CURRENT MONTH (June 2023)
Delaware Supreme Court Holds that Tesla’s 2016 All-Stock Acquisition of SolarCity Satisfied Exacting Entire Fairness Review, Ruling in Favor of the Sole Remaining Defendant, Elon Musk
In re Tesla Motors, Inc. S’holder Litig., No. 181, 2022 (Del. June 6, 2023) (Valihura, J.)
By Rebecca E. Salko, Christopher D. Renaud, and Charles R. Hallinan, Potter Anderson & Corroon LLP, and Summer Associate Alaiya Kollie, J.D. Candidate, Emory University School of Law
In this unanimous en banc decision, the Delaware Supreme Court affirmed the Court of Chancery’s post-trial opinion finding that the 2016 all-stock acquisition of SolarCity Corporation (“SolarCity”) by Tesla, Inc. (“Tesla”) satisfied the entire fairness standard of review, resulting in a verdict on all claims in favor of the sole remaining defendant: Tesla’s co-founder, CEO, and former chairman, Elon Musk.
In connection with Tesla’s master plan of transitioning to clean energy, the Tesla board of directors (the “Board”) began discussing the possibility of acquiring a solar company in March 2015. SolarCity, founded by two of Musk’s cousins, was a market leader in that space, dedicated to producing and selling solar panels.
In 2015, SolarCity feared it would soon face a major liquidity crisis. Despite SolarCity’s efforts, including “cash equity” transactions, cost cutting, and a focus on cash sales, the company’s financial difficulties continued.
In February 2016, Musk proposed to the Board a possible merger between Tesla and SolarCity. The Board initially declined to move forward, but it engaged independent advisors in March 2016, including Evercore, to consider potential acquisitions. Later in March 2016, after Musk again raised the idea of a possible merger, the Board declined to move forward with SolarCity, and also determined that Musk must recuse himself from any vote related to a potential transaction with SolarCity. The Board, however, permitted Musk to participate in high-level strategic discussions. In June 2016, Evercore determined that SolarCity was Tesla’s best strategic option for a potential solar acquisition target, and the Board thereafter delivered a preliminary nonbinding proposal to acquire SolarCity subject to due diligence, conditioning the sale on the approval of a majority of Tesla’s disinterested stockholders. The Board did not, however, form an independent negotiating committee. The offer was publicly announced later that month.
In July 2016, due diligence revealed the depth of SolarCity’s financial woes, which Evercore discussed with the Board coupled with a recommendation for Tesla to lower its offer price. On July 30, the Board approved—without Musk’s participation—a decreased final offer, and Evercore presented its opinion to the Board that the offer was fair to Tesla. The definitive merger agreement was executed on July 31, pursuant to which Tesla would pay an equity value of approximately $20.35 per share of SolarCity common stock (or approximately $2.1 billion). In November 2016, Tesla’s stockholders voted overwhelmingly in favor of the proposed acquisition. After closing, this stockholder challenge followed.
Following trial, the Court of Chancery determined that the acquisition was entirely fair. The Court assumed, without holding, that Musk was Tesla’s controlling stockholder, and acknowledged Musk was more involved in the deal process than he should have been. Nevertheless, the Court found that the Board—led by an indisputably independent director—effectively neutralized Musk’s attempts to control the sale process. Regarding fair price, the Court found that Musk presented the most persuasive evidence regarding SolarCity’s value and the fairness of the price Tesla paid to acquire it, largely based on market evidence.
On appeal, the appellants did not challenge the Court of Chancery’s factual findings, but rather challenged its application of the entire fairness standard of review. In essence, appellants argued that the trial court placed too great an emphasis on fair price, and particularly on evidence of market price. The Supreme Court largely rejected appellants’ arguments, with one exception, and affirmed the Court of Chancery’s decision.
First, the Supreme Court affirmed the Court of Chancery’s ruling that the acquisition resulted from a fair process, holding that the Court of Chancery’s fair dealing analysis coincided with (despite not expressly applying) the Weinberger factors—how the deal was initiated, timed, structured, negotiated, and approved—and holding that the record showed that each factor supported the process. Despite Musk’s initial interest in the deal, the record showed that the Board—not Musk—initiated the sale process in earnest. Multiple times, the Board declined to explore the transaction, focusing instead on other opportunities. Additionally, the timing of the deal was right for Tesla, as evidenced by the historically low trading price of solar company stocks.
Despite the absence of an independent committee, the Supreme Court recognized that the deal was negotiated by a majority independent board (led by an indisputably independent director and advised by independent legal and financial advisors) that focused on the bona fides of the acquisition and succeeded in obtaining a lower price; the transaction was approved by a majority of the disinterested stockholders; and Musk recused himself from meetings and the ultimate vote on the transaction. In doing so, the Supreme Court continued to encourage the use of special negotiation committees as a “best practice,” but rejected any suggestion that the Board was required to form one.
The Supreme Court next affirmed the Court of Chancery’s holding that the stockholder vote was fully informed. In particular, the Court held the record showed that: (i) Tesla sufficiently disclosed Musk’s involvement; (ii) Musk’s optimistic statements about Tesla’s future commercialization of SolarCity were purely prospective and not created to secure votes; (iii) SolarCity’s undisclosed liquidity risk was generally known by the market and thus was not material; (iv) SolarCity’s credit downgrade was immaterial because, among other reasons, the change left SolarCity’s largest creditor undeterred; and (v) the fact that some of Tesla’s stockholders also held SolarCity stock was immaterial, because most of that group held a larger stake in Tesla than in SolarCity.
