The world’s richest man had a pretty good April. First, he announced he had financing for a $44 billion takeover of social media platform Twitter. Then he capped off the month with a resounding victory in a legal dispute over Tesla’s 2016 SolarCity acquisition, accusing him of all manner of self-dealing, deception and breaches of fiduciary duty.
Such is life for Elon Musk, the visionary billionaire entrepreneur.
But his celebrations may be short-lived, according to some observers. There is widespread discomfort with the idea of Musk owning a de facto public square, and people have suggested the deal might not go through. The picture with SolarCity also might not turn out as rosy for Musk as it currently appears.
Some attorneys and legal scholars suggest that the Delaware judge who made the ruling based his decision on twisted logic, leaving it vulnerable to be overturned on appeal. At the end of the day, both situations could end up being costly for Musk, with a $1 billion break fee if the Twitter acquisition doesn’t go through, and potentially billions of dollars still potentially on the line in the SolarCity case.
What the shareholder suit exposed
Why was SolarCity in particular such a potentially ugly mess for Musk? According to legal scholars, the shareholder lawsuit shed light on how Musk aggressively dominates and influences supposed independent boards of his companies, even after businesses go public. It also illustrated, according to scholars and attorneys, how Musk thumbs his nose at conventional corporate governance and regulators.
”We have a system that I call insider capitalism, and Musk is the poster child for insider capitalism,” said Stephen F. Diamond, associate professor of law at Santa Clara University, who advised some of the institutional investor plaintiffs in the SolarCIty case. “At the end of the day, he's able to bulldoze his way through any way he wants.”
If the ruling is revised, it will likely intensify criticism of Delaware’s Chancery Court, the battleground for the shareholder suit. The court has frequently come under fire for unfairly favoring corporations over shareholders. In fact, the leanings of the court and the state’s favorable corporate tax treatment are big reasons why so many companies are registered in Delaware.
“The state of Delaware survives on the franchise tax,” said Diamond. “And the Delaware chancery courts’ reputation is linked to the franchise tax. Every corporate lawyer in the country will tell clients they want to be incorporated in Delaware because the Chancery Court is friendly to management.”
Certainly to the layman, the Tesla/SolarCIty deal seems fraught with familial conflicts, secret negotiations, bad faith communications, and deceptive practices. SolarCity, after all, was founded by Musk’s cousins. The judge in the case, Joseph R. Slights III, acknowledged the issues in his 132-page decision.
“The process employed by the Tesla Board to negotiate and ultimately recommend the acquisition was far from perfect,” Sights wrote. “Elon was more involved in the process than a conflicted fiduciary should be.”
In another passage, the judge said “Elon was undoubtedly involved in the deal process in ways he should not have been.”
Did the judge overlook flaws?
And yet, to the amazement of the plaintiffs - which included institutional investors the Arkansas Teacher Retirement System, Boston Retirement System, Roofers Local 149 Pension Fund, Oklahoma Firefighters Pension and Retirement System, and KBC Asset Management NV, among others - the judge overlooked all the admitted flaws in the process and found that since the price Tesla paid for SolarCIty was fair, in his opinion, the allegations were moot.
“It was a mistake,” said Diamond. “It was remarkable how in my eyes, he could acknowledge that Musk had his fingers in every little piece of this deal from start to finish, and yet somehow he magically no longer had his thumb on the scales when it came to affecting the price.”
The roots of the case began in 2016 when Tesla announced in a blog post it had made an offer to acquire SolarCity and two months later said an all-stock offer was a accepted in a deal that valued SolarCity at around $2.6 billion, or between $25.37 and $25.83 per share. The boards at both companies had unanimously approved the transaction, a fact that the judge in the case seemed to say it was thus independently affirmed.
But it’s unlikely anyone would concede the deal was completely what lawyers call “a clean hands transaction.” Musk founded both companies and was the majority stockholder in both. His cousins, Peter and Lyndon Rive, were SolarCity’s CEO and Chief Technology Officer, respectively, and both were also company directors.
Moreover, SolarCity’s financial health, which was teetering, wasn’t fully disclosed to board members, the plaintiffs contended. It was on the brink of bankruptcy and veering close to tripping covenants it had with creditors. The company had never turned a profit and was more than $3 billion in debt.
It incurred operating losses of $768 million in 2015 and $719 million in the first three quarters of 2016. It was staying afloat through bonds issued by Musk’s other company SpaceX. Thus, shareholders alleged, the SolarCity acquisition was a bailout for six of the seven members of the Tesla board and their family members and business partners, who also owned significant shares in the solar company.
Conflicts laced throughout the deal
The plaintiffs and their attorneys contended that the judge’s findings that the transaction was independently reviewed by the Tesla board should be discounted because the members were either related to or indebted to Musk.
They pointed most harshly to the case of Robyn Denholm, chair of the Tesla board’s audit committee and a member of its compensation committee. Court testimony showed there were no board minutes that gave her authority to negotiate the SolarCity transaction, as was contended.
There was no record of any reports she gave to the board about her negotiations and she admitted she knew nothing about meetings Musk was having with management about the transaction.
She acknowledged in testimony that she was never told that SolarCity needed the deal to meet its liquidity requirements. Denholm, according to her bio, did not have a full time job from 2016 to 2017 and was paid about $7.2 million and $5 million for those years, respectively, as a Tesla director.
Musk contended none of this mattered. That acquiring a solar energy company was always part of his “Master Plan” for Tesla and ultimately the price Tesla paid for the solar company was fair and the judge concurred, though based some or his conclusion on how Tesla stock has performed since the SolarCity deal was consummated.
The legal case seemed to boil down to whether Musk, with nearly a 22% share of Tesla’s stock, really controlled the board of directors.
“Musk is the kind of figure that boards, and shareholders, might be afraid to buck because he can’t be dislodged,” said Ann Lipton, a professor at Tulane University Law School. “He in fact testified that Tesla would ‘die’ without him and he can send Tesla’s stock price tanking with a single tweet.”
Lipton agrees that the judge’s decision seemed to discount a high level of conflict and self-dealing but nonetheless found believed the ultimate transaction was fair to shareholders.
“I’m not good at predicting but there’s quite a mountain to climb from the plaintiffs to succeed on appeal,” she said. “The Supreme Court in Delaware is historically loath to overrule Chancery decisions.”