Her ruling could cost Tesla over $10 billion

This article is compiled from Sina Technology.

Jack Ma is very angry, and the problem is serious.

Elon Musk has been feeling a bit frustrated recently because he lost a crucial lawsuit that directly affects his personal wealth of $56 billion, which could ultimately result in a loss of over $10 billion.

As a controversial figure in the business world, Musk is accustomed to facing various lawsuits. His team of lawyers has been handling all kinds of litigation cases for years, and Musk himself often has to testify in court, earning him the title of "battle-hardened Buddha".

In lawsuits, there are winners and losers. Over the past few years, Musk has won many important lawsuits. In 2016, Tesla shareholders sued Musk over the acquisition of SolarCity, which was accused of being driven by personal interests. In 2018, a British diver sued Musk for defamation in a claim related to "pedophilia". In the same year, Tesla shareholders filed a claim against Musk for his tweet announcing the privatization of the company. Musk ultimately had the last laugh, avoiding astronomical compensation payouts time and time again.

However, there are also times when Musk admits defeat. In 2022, when the Twitter board of directors sued Musk for breach of contract, Musk, who was destined to lose, chose to give up and directly acquired Twitter at the agreed price of $44 billion, even though its valuation had halved. After various subsequent operations, based on the latest valuation of X platform, Musk has lost over $30 billion in this transaction.

Losing the most important lawsuit

But this time, Musk lost miserably because it directly affected the core component of his personal wealth - his stake in Tesla.

Last week, Judge Kathaleen McCormick of the Delaware Chancery Court ruled that there were serious flaws in the process by which the Tesla board of directors granted Musk his compensation agreement. As a result, she rejected this multi-billion-dollar compensation and ordered the Tesla board to reconsider the compensation plan for Musk.

Obviously, Musk is very frustrated with this ruling and has been publicly criticizing the female judge on his X platform (formerly Twitter). Musk has openly launched an investigation, questioning whether he should move Tesla's registration from Delaware to Texas, where the actual headquarters is located. He also mocked McCormick, saying, "The damage she has caused to Tesla exceeds that of any judge in modern history."

This is not the first time that 45-year-old Judge McCormick has presided over a lawsuit involving Musk. She also presided over the lawsuit filed by the Twitter board of directors against Musk for breach of contract in 2022. However, knowing that he was bound to lose, Musk chose to give up resistance at the last moment and proactively contacted the Twitter board of directors to complete the acquisition at the original price.

Due to repeated investigations and restrictions by the U.S. Securities and Exchange Commission (SEC), Musk publicly berated the SEC as "shameless puppets of Wall Street short-sellers". As the Institutional Shareholder Services (ISS) recommended that Tesla shareholders vote against Musk's compensation plan, Musk even angrily denounced ISS as the terrorist organization ISIS. In contrast, Musk's mockery of McComick can be considered quite restrained.

Sky-high Incentive Plan

It is necessary to explain the related lawsuits triggered by this compensation agreement. In the summer of 2018, Musk reached a salary plan with Tesla's board of directors: Musk voluntarily gave up all salary and bonuses, and only received a salary of $1 (only for tax purposes). However, if Musk can lead Tesla to achieve various expected targets such as performance and market value, he will receive options equivalent to 20.3 million Tesla shares in 12 installments (about 12% of Tesla's outstanding shares).

Of course, Tesla's board of directors has set clear performance targets for this: Tesla needs to reach a minimum threshold of a market value of $100 billion for this compensation plan to take effect. After that, for every $50 billion increase in Tesla's market value (up to $650 billion), Musk can receive options incentives for 1.69 million shares of stock, equivalent to 1% of Tesla's market value. And after these options are exercised, there is a five-year lock-up period.

In fact, at that time, this compensation did not cause much controversy. After all, Tesla was still in its most difficult period at that time, with difficulties in mass production of Model 3, delayed scale delivery, rapid cash consumption, and even the risk of running out of funds. Tesla's stock also attracted short sellers in the stock market and became the biggest target for short selling.

Perhaps no one at that time would believe that Musk could actually achieve all these performance targets one by one and obtain all the incentive options agreed upon at the beginning. But it seems that Musk really believed it. At the beginning of that year, he publicly stated to the media that he believed Tesla's market value would exceed $1 trillion in the next ten years.

Perhaps Musk himself did not expect that just three and a half years later, Tesla's market value would surpass $1 trillion. With the exercise of these incentive options one by one, Musk's personal assets skyrocketed from $20 billion to over $200 billion at one point, surpassing Bezos to become the world's richest person.

