West Palm Beach Firefighters Pension Fund v. Moelis & Co.

West Palm Beach Firefighters Pension Fund v. Moelis & Co. is a new Delaware Chancery Court opinion by VC Travis Laster. The case involves what VC Laster calls "new wave" stockholder agreements: "The new wave of stockholder agreements does not involve stockholders contracting among themselves to address how they will exercise their stockholder-level rights. The new-wave agreements contain extensive veto rights and other restrictions on corporate action."

These sort of arrangements are very old school in the close corporate context. Think of such corporate law chestnuts as Clark v. Dodge, 269 N.Y. 410, 199 N.E. 641 (1936). I discuss these cases in my book Corporate Law at pp. 528-35. 

What gives the new wave versions their newness is that these purport to apply to public corporations:

Moelis & Company (the “Company”) is a global investment bank. Ken Moelis is its eponymous founder, CEO, and Chairman of the Board. After years of success operating the investment bank as a private entity, Moelis decided to raise capital from the public markets. He created the Company as a new holding company and reorganized the bank’s underlying entity structure. One day before the Company’s shares began trading publicly, Moelis, three of his affiliates, and the Company entered into a stockholder agreement (the “Stockholder Agreement”).

The Stockholder Agreement is a new-wave agreement. Under its terms, the Company’s board of directors (the “Board”) must obtain Moelis’ prior written consent before taking eighteen different categories of action (the “Pre-Approval Requirements”). The Pre-Approval Requirements encompass virtually everything the Board can do. Because of the Pre-Approval Requirements, the Board can only act if Moelis signs off in advance. 

Other provisions in the agreement are intended to ensure Moelis will still be able to select a majority of the board of directors and to populate board committees with Moelis nominees in the same proportion that they represent on the full board.

The statutory provision that comes immediately to mind is DGCL 141(a). As Laster explains: "That provision famously states that 'the business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.'" Private ordering of the board's functions thus must be effected through the articles of incorporation not in a mere shareholder agreement.

A whopping 132 pages later VC Laster concludes that Section 141(a) trumps most of the provisions of the agreement:

When market practice meets a statute, the statute prevails. Market participants must conform their conduct to legal requirements, not the other way around. Of course, the General Assembly could enact a provision stating what stockholder agreements can do. Unless and until it does, the statute controls.

I note that the MBCA has a statutory provision that allows shareholder agreements sweeping ability to limit board powers. But even if Moelis were incorporated in an MCA state, the statute would not apply. Under the MBCA statute, the agreement must be unanimous with all shareholders being a party to it. Secondly, the agreement is voided by operation of law when the company has a class of stock registered with the SEC. 

Speaking purely in my capacity as a casebook editor, this is yet another example of an important Delaware opinion I would very much like to include in my Business Associations casebook, but that I see no way to edit down to a manageable length--say 20 pages at max.

But I am grateful to VC Laster who cites my work in footnotes 15, 286, 297, 298, and 299.

My good friend and leading Delaware corporate law litigator Francis Pileggi has a new blog post that digs into an earlier decision in the case. As always, he does a brilliant job.

Top Sirloin with Barbecue Butter Sauce and Fried Potatoes, Onions, and Bacon

Steak

I had wanted a flat iron steak for this recipe, but couldn't get one at my store. So I opted for two 1.5" thick top sirloin steak that each weighed about 10 ounces. 

I heavily seasoned both sides of the steak with salt, pepper, and Creole seasoning. I vacuum sealed each steak in its own bag. I let the steak rest in the refrigerator for 1 hour. I set up my sous vide machine, using a stock pot for the water bath. I added the bags to the water bath, set the machine to 134°, and set the time for 75 minutes. 

When the steaks were finished, I set a 10-inch non-stick skillet with 1 tablespoon of bacon fat (see below) over medium-high heat. I removed the steaks from the bags, patted them very dry with paper towels, and added them to the hot pan. I seared the steaks for about a minute per side and transferred them to a cutting board to rest.

Slice against the grain.

Sauce

• 1½ tablespoons beef broth
• 1½ tablespoons Kansas City-style barbecue sauce
• 1 teaspoon butter

Combine all three ingredients in a small bowl. After cooking the steaks, add the sauce ingredients to the still hot skillet. Mix well and let reduce very slightly. Add any juices that collect on the cutting board.

Potatoes

• 4 slices thick cut bacon
• medium red onion
• 1 pound medium Yukon Gold potatoes
• 2 cloves garlic, minced
• salt
• pepper
• Creole seasoning

Cook bacon in a 12-inch non-stick skillet. 

Cut red onion in half. Reserve one half for another use. Slice the other half into 1-inch long thin moons.

Slice potatoes using the 7 mm blade of your v-slicer. 

When bacon is ready, transfer to a paper towel lined plate to drain. When cool, crumble bacon. Reserve.

Transfer 1 tablespoon of bacon fat into a 10 inch skillet and set aside.

Drain remaining bacon fat out of skillet into a glass bowl. Put 4 tablespoons of the fat back into the 12-inch skillet. Put skillet over medium-high heat (I used the 7 setting on my electric stove).

Add onion slices to pan. Salt well and sauté for 2-3 minutes. Add potatoes. Season generously with salt, pepper, and Creole seasoning. Mix well, cover, and reduce heat to medium. Cook a total of approximately 15 minutes, stirring potatoes every few minutes, until lightly browned and tender.

