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EDITORIAL: Mr. Musk, the shareholders and the Delaware court question

Katie Tabeling

Editor Katie Tabeling weighs the question of how much impact Delaware’s Court of Chancery’s moment in the spotlight matters on incorporation tax.. | PHOTO COURTESY OF TINGEY INJURY LAW FIRM/UNSPLASH

So ends one high-profile national matter that gripped Wilmington — the Hunter Biden trial and so begins a new one. 

Elon Musk, the celebrity CEO of electric car company Tesla, space rocket company SpaceX and, as of 2022, the owner of social media site X (formerly known as Twitter) is back and he’s bringing Delaware in the spotlight once more.

On June 13, Tesla shareholders held its annual meeting, and the major topic of discussions is whether or not it should reinstate Musk’s $44.9 billion pay package. The board has voted in his favor, even though the issue still is likely to be settled in court.

And much like it was three years ago, Musks’ battle was kicked off by a Delaware Court of Chancery ruling. In January, Chancellor Kathaleen McCormick ruled on a five-year-old matter when shareholders sued Musk and the board of directors on breaching fiduciary duties. 

The shareholder’s lawyers successfully argued that the compensation package was the product of “sham negotiations” with directors with Musk, and the other shareholders were given misleading and incomplete information.

Even though the shareholder vote is being held in person in Texas, the national media has yet again turned its attention to Delaware. With the Chancery Court quickly issuing decisions on corporate matters that have far-reaching impacts across America.

SDespire the outcome, the heat lamp will stay in Delaware, as the Chancery Court continues to shape what it means to be a controlling shareholder.

Reports from Bloomberg legal correspondents and other analysts I’ve talked with note that the Tesla case, and others with TripAdvisor and Sears Hometown and Outlet Stores, Inc., have worked to really set the definition of what it means to be a controlling shareholder. 

In February, Vice Chancellor J. Travis Laster ruled that TripAdvisor may move its incorporation to Texas, but the company still would have to face shareholder lawsuits over it. It’s what Brian Quinn, a Boston College law professor focused on corporate law, called “an exit tax” in exchange. 

Similarly, the court issued an opinion in a case where the board of directors for Sears had attempted to liquidate one of its business segments and hold onto its outlet business. But its majority shareholder and former Sears Holdings CEO Eddie Lambert pushed against it, but he leveraged his controlling interest to change the process for securing board approval – and he pushed out two directors in the process. The eventual deal that led Lampert’s investment fund to buy the company brought on a lawsuit from minority shareholders.

Laster’s ruling on that case caught attention for confirming that stockholders can act in their interests, unlike directors, so long as they do not harm the company.

“Directors, by contrast, must act affirmatively to promote the best interests of the corporation, and they must subjectively believe that the actions they take serve that end. A controller need not meet that higher standard when exercising stockholder-level voting rights,” Laster wrote.

It’s a complex task to navigate these fine lines set in these cases on whether some deals require more scrutiny. It’s also why many of the best corporate litigators practice in Delaware, and argue before some of the more seasoned legal minds in the country. It’s not a black or white issue, although it would probably be easier on journalists like me if it was.

This gray area appears to be vexing companies, much like TripAdvisor and, yes, Tesla, enough to consider moving incorporation to Texas and Nevada. Musk has made his opinions very clear when he blasted the First State many times on X and held several polls on the issue. Tesla’s board of directors is set to vote on the potential move today.

Nevada and Texas have been working for decades to set up a welcoming legal system. Nevada in particular, offers a lower tax rate. TripAdvisor reported to shareholders it would pay $1,725 in annual fees as there is no corporate tax in Nevada. In Delaware, the company paid $250,725 in taxes in Fiscal Year 2022.

Obviously, Delaware officials are nervous about Musk’s complaints about the First State since the franchise tax and the corporation income tax are major drivers to the state. In FY 2023, corporate income tax brought in $457.4 million. The Delaware Economic and Financial Advisory Council noted that it was up by $6 million as of the May meeting. Franchise taxes brought in $1.8 billion in FY 2023.

But here’s the thing: Delaware’s system can trace back to 1899 – that means there’s more than a century of case law that has shaped corporate case law which continues to be cited in courts all over the county. Its laws are reviewed every year by the state bar to keep it up to date, and address risks to stockholders without opening the company to frivolous lawsuits.

Nevada and Texas may be responding to recent events to cater to company officers and offering more protections afforded in Delaware. But Delaware’s reputation sets it above the rest for a reason. It should be noted that other lawyers have noticed the stark difference between the three states: lawyers who filed the original complaint against TripAdvisor cited numerous academic studies that called Nevada’s path on corporate law as “a race to the bottom.”

What does the relocation question posed by Musk mean for Delaware’s financial picture? We’ll have to see what the future holds.

Editor’s note: A print version of this editorial was written before the Tesla shareholder meeting on June 13.

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