The skyrocketing Tesla stock price is certainly beneficial to investors, so why are there shareholders suing Musk?

In fact, this lawsuit is somewhat symbolic, not because they envy Musk becoming the richest person, but because of "procedural justice". As early as 2018, a Tesla shareholder named Tornetta filed a shareholder derivative lawsuit against Tesla and Musk, believing that Tesla's board of directors at that time did not operate independently, blindly obeyed Musk, and provided misleading information to shareholders. He filed a lawsuit, asking the Delaware Chancery Court to revoke the incentive compensation granted by Tesla's board of directors to Musk.

It is worth mentioning that the plaintiff Tornetta only held 9 shares of Tesla stock at that time. He is a drummer in a heavy metal band in Philadelphia. Obviously, the lawyers who are willing to represent this lawsuit do not expect Tornetta to pay for it, but plan to win the lawsuit and let Tesla and Musk pay at least millions of dollars in legal fees. But even if the lawsuit is lost, these lawyers have gained enough publicity from this high-profile lawsuit.

In the United States, there are often investors who hold symbolic shares and file lawsuits against listed companies. Usually, these lawsuits are quickly dismissed or settled. However, the Delaware Chancery Court rejected Tesla's motion in 2019 and approved the lawsuit to proceed to the trial stage. In the end, at the end of 2022, it brought the world's richest person, Musk, from the West Coast to Delaware to participate in the trial, and stayed in court for a full three hours. Special Status of Delaware

Tesla's headquarters used to be in California, but it moved to Texas after the pandemic. It doesn't have much business in Delaware, so why is it being tried in this state? It is necessary to explain the special status of the Delaware Chancery Court in commercial litigation in the United States.

On the map of the United States, Delaware, located on the northeast coast, is inconspicuous. It is the second smallest state in terms of land area, with a land area similar to that of Shanghai, and a population of only 1 million. However, Delaware was one of the first states to join the federal government and is known as the "First State" of the United States. The current President of the United States, Joe Biden, is also from here.

Due to its small size, Delaware accounts for less than 0.4% of the U.S. GDP. However, it is not an exaggeration to say that Delaware is the commercial center of the United States. Over 90% of U.S. companies are registered in Delaware. In addition to factors such as a sound corporate legal system and favorable registration taxes, the Court of Chancery, established in 1792, is also an important attraction.

The majority of companies registered in Delaware do not actually conduct business in the state and have almost no commercial interests here. Therefore, the Delaware Chancery Court does not show bias towards local companies, and its fairness and impartiality can be fully trusted. It is the most reliable commercial court in the United States.

In fact, every corporate law course in U.S. law schools involves cases and judgments from the Delaware Chancery Court. Almost all well-known commercial lawyers in the United States are familiar with Delaware's corporate laws and the Chancery Court. To some extent, Delaware companies have become the de facto national standard for corporate law in the United States. The predictability of judgments from the Chancery Court here is unmatched by other states.

Elon Musk is certainly not unfamiliar with Delaware. In the past few years, he has appeared in court here almost every year. From Tesla's acquisition of SolarCity, to retracting the decision to acquire Twitter, to not timely disclosing his holdings in Twitter, many of Musk's controversial actions have led to civil lawsuits. And Delaware is the preferred venue for these lawsuits.

Judge Andre Bouchard, a graduate of Harvard and the University of Notre Dame, served as a corporate lawyer in Delaware for many years. In 2018, he was nominated to be one of the seven judges of the Chancery Court and three years later became the first female Chief Justice in the 230-year history of the Delaware Chancery Court, making her the highest court in practice for U.S. corporate law litigation.

Questioning the Board's Performance

So why did Judge Bouchard reject the compensation plan given to Musk by the Tesla board?

In her ruling, she explained, "(The Tesla board) approved Musk's compensation plan in a process that had serious flaws... Musk is a superstar CEO who holds the most influential positions in Tesla as CEO, Chairman, and co-founder, and has close ties to the Tesla board members who approved his compensation plan... He dominated the entire process of the board's approval of his compensation plan."

During the trial at the end of 2022, Musk stated that it was in 2018 when the Tesla board discussed granting him this stock option incentive plan, and he did not participate in it. He also refuted the claim that the Tesla board at that time consisted of his relatives and friends. Elon Musk stated that he was fully focused on running Tesla at the time and even considered stepping down as CEO. However, Musk himself had to admit that this compensation plan was like bargaining with himself.