Plate potatoes. Top with steak slices. Top with sauce. Serve a side salad.

 

Wine

We drank a 2021 Ridge Three Valleys (Sonoma County), which is a blend of 65% Zinfandel, 26% Petite Sirah, 5% Syrah, and 4% Alicante Bouschet. Great match. Deep purple. Rich and full bodied. Plums, blackberries, black cherry, and some peppery spice.

 

Seared Tuna with Cold Soba Noodle Salad

Cold Soba Noodle Salad

• 1 tablespoon fish sauce (I like Red Boat)
• 1 tablespoon mirin
• ½ tablespoon soy sauce 
• 1 crushed garlic clove
• ¼ teaspoon grated ginger
• ¼ teaspoon honey
• 5 ounces soba noodles, prepared per package directions
• 5 ounces frozen spinach, prepared per package directions
• 5 radishes, trimmed, rinsed, and dried
• green parts of 3 scallions sliced thinly on the diagonal
• 3 tablespoons wonton strips

To make the dressing, thoroughly whisk together the first six ingredients in a small bowl. Set aside.

Drain soba noodles through a colander or strainer. Rinse with cold water until the noodles are cold. Pat dry with paper towels. Transfer to a mixing bowl.

Drain spinach through a colander or strainer. Rinse with cold water until cold. Put the spinach in middle of a clean kitchen towel or a big wad of paper towels. Squeeze out as a much water as possible. Add to the mixing bowl.

Slice radishes using the 3.5 mm blade of a v-slicer. Add to mixing bowl.

Add scallions to mixing bowl.

Put bowl in the refrigerator until ready to serve. Just before service add dressing to taste. Mix. Top with wonton strips. Divide between plates.

Seared Tuna

• 2 6-ounce tuna steaks
• salt
• pepper
• Cajun seasoning
• sesame seeds
• 1 tablespoon Ponzu sauce
• ½ tablespoon fish sauce 

Pat tuna steaks very dry with paper towels. Spray one side of each tuna steaks with Pam. Season with salt and pepper. Liberally sprinkle with sesame seeds and press into tuna. Flip steaks over and repeat on the other side.

Spray a 12-inch non-stick skillet with Pam. Heat over medium-high heat (I use the 8 setting on the 10 point dial on my electric stove). When the pan is very hot but before Pam starts to burn, add steaks and reduce heat slightly (I use 6). For rare to medium-rare, cook 2 minutes. Flip steaks (trying to avoid knocking off seeds). Cook another 2 minutes. (If the steak is very thin, reduce cooking time by 30 seconds per side. If the steak is very thick, add 30 seconds per side.)

Slice steaks against the grain.

Mix Ponzu and fish sauce. Brush liberally onto cut sides of the steaks.

The Wine

We drank a 2019 Trimbach Gewürztraminer, which is one of my favorite wines for quasi-Asian foods. It's a delicious wine. Bright gold color. Big nose of rose petals, pineapple, nutmeg, and lychee. The palate followed through with the same associations and a medium-long finish.

Bainbridge for Delaware Vice Chancellor

I note that Delaware Vice Chancellor Sam Glasscock intends to retire at the end of the year. As usual when there is an opening on thee Chancery Court, I expect to throw my hat into the ring. After all, am I not the leading proponent of Delaware corporate law in the academy? Am I not the voice crying in the wilderness that we don't need a Restatement of Corporate Law because we already have Folk on the Delaware General Corporation Law? When Lucian Bebchuk said Delaware is winning a race to the bottom, did I not proclaim that the race is to the top?

Of course, the usual blatant discrimination against non-Delaware residents will probably scupper my chances. It's a moral outrage.

Elon Musk sends part of his empire to Texas and part to Nevada. Why not just pick one?

Not unexpected. I'd love to learn why Neurolink went to NV and SpaceX to TX. https://t.co/8SkugTozOw

— Anthony Rickey (@anthonyrickey) February 15, 2024

Cunningham on the SEC's Climate Change Disclosure Rule

Larry Cunningham argues that the SEC's pending climate change rule suffers from the same problems as the now defunct proposal to require disclosure of share buyback rationales and data. 

State laws allow corporations to repurchase shares, which are seen by some as beneficial for shareholders but criticized by others for negatively impacting workers and social equality. The SEC's rule on disclosing buyback motives was vacated by the Fifth Circuit Court of Appeals for lack of substantial evidence on its benefits, specifically in reducing investor uncertainty. The court argued that without proving buybacks as problematic for investors, the SEC had no basis for mandating rationale disclosure, questioning the rule's focus on stakeholder interests.

The decision raises questions about the SEC's authority and its ability to enforce similar regulations, such as the controversial climate disclosure proposal, which faces scrutiny for potentially overstepping SEC's mandate and being burdensome and controversial. The climate disclosure rule's viability is uncertain, with critics comparing it to the failed conflict minerals rule, which was struck down for imposing a moral judgment under the guise of factual disclosure.

Both cases highlight the ongoing debate over the scope of the SEC's regulatory powers and the balance between investor interests and broader societal or environmental concerns.

ABA adopts law school freedom of speech accreditation policy

As the main accreditation body for American law schools, the ABA has considerable influence over legal education. Via Brian Leiter, I learn that:

Law schools will now be asked to explicitly protect free speech rights for faculty, students and staff as part of the ABA accreditation process. Though law school faculty have long enjoyed protections for academic freedom, this would be the first accreditation standard to address free speech for the entire community within law schools.

Leiter observes that:

... what's new here is the protection for free speech rights, not academic freedom, which faculty already enjoy in almost all (maybe all) law schools by contract or as a matter of constitutional right at public law schools.  Under the AAUP definition of academic freedom, faculty are protected from sanction for their extramural speech, e.g., on political or other topics.  In effect, this new provision appears to extend that protection to students and staff at a law school. 

Still, it may supplement the academic freedom guarantee for faculty and help protect faculty from being thrown under the bus by spineless administrators.

Moreover, I am somewhat troubled because the new policy requires law schools to protect speech communicated through "demonstrations or protests." Would protestors now be allowed to march into a classroom and disrupt the class?

Guest Post by Anthony Rickey: Five Reasons Tesla May Want to Move to Texas

Last week, the Court of Chancery’s ruling in Tornetta v. Musk rescinded Elon Musk’s unprecedented $55.8 billion pay package.  Musk responded by tweeting that Tesla will hold a stockholder vote on reincorporating in Texas.  The Houston Chronicle offered five reasons Musk might want to do so, including “politics” and “simplicity.”  Professor Ann Lipton, on the other hand, argues that Musk wants the move “because he expects the judges will be biased in his favor.”  I don’t find these explanations satisfying.  If nothing else, Texas hasn’t appointed its new business court judges yet, and those judges will have two-year terms.  If anything, the risk is that the character of the court can change with an administration.

But Musk’s tweets have put a spotlight on jurisdictional competition and, in that spirit, I’d like to offer five alternate reasons that Musk might find that a Texas move benefits Tesla.  Fair warning:  this analysis stems less from my perspective as a Delaware lawyer than from my status as a Tesla stockholder.   I bought 50 shares—far more than the Tornetta plaintiff—in late 2022.  My holdings have almost doubled in value, making Tesla my most successful investment since my law degree.  Perhaps Tornetta will result in a more efficient, successful company and my investment will double again.  Then again, perhaps not.  With that in mind, here are five reasons Tesla might want to move to Texas.

1. Musk and Delaware Just Don’t Vibe.

Even before Tornetta, there was little doubt that Elon Musk places little value on procedural niceties.  Not his style.  His Boring Company made a flamethrower.  More seriously, he landed in hot water after tweeting about taking Tesla private.  It is hard to argue with Tornetta’s proposition that Musk “has no filter.”  But he’s also provided considerable stockholder value:  even the Tornetta opinion concedes that Musk’s tenure coincided with remarkable growth in Tesla’s stock price, which is what made him eligible for a $55.8 billion payout in the first place.  Process may not be a prerequisite to growth.

 But Musk’s temperament may be ill-suited to Delaware, which places greater value on process.  While nothing in Delaware statutory law bars Musk’s pay package, longstanding doctrine protects stockholders from “controlling shareholders” by subjecting conflicted transactions to entire fairness review, under which a company and its board must prove that a transaction is fair in price and process.  While it is possible for a defendant to meet that burden—indeed, Musk did so in the SolarCity case—it’s challenging.  To avoid this harsh burden, Delaware permits controlling stockholders to “cleanse” a conflicted transaction by seeking approval from both (a) a committee of independent directors and (b) fully-informed, disinterested stockholders.

After Tornetta, it is easy to see why Tesla (and Musk) may have difficulty meeting this burden, even outside the executive pay context.  While director and stockholder approval are technically different analyses, in practice they can collapse into one another.  Tornetta (a) finds that Tesla’s board was not independent of Musk, at least for this decision, and (b) holds that the vote was not fully informed because stockholders were told that the board was independent.  Failing the first hurdle may lead to failing the second.

Thus, Delaware law leaves Tesla in a conundrum.  Musk may be mercurial—but he’s led the business to profit.  Perhaps Tesla can appoint a few directors that the Court of Chancery might ultimately consider independent of Musk.  But perhaps not, or at least not without changing the corporate culture:  the Tornetta opinion condemns the Tesla board’s negotiation of Musk’s pay package for being a “cooperative and collaborative process.”  In a business context, cooperation and collaboration are generally considered positively, not negatively.  Tornetta essentially imposes a choice between (a) adversarial, non-cooperative salary negotiations with Musk or (b) perpetual lawsuits where Tesla must prove that its decisions are fair.  Tesla, and Musk, may desire other options, and Texas incorporation could provide an alternative.

2. One More Delaware Lawsuit.

Tornetta leaves Tesla with another problem:  even if it reformed its governance, it’s a large, successful company that’s an attractive target for plaintiffs’ lawyers.  In the best of scenarios, it’s likely to get sued.  And reality isn’t the best of scenarios:  as Professor Lipton noted on Bluesky, a California lawsuit alleging that Tesla mishandled toxic waste will likely lead to a books-and-records and then a derivative suit against the Tesla board.  The question isn’t whether Tesla will be sued in Delaware again, but how many times.

Reincorporation in Texas reduces that number to, potentially, one.   Another Delaware plaintiff is currently suing to prevent TripAdvisor from reincorporating in Nevada.  The Court of Chancery’s decision is pending.  Barring total victory for TripAdvisor, however, the odds that Tesla can reincorporate in Texas without first facing expedited litigation in Delaware seem slim.

