In re Tesla Motors Stockholder Litig., 2023

This was an appeal of an April 2022 Chancery Court opinion. At issue was the 2016 stock  acquisition of SolarCity Corp. by Tesla Inc. Tesla’s shareholders claimed that Elon Musk  caused Tesla to overpay for SolarCity through his alleged domination and control of the  Tesla board. Their primary theory of liability at the trial was that SolarCity was insolvent at the time of the acquisition. The Court of Chancery assumed Musk had control of Tesla and, therefore, applied Delaware’s most stringent standard of review: entire fairness. 

The Court of Chancery found the acquisition to be entirely fair. In the appeal, the parties  disputed the degree of importance that the Court of Chancery had on market evidence in  determining entire fairness. The parties did not challenge any of the Court of Chancery’s  factual findings. They raised only a legal challenge focