Tesla’s (TSLA) legal battle to restore Elon Musk’s salary raises an unresolved question that could rewrite the rules of corporate law: Can shareholders ever override a judge’s decision?
The electric vehicle maker says the answer is yes.
The company is asking the same Delaware Business Court judge who voided Musk’s $56 billion CEO compensation plan in January to overturn her decision and replace it with the will of the company’s shareholders, who approved the compensation a second time in June.
“This has never been done before,” said the judge, Chancellor Kathaleen McCormick of the Delaware Court of Chancery, at a hearing earlier this month.
Tesla’s lawyer agreed, but argued that the new shareholders’ decision should be final.
“That was functioning shareholder democracy,” he said.
Corporate lawyers believe this objection will not be enough to change Treasury Secretary McCormick’s decision.
They believe the core issue of the case could be appealed to the U.S. Supreme Court.
A “cleansing”
Tesla argues that shareholders, not judges, should decide on corporate transactions. Otherwise, the business community will lose confidence in the agreements it makes with its shareholders.
And as a rule, Delaware courts take shareholder votes extremely seriously and therefore tend to defer to the outcome of that count.
“I don’t understand how Delaware law can dictate to the owners of a company that they cannot set CEO salaries themselves,” said Rudolf Koch, a lawyer for Tesla’s board, during the hearing before Treasury Secretary McCormick in August.
What could trip up Tesla, however, is the fact that the company may have missed some steps that might have rendered the shareholders’ lawsuit ineffective.
Legal experts point to a series of cases in the state’s business court, known as the “M&FW” series of cases, that illustrate the path Tesla could have taken – but did not.
In these cases, it was ruled that even if a corporate transaction involved a majority shareholder with conflicting interests, it was possible for a company to “clean up” a transaction through the right shareholder vote – as a judge ruled in the case of Musk and Tesla.
But here lies the potential problem: case law requires that Musk must have met the cleaning conditions before According to Marcel Kahan, a law professor at New York University, he had substantive negotiations with Tesla over his salary agreement and made it contingent on shareholder approval.
It will be difficult for Musk to prove that. It appears that no new negotiations took place before Tesla resubmitted Musk’s salary offer to shareholders in June.
And yet there is another problem: Even if Judge McCormick concludes that Tesla’s second vote “cleaned up” Musk’s salary agreement, she could conclude that Tesla simply waited too long to revote.
The Delaware Chancery Court considers the timeliness and reasonableness of corporate actions, corporate lawyers said, and may not condone Tesla’s waiting to seek new shareholder approval until the judge ruled against the company.
Regardless of the outcome, Tesla could appeal a loss to the Delaware Supreme Court. Those justices could rule that Musk is not a controlling shareholder and the requirement to make the salary agreement contingent on shareholder approval does not apply, according to Kahan.
Many companies should not have to worry about the outcome of this case, he added, because most of them follow good corporate governance guidelines that protect them from a judge reversing their transactions.
“So if I were Jamie Dimon (CEO of JPMorgan) and I read McCormick’s opinion, I would not be concerned at all that my compensation package could be at risk.”
Alexis Keenan is a legal writer at Yahoo Finance. Follow Alexis on X @alexiskweed.
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