In that sense, Tornetta presents a challenge to states like Nevada and Texas that have created business courts to compete with Delaware.  If Delaware plaintiffs can make it more difficult for corporations to leave the First State, can competitors adopt legal provisions making it easier, or allowing corporations to recover after reincorporation from shareholders who frustrated an attempted exit?  I don’t know—but given that Governor Abbott explicitly encouraged Tesla’s move, it would not be surprising if some legislative aid has been diligently researching possible reforms over the last week.

3. Stockholders Might Recover More in Texas.

Meanwhile, stockholders may be better off litigating against Tesla in Texas.  A Texas business court might not have decided Tornetta any differently.  As Professor Ben Edwards notes, “The last thing Texas is going to want is a reputation that their corporate law is a game where billionaires always win, because then investors aren’t going to trust it.”  Unlike Nevada (where X/Twitter is now incorporated), Texas has not statutorily abolished entire fairness review.  It remains to be seen whether the Lone Star state will be any less plaintiff-friendly than Delaware.

However, Texan tort reform may benefit post-reincorporation Tesla stockholders by allowing them to keep a greater percentage of recovery from a successful lawsuit.  In class actions, Texas limits attorneys’ fees to 400% of the plaintiffs’ attorneys’ lodestar.  If the recovery is in “noncash common benefits,” then attorneys fees must also be noncash.  Texas has yet to apply this rule to derivative lawsuits like Tornetta, but that is a potential next step for the business court. 

Were the Tornetta plaintiffs to receive fees in this fashion, each attorney would still make thousands of dollars per hour—but even at 400% of lodestar, the fee probably wouldn’t reach $1 billion.  And Tornetta did not result in a cash judgment but the rescission of Musk’s unexercised stock options.  It seems odd, but a Texas court could potentially compensate a Tornetta-style plaintiff by awarding their counsel an interest in Musk’s options—which the attorneys would have to pay to exercise and perhaps, like Musk, hold for a period of time.  That might not be bad:  the attorneys would immediately become some of Tesla’s largest stockholders, but they would also have skin in the game.  A cash award offers attorneys no reason to care whether Tornetta benefits or harms Tesla in the long term.  (And stockholders who, like Tornetta, own nine shares have little interest altogether.)

Delaware is very different:  rather than using lodestar, Delaware bases fee awards on a percentage of any benefit secured in litigation.  And a recent Delaware decision, In re Dell Technologies Inc. Class V. Stockholders Litigation, held that the percentage awarded does not decline in mega-settlements.  (Full disclosure:  I represent some law professors pro bono as amici curiae in Dell, which is on appeal.)  Instead, Delaware plaintiffs’ attorneys typically receive somewhere between 10-15% of a class recovery in cases that settle early, 15-25% that settle after some motion practice and depositions, and up to 33% after trial (as in Tornetta).  The Court of Chancery has yet to award fees to the Tornetta attorneys, and the award will be complicated by the need to determine how much Musk’s shares are worth to Tesla.  (A similar issue has arisen in a dispute over pay to Tesla’s other directors.) But lawyers are already speculating that the award may exceed $1 billion.

Tornetta highlights two paradoxes in Delaware mega-cases.  First, even when plaintiffs win big, stockholders might be better off with smaller victories if their attorneys were limited to, say, a mere $5,000 per hour in fees.  Second, Dell and Tornetta set different standards for directors and attorneys.  Plaintiffs’ lawyers in the Court of Chancery receive an ever-greater percentage of stockholder gains based on a set of milestone payments.  One doesn’t have to squint hard at Musk’s pay package to recognize that it is also an escalating percentage award based on milestone payments—although the percentage increases more slowly than the brackets in Dell.  Yet Tornetta repeatedly faults Tesla’s directors for not considering whether Musk warranted any incentive pay beyond the 21.9% of Tesla he already owned.  Corporate directors might reasonably ask why CEOs require less incentive to produce stockholder value than the attorneys who sue them.

4. Tesla May Have an Easier Time Renewing Musk’s Pay Package.

In 2006, Professors Lucian Bebchuck and Jesse Fried published Pay Without Performance:  The Unfulfilled Promise of Executive Compensation.  Tornetta results in the opposite:  performance without pay.  Back in 2018, the New York Times Dealbook recognized the challenge for Tesla to reach $650 billion in market capitalization:  “many experts would contend [it] is laughably impossible.”  Dealbook offered that critics would say Musk’s pay deal was “the company’s latest publicity stunt.”   Reaching a laughably impossible goal certainly seems to qualify as CEO performance in the Bebchuck/Fried sense.

Yet unless Tesla reinstates some form of pay package, Musk receives nothing for this achievement apart from his existing holdings.  Thus, commentators have spent much of the last week speculating over whether, and how, Tesla might compensate Musk for past services.

Professor Lipton argues that awarding Musk “compensation for services provided would likely be waste. . . .”  I don’t think that’s right, for two reasons.  First, the Court of Chancery has dismissed waste claims challenging one-off payments for past services rendered, albeit typically in the context of a severance or retirement arrangement.  I’m only aware of one case where a waste claim concerning executive compensation withstood a motion to dismiss, and there a company agreed to a continuing salary payment in exchange for services that it allegedly knew the executive could not render due to age and disability.  That’s certainly not the case here.  Second, the standard for waste is severe.  A corporation must enter into a transaction “so inadequate in value that no person of ordinary, sound business judgment would deem it worth that which the corporation has paid.”  A cursory glance at the internet—where Tesla stockholders are debating the decision—shows that at least some stockholders believe Musk’s compensation was fair and want it reinstated.  A plaintiff would need to argue that these stockholders are, essentially, not in their right mind.  Even Tornetta does not go that far.