Next, the Court held that the Court of Chancery did not reversibly err in ruling that the acquisition price was fair. As an initial matter, the Supreme Court rejected appellants’ argument that the Court of Chancery applied a bifurcated fairness analysis in which fair price alone satisfied entire fairness. The Supreme Court held, however, that the Court of Chancery erred in comparing the purchase price to the unaffected stock price as of the date the acquisition was announced by Tesla, because the stock price on that date did not reflect material, non-public information concerning SolarCity’s liquidity problems and credit downgrade. Nevertheless, the Court held that the record supported the Court of Chancery’s fair price determination because appellants relied solely on an insolvency theory of valuation that lacked credibility. Moreover, the record revealed that (i) Evercore’s fairness opinion supported the purchase price; (ii) using a retained value methodology indicated substantial future cash flows; (iii) the acquisition provided value in the form of non-speculative synergies that reduced costs; and (iv) some market evidence supported the price, such as the efficiency of the market and the overwhelming stockholder approval of the acquisition.
The Court concluded by affirming the Court of Chancery’s decision, finding that Tesla’s acquisition of SolarCity satisfied entire fairness scrutiny, and the transaction was therefore entirely fair.
Delaware Court of Chancery Finds Therapeutic Governance Reforms Insufficient and Rejects Settlement in Executive Compensation Derivative Suit
Knight v. Miller, C.A. No. 2021-0581-LWW (Del. Ch. June 1, 2023) (Will, V.C.)
By Timea Soos
On June 1, 2023, in Knight v. Miller, the Delaware Court of Chancery declined to approve the settlement terms in the executive compensation derivative suit filed against the directors and officers of Universal Health Services, Inc. In a letter opinion, Vice Chancellor Lori W. Will found the targeted governance reforms inadequate, noting, “The slight governance enhancements that form the ‘get’ are inadequate consideration in view of the ‘give’ of the release of claims.”
The Court recognized the variation in settlement terms in cases brought after the Delaware Supreme Court’s In re Investors Bancorp decision. There, the Delaware Supreme Court held that the entire fairness standard applies when reviewing non-employee director awards due to the inherent conflict of interest involved when directors set their own total compensation. The Court noted that approved settlements since Investors Bancorp have resulted in “meaningful improvements like fixed caps on compensation.”
Here, however, the Court found a “more extreme scenario” with inconsequential governance enhancements that did not require the adoption of meaningful caps on director compensation by the board. During the December 15 settlement hearing, Vice Chancellor Sam Glasscock III had suggested the parties “talk about whether there is something more tangible that can be done in the way of corporate governance.”
The oversight role played by the Court requires the balancing of the “give” and the “get” when approving derivative settlements. These settlements provide for governance reforms benefiting the company in exchange for the dismissal and release of claims. The Court concluded that without binding governance reforms, such as Compensation Committees being required to follow the guidance of outside counsel within the bounds of their respective fiduciary duties, the governance enhancements remain “precatory.”
Timea Soos is an incoming Law Clerk to the Honorable Judge Vivian Medinilla. She clerked as an ABA BLS Diversity Clerk to Justice Tamika Montgomery-Reeves at the Delaware Supreme Court and externed for Vice Chancellor Sam Glasscock III at the Delaware Court of Chancery.
California Federal Court Invalidates California’s Board-Diversity Statute
The U.S. District Court for the Eastern District of California Federal concluded that the 2020 California Assembly Bill 979, which required public companies headquartered in California to have a minimum number of directors from designated groups that the legislature viewed as historically underrepresented, was unconstitutional on its face. The Alliance for Fair Board Recruitment (a nonprofit organization composed entirely of persons who do not self-identify within any of the designated groups) challenged the law, alleging violations of the U.S. Constitution’s Equal Protection Clause and 42 U.S.C. § 1981.
Siding with the challengers, the court invalidated the bill, holding that the bill facially violated the Equal Protection Clause because it imposed “a racial quota,” despite Supreme Court authority prohibiting such quotas, “as it requires a certain fixed number of board positions to be reserved exclusively for certain minority groups.” The court also ruled that the statute violated § 1981, because, under Supreme Court precedent, “a violation of the Equal Protection Clause of the Fourteenth Amendment also constitutes a violation of § 1981.”
Finally, the court held that the unconstitutional language could not be severed from the bill because without it the bill would no longer be coherent. Further, the Court held that the language of the statute, its main purpose to remedy racial and ethnic discrimination, and the lack of a severability clause collectively indicated that the legislature would not have adopted the remainder of the bill had it foreseen partial invalidation. This Alliance for Fair Board Recruitment decision stands to impact other challenges to statutory or rule-based efforts to diversify corporate boards, including pending appeals on the same and similar bills in California.
Delaware Court of Chancery Rules that Corporations Seeking Written Consent of Stockholders to Mergers Must Give Notice of Appraisal Rights Twice, with the Second Notice Triggering the 20-Day Period to Demand Appraisal
By James G. McMillan, III, Esq.
Visit Business Law Today’s June 2023 in Brief: Business Litigation & Dispute Resolution to read the full entry on this ruling.