Evidence presented by the plaintiff's lawyer showed that Musk, who was then the Chairman and CEO of Tesla, had sent a text message to the Chairman of Tesla's Compensation Committee as early as April 2017, proposing this compensation structure and expressing his desire to obtain 10% of Tesla's shares through the incentive plan. Moreover, in June of that year, Musk personally attended a Tesla board meeting regarding his exorbitant compensation.

Robyn Denholm, the former independent director of Tesla and current Chairman, testified that Musk claimed he needed the largest compensation in history in order to accelerate his goal of "interplanetary travel." Musk was forced to step down as Tesla Chairman at the end of 2018 due to a tweet about privatization, and Denholm took over as Chairman.

However, Denholm emphasized that Musk did not force the Tesla board to approve this compensation plan, as it was a decision made independently by the board. She stressed that without Musk, Tesla would not be where it is today, and the reason for giving Musk this astronomical incentive plan was to ensure his long-term focus on Tesla's operations.

Jill Fisch, a professor at the Wharton School of the University of Pennsylvania, commented that the key to the judgment of this lawsuit lies in whether Musk was a controlling shareholder of Tesla at the time and whether he had significant influence over the Tesla board, and whether the Tesla board took sufficient measures to protect the rights of minority shareholders.

In fact, Judge MacKenzie questioned whether the Tesla board, at that time and now, always obeyed Musk's orders and became Musk's rubber stamp, without fulfilling the board's oversight responsibilities.

From this perspective, this judgment may have a significant impact on corporate governance in the United States, as most of the major corporations in the United States are registered in Delaware. After Musk received this astronomical incentive compensation, other giant companies like Intel also provided their CEOs with performance-based astronomical compensation. However, not every CEO can receive as much literal compensation in return.

Appeal or Change of Registration

After losing the lawsuit, what will Musk do next?

Musk has the right to appeal within 30 days to the Delaware Superior Court, but many legal experts believe that Musk's chances of winning the appeal are not high. This is because the Delaware Superior Court usually only evaluates whether the Chancery Court judge applied the correct law and does not evaluate the judge's specific ruling itself.

Instead of appealing, Musk is more likely to change the company's place of registration. He has recently publicly stated his intention to move Tesla's registration from Delaware to Texas and plans to hold a shareholder vote as soon as possible. Compared to Delaware, Texas laws are more inclined to protect the interests of companies and business leaders. Among the Fortune 500 companies, 55 have already chosen to register in Texas. Moreover, Texas is actively attracting more companies and competing with Delaware. Recently, Musk has been publicly pressuring the Tesla board to grant him double voting rights (he currently holds 13% of the shares and wants 25% of the voting rights). Musk stated on X platform that without sufficient voting rights, he cannot lead Tesla to become a leader in the artificial intelligence and robotics industry. If he cannot achieve his goal, he would rather develop products outside of Tesla.

Obviously, if the Tesla board agrees to give Musk 25% of the voting rights, shareholders like Tornetta will definitely file lawsuits again, accusing the Tesla board of blindly following Musk's orders and failing to fulfill their duty to protect shareholders' interests.

When the compensation plan was originally formulated, Musk still held 22% of Tesla's shares. However, due to continuous selling of Tesla stocks to cash out for the acquisition of Twitter and to pay astronomical taxes for exercising options, Musk's current stake has dropped to 13%. From the end of 2021 to the end of 2022, Musk has sold Tesla stocks and cashed out $39 billion.

Unlike the peak two years ago when Tesla's market value exceeded $1 trillion, the company's stock price is currently at a low point. Since the beginning of this year, Tesla's stock price has fallen by nearly a quarter, and its market value has dropped below $600 billion. But this is mainly due to the pessimistic growth prospects of Tesla. After releasing its earnings report recently, Tesla warned that its sales growth this year may significantly slow down.

Previously, some investors called for the establishment of a new compensation and incentive plan for Musk, and Musk publicly responded with approval. However, the new incentive targets have not been announced, and the previous compensation plan was rejected by the Delaware Chancery Court.

Some corporate law experts predict that given the current performance and stock price trend, the Tesla board may significantly reduce the size of the options granted to Musk in the previous incentive plan and be more cautious in the new incentive plan.

A rock-loving retail investor who holds only 8 shares but is particularly persistent, and a female chief justice who is the first in the history of the Tesla Chancery Court, may cause Musk's personal wealth to shrink by more than $10 billion.