But another lawsuit for breach of fiduciary duty would be likely.  Suppose Tesla comes up with an alternate pay package.  Even if Tesla nominates some new directors, it can’t know that the Court of Chancery will ultimately find them to be independent.  It certainly can’t have a “cooperative and collaborative process.”  And even if Tesla offers ridiculously thorough disclosure—perhaps it livestreams the relevant board meeting?—it can’t ensure that the Court will find its vote fully informed.  Without both conditions, it will just get sued again, with (at best) the plaintiff bearing the burden of proving the deal unfair.  As Matt Levine puts it:

It is possible that the rule of this case is that Tesla is not allowed to pay Musk $55.8 billion, no matter what its shareholders think, no matter how many of them vote to approve it in a fully informed vote. It’s enough to make you want to move to Texas.

Tesla may find it easier to reinstate Musk’s pay package—or adopt an amended pay package—after reincorporating.  That would raise another thorny question:  given that the new pay package would largely moot the benefit in Tornetta, is there a mechanism to make the plaintiffs’ firms give the fees back?

5. Tesla Might Adopt Fee-Shifting Bylaws and Texas May Make Additional Legislative Reforms.

The Texan legal environment could provide Tesla with further protection against inevitable stockholder litigation.  While Delaware’s corporate statute is notably flexible, it has limits—such as its famous prohibition against corporations adopting bylaws requiring unsuccessful stockholder litigants (or their attorneys) to bear a corporation’s legal fees.  Professor Bainbridge described this ban as “Delaware’s self-inflicted wound.”  Several states adopted similar legislation after Delaware did so.  To my knowledge, Texas has not.  A post-reincorporation Tesla could potentially make itself a less-attractive target by requiring plaintiffs—whose lawyers make millions, and potentially billions, by suing the firm—pay fees when they fail.

Tesla’s Delaware experience already puts the lie to the old plaintiffs’ saw that fee-shifting bylaws are “one-sided” in favor of corporations.  While the popular observation is that Tesla won its derivative litigation over SolarCity, it is more accurate to say that Musk won, and won again on appeal. Every other director settled before trial for $60 million (from insurance), and the SolarCity plaintiffs received over $16 million in fees.  Tesla did not get the fees back, or its own fees covered, after plaintiffs lost.  As Professor Griffith puts it, with only slight exaggeration, in Delaware stockholder litigation “the starting point is not the American Rule, under which each side bears its own fees, but rather the Delaware rule, under which the corporation always pays.”  Texas might correct this imbalance.

Texas could consider other reforms.  For instance, Reuters reported that the Tornetta plaintiff is a former drummer who owned only nine shares.  The Tornetta opinion, however well-reasoned, eloquently constructed, and doctrinally correct, remains just that:  an opinion.  It has the force of law because a tiny stockholder, backed by one of the world’s wealthiest law firms, convinced a judge.  That procedure overrides the opinions of other stockholders, including the vast majority who voted in favor of Musk’s pay, because Tesla did not fully disclose all material facts when it asked for stockholder approval.  Again, as a matter of Delaware doctrine, this fits:  an omitted fact need not change the outcome of a stockholder vote, or even sway any stockholder’s vote, to be material.  Thus, Tornetta faults Tesla’s failure to disclose that certain directors were not “independent” and that Musk and another director discussed his pay before the Compensation Committee did.  But while the reasoning is doctrinally sound, the result has an Alice-in-Wonderland feel to it.  I’d be surprised if one could find more than a few dozen stockholders who would have changed their votes based on that fact, much less enough to affect the outcome.  Again, Matt Levine has a point:

But I think that if you put it to a vote of Tesla shareholders — “would you rather give Musk $55.8 billion of Tesla stock for running Tesla, or these lawyers $1 billion of Tesla stock for suing Tesla?” — you’d get a pretty large majority for Musk? I’m not Musk’s biggest cheerleader or anything, but I feel like he has probably done a lot more for Tesla than these lawyers have.

But in Delaware, the stockholders who disagree with the Tornetta plaintiff lack a mechanism to stop his lawsuit, even if other stockholders are much larger investors.  Texas could consider legislative reforms that would strengthen corporate democracy, perhaps by requiring derivative plaintiffs to hold significant stakes before they can sue to redirect corporate decision making.  I suspect that, if Tesla does reincorporate, the enthusiasm of the Texas legislature for other innovative reforms will intensify.

Of course, Tesla may not ultimately decide to reincorporate.  Right now, the only indication that it will do so is Musk’s tweet.  This may be much ado over nothing.

5. Conclusion.

            Still, I can’t end this post without addressing what most other commentators have pondered:  how does a potential Tesla reincorporation affect Delaware?  Professor Bainbridge concludes that, after Tornetta, “Delaware’s dominance will be preserved” because the decision demonstrates that Delaware will hold even one of the richest CEOs in the world to account.  That is the conventional wisdom.  And I hope Professor Bainbridge is correct.  I’m a Delaware lawyer, after all.  But that may be the wrong question.

In the recent debate between former attorney general William Barr and Vice Chancellor Laster, both discussed the New Jersey policy failures that led most corporations to move to Delaware over a century ago.  But history need not repeat itself, it merely needs to rhyme.  If Texas took 20 percent of Delaware’s corporations—or over the long term, attracted 20 percent of new firms—its new business court would turn the Lone Star State a tidy profit.  The same loss to Delaware would perhaps not be apocalyptic for the First State’s finances, but it would certainly be uncomfortable.  A still-dominant but less-dominant Delaware is not an optimal outcome, at least for my home team.

And, returning to my first point, the new competition may become a matter of “vibes.”  Delaware law provides a broad enabling statute, and then every decision may be “twice tested” for compliance with both law and equity.  The second test takes place in lengthy, expensive legal proceedings, and the results are not always predictable.  (Take James Murdoch, former CEO of 21st Century Fox and himself wealthy beyond my imagining even apart from his Tesla investment.  I did not attend the trial and I have not reviewed the evidence as the Chancellor has.  But if you had asked me a month ago whether Murdoch was independent of Musk, I would have thought so.)  For established, mature companies, Delaware’s equity-based jurisprudence may be ideal.  But newer companies with differing business cultures—even companies whose CEOs don’t produce flamethrowers—may find more certain legal paradigms more attractive.  Tornetta provides a potential roadmap for states that want to compete with Delaware:  corporate law based less on equitable principles, with more clearly defined safe harbors for director conduct. 

And while it has gone largely unremarked, the nature of state competition has changed since I co-authored a paper about it over a decade ago.  In the early 2000s, most business courts imitated the Court of Chancery.  Today, not only do they seek to differentiate themselves, but reforms—for instance, Nevada’s elimination of “inherent fairness” review and the Texas class action rules—are more often driven by legislatures rather than lawyers.  The Texas legislature created its new business court despite substantial opposition from some local legal associations.  By contrast, Delaware corporate legislation tends to be driven by the Delaware bar.  Differing political economies may adopt different reforms that are attractive to different types of corporations.

Finally, I’ll end on a personal observation.  It is not my intent to criticize the Tornetta decision’s legal reasoning.  That is a task for other practitioners on appeal.  The simple fact is that once a Delaware stockholder files a derivative complaint, a court must reach some decision:  even if the parties settle, the settlement must be judicially approved.  No opinion can satisfy everyone.  But my mind keeps uneasily turning back to Tornetta’s criticism of the “cooperative and collaborative process” that led to Musk’s pay package.  In fairness, Tornetta addresses my discomfort in footnote 733, assuming that perhaps “some level of cooperation and collaboration is called for” but that Tesla exceeded that level.

Still, that phrase pulls at the businessman in me that preceded the lawyer.  Law firms, and particularly BigLaw firms, may have zero-sum distribution negotiations in partners meetings and lockstep compensation among associates, but that was never my expectation of work before law school.  I didn’t join the bar until my early thirties.  Before that, I was never a CEO or a director, but I did lead small teams and conduct salary negotiations.  Perhaps my former teammates would not describe my discussions with them as a “cooperative and collaborative process,” but I hope they would.

Before my legal career, I would never have imagined that anything approaching adversarial salary negotiations were necessary for a process to be fair.  Again, perhaps it’s “vibes,” but those passages about cooperation make me think that the conventional wisdom may be more fragile than we expect, and Tornetta more consequential.

Thilo Kuntz on "The Promise and Perils of Promoting ESG With Demand-Side Regulation"

Thilo Kuntz, chair in private, commercial, and corporate law and managing director of the Institute for Corporate Law at Heinrich-Heine-University in Düsseldorf, Germany, is currently a visiting scholar at UCLA School of Law. I am very much enjoying getting to know this learned and insightful colleague.

Kuntz has a book chapter “ESG Demand-Side Regulation – Governing the Shareholders,” forthcoming in Corporate Purpose, CSR and ESG: A Trans-Atlantic Perspective (Jens-Hinrich Binder, Klaus J. Hopt, Thilo Kuntz, eds., Oxford University Press 2024), which is available here.

Kuntz posted a summary of the chapter to the CLS Blue Sky Blog:

If a regulator (in the broadest sense of the word) wants companies to incorporate ESG-oriented decisions into their governance structures, the regulatory strategy must include the shareholders and investors. When stockholders have to abide by norms mirroring those of the corporate board, at least in theory, the incentives and investment aims of corporate directors and shareholders should align.

Many U.S, and European laws and legal frameworks involving ESG already reflect demand-side regulation. Notwithstanding their differences, what those laws have in common is their target: It is no longer the board of directors, the German Vorstand, the French conseil d’administration, or a similar body managing the affairs of the public corporation or company, but rather the shareholders and investors. After decades of focusing on directors’ duties to the corporation, stockholders, and society at large, this development is a major change. ...

Kuntz draws a distinction between direct and indirect demand-side regulation. "Whereas the first addresses shareholders and investors directly through ESG disclosure rules and requirements to commit to ESG, the second targets retail investors as a group and seeks to move them toward preferring ESG."

Kuntz then suggests limitations to both direct and indirect demand-side regulation. He concludes:

Many empirical studies show that even those opting for an ESG product often prefer financial gains once the investment is made. Consequently, the largest group of shareholders will still judge directors based on financial performance. Therefore, the effects of indirect demand-side regulation are rather limited, and it will probably not cure the incentive problem of supply-side regulation. The same is true regarding ESG proponents who may be willing to give up profit for non-monetary benefits. Having more shareholders expressing general ESG preferences does not help solve the conflicts within that group ....

I highly recommend checking out the paper.

 

Some initial thoughts about Tornetta v. Musk

A plea to Delaware jurists: Chancellor McCormick's Tornetta v. Musk opinion raises an important issue. I edit a widely used casebook on corporate law. I need to keep keep blocks of reading to about 20 pages if I want students to read it. How the heck am I supposed to trim a 200…

— Steve Bainbridge (@PrawfBainbridge) February 1, 2024

If we assume founders and managers have an incentive to minimize their cost of capital, they will prefer to incorporate in a state that ensures investor protection. By demonstrating that Delaware will hold even one of the richest CEOs in the world to account, the Chancellor…

— Steve Bainbridge (@PrawfBainbridge) February 1, 2024

In re the proper standard for reviewing controlling shareholder transactions, see also:
As Delaware contemplates the https://t.co/CJZRDylwyu case, the court should acknowledge that not all controlling shareholder transactions should require cleansing.https://t.co/iijBk1N9Tg

— Steve Bainbridge (@PrawfBainbridge) January 31, 2024

In Tornetta v. Musk, Chancellor McCormick states that "Delaware's most onerous standard of review, entire fairness, applies because [Musk's compensation plan] was a conflicted-controller transaction." But do all controller transactions involve a conflict? I think not.

— Steve Bainbridge (@PrawfBainbridge) January 31, 2024

Reading Tornetta v. Musk,my initial reaction is that Chancellor McCormick is trying a little too hard to be funny. The Star Trek reference, for example.

— Steve Bainbridge (@PrawfBainbridge) January 31, 2024

Exxon sues climate activist shareholders in federal court because Gary Gensler's SEC won't do its job

The WSJ reports:

Exxon Mobil is suing two sustainable investment firms in a bid to block them from putting forward a shareholder proposal that would commit the oil company to further curb its greenhouse-gas emissions and target its customers’ emissions. ...

“Defendants are asking Exxon Mobil to change its day-to-day business by altering the mix of—or even eliminating—certain of the products that it sells,” the oil company said in the lawsuit. Their goal, it alleged, is “to force Exxon Mobil to change the nature of its ordinary business or to go out of business entirely.”

The problem Exxon is facing is one about which I have frequently blogged; namely, that Gary Gensler's SEC is now full of ESG activists who he has authorized to allow shareholders to micromanage corporate business operations via Rule 14a-8 shareholder proposals. In July of last year, for example, I noted that:

As I detailed at some length in my article, Revitalizing SEC Rule 14a-8’s Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705 (2016), the SEC shareholder proposal was never intended to allow shareholders to manage--let alone micro-manage--the corporations in which they invest. Yet, in recent decades, the SEC staff has basically eviscerated those safeguards.

Back in November 2021, I had predicted that Gensler approved changes to how the SEC staff interprets Rule 14 a-8 would lead to that result:

In effect, the SEC is saying that corporate proxy statements can be conscripted by somebody owning a trivial amount of stock to solve "societal problems" that may have virtually no nexus to the company.

In addition, the SEC is encouraging shareholders to micromanage the company when it comes to woke issues:

For example, a proposal requesting a company set greenhouse gas emission targets, but providing the company with discretion on a method for its implementation, will no longer meet the threshold for exclusion based on micromanagement.  

How is deciding corporate environmental policy not micromanagement?

Wachtell concludes:

it is not clear which social issues the Staff will deem broad enough to “transcend the ordinary business,” beyond the Staff’s examples of proposals relating to human capital management with a broad social impact or to greenhouse gas emissions targets without specific methodologies.  

Piffle. It is perfectly obvious that the SEC has become a tool of the Warren/Sanders/AOC wing of the Democratic Party and is now leading the charge towards woke capitalism. I feel confident in predicting that woke shareholder proposals will breeze through the process. In the unlikely event that conservatives emulated progressives and started using the shareholder proposals to effect their policy goals, however, I'd bet the SEC allows their exclusion.

The message seems to finally be reaching a wider audience. The WSJ report continues:

Under normal circumstances, companies that want to exclude shareholder proposals from their proxy statements submit a request to the SEC. Exxon’s move is an unusual attempt to bypass that process as the SEC during the Biden administration has become less inclined to let companies block proposals. 

In the lawsuit, Exxon said the shareholder proposal and proxy voting process has become “ripe for abuse by activists.” 

In 2021, the SEC reversed a Trump-era policy that made it easier for public companies to reject shareholder proposals, which—though typically nonbinding—have long been a thorn in the side of executives. The guidance indicated that SEC staff would be more receptive to shareholder proposals regarding issues that have “a broad societal impact” and focus less on an issue’s relevance to a particular company.

It seems woke capitalism remains Gary Gensler's main policy goal.

Lowell Milken Funds New UCLA Center for Philanthropy and Nonprofits

In 2011, Lowell Milken (UCLAW alum Class of 1973) gave the UCLA School of Law over $10 million to start the Lowell Milken Institute for Business Law and Policy, with which I have been proud to be associated since its founding. Lowell's continuing generosity has grown the Center's endowment to substantially higher levels. As such, his generosity has not only supported my work in many ways, but also the work of the whole business law faculty. It has elevated UCLA's visibility and reputation in business law. Along with my colleagues, I am deeply grateful to Lowell for his support.

The law school has just announced gifts from Lowell totalling over $11 million to fund the Lowell Milken Center for Philanthropy and Nonprofits. The initial ddirector will be my friend and colleague Jill Horwitz:

She is a renowned expert in nonprofit law and in health law. Horwitz served as the reporter for the American Law Institute’s Restatement of the Law, Charitable Nonprofit Organizations, a publication that was a landmark step forward in the field.

“Our work brings a much-needed forum to the nonprofit sector, particularly one on the vibrant West Coast,” Horwitz said. “There is a lot of exciting work to be done, and the creation of the center will serve UCLA, Los Angeles, and far beyond.”

I think this is great news. There is a need for serious scholarship in the non-profit sector that I am confident the new Center will promote. In addition, it will serve our students who are interested in legal careers that bridge public service and business.

My only quibble is the title. Shouldn't it be Non-Profits?

I realize that the Chicago Manual does not require use of a hyphen with non as a prefix, but Chicago has become notoriously lax.

I May (Possibly) Have Overreacted to McDonalds: Should Business Associations Teachers Teach It?

A friend who uses my Business Associations casebook asked whether I was going to include the McDonalds case in the 2024 update to the casebook (available to law school faculty here). I responded that I was not, to which she responded "As I read the several posts you had on the decision (before reading it today), I had thought it was important to include!"

Well, yes, but.

Regular readers likely will recall my posts on Vice Chancellor Travis Laster's opinion in In re McDonald's Corp. Stockholder Deriv. Litig., in which the VC held that Caremark's oversight duty applies to officers as well as directors. As I explained in the first post, the decision initially exacerbated my longstanding concern that the scope of Caremark liability just keeps growing and growing.

In the second post, I noted that the estimable attorney and D&O Diary blogger Kevin LaCroix shared my concern that the defendant's conduct, "while doubtless egregious, did not go to the sort of existential, 'mission critical' failures that drove the recent Marchand and Boeing decisions."

My initial reaction to McDonald's admittedly was driven by my deeply held beliefs that:

1. Caremark was wrong from the outset. 
2. Caremark was further mangled by subsequent decisions. 
3. In recent years, there has been a steady expansion of Caremark liability. 

In my third post, which came somewhat later, I acknowledged that some of my concern had proven unfounded. In particular, VC Laster's subsequent decision with respect to the potential liability of the McDonald's board dismissed the plaintiff's claims against the board and reaffirmed that:

The plaintiffs must do more than plead that the directors responded in a weak, inadequate, or even grossly negligent manner. The pled facts must indicate a serious failure of oversight sufficient to support an inference of bad faith.

So where does this leave us? Insofar as teaching the Caremark doctrine is concerned, what McDonald's adds is simply the proposition that Caremark's oversight duty extends to officers. But so what? As I noted in the first post:

There is a certain logic to Laster's conclusion. After all, in general, Delaware law holds that officers have the same fiduciary duties as directors.

To be sure, I still think the conduct alleged in McDonald's was personally appalling, but did not rise to the level one associates with Caremark liability:

• At least by 2018, the Board was aware of the problems and was dealing with them.
• There is no allegation of pervasive criminal conduct (one of Fairhurst's own acts of misconduct is described as "technically" constituting an assault), especially by the people that Fairhurst was charged with supervising. (Presumably, Fairhurst has no Caremarkduty to supervise himself).
• The problem is not a lack of supervision or oversight, but rather one of inaction in the face of a known problem. The decision of how to handle sexual harassment is a business decision. Fairhurst and the McDonald's C-suite handled the decision poorly but that's not what Caremark is supposed to be about.
• As appalling as Fairhurst and CEO's conduct undoubtedly was, it never posed the sort of existential threat that were involved in Marchand and Boeing. 

But, having said that, I don't think that the opinion's arguably erroneous application of the doctrine to the facts at bar merits inclusion in the casebook. After all, since Bill Klein's first edition of the casebook our book has been intentionally the antithesis of the Cary and Eisenberg approach of including every case that comes along. Keep it lean and clean.

Looking to the future, however, McDonald's potentially could result in a significant expansion of officer (and director) liability unrelated to Caremark:

At the end of the opinion, VC Laster addressed the separate question of whether Fairhurst’s own personal misconduct constituted a breach of his fiduciary duties. Laster concluded that:

When Fairhurst engaged in sexual harassment, he was not acting subjectively to further the best interests of the Company. He therefore was acting in bad faith. The allegations against Fairhurst accordingly support a claim for breach of the duty of loyalty.

VC Laster thereby transformed sexual harassment—and who knows how much more of employment and civil rights law—into cognizable corporate law claims.

To be sure, VC Laster anticipated just such a complaint:

Some might ask whether the Court of Chancery should be hearing sexual harassment claims and worry that recognizing such a claim will open the floodgates to employment-style litigation. ...

... Like an oversight claim, a claim for breach of duty based on the officer’s own acts of sexual harassment is derivative, so all of the protections associated with derivative claims apply.

But so what? Is Laster saying that if Fairhurst had moved to dismiss for failure to make demand on the board per Rule 23.1 that Fairhurst would have won?

I do not see a firebreak between Laster's decision and "employment-style litigation." But I do see a slippery slope.

If that aspect of the opinion is picked up and approved in future cases, I will add a case to the section of the casebook that deals with the subset of the duty of loyalty that deals with the "duty" of good faith.

If you're an adopter of the casebook, let me know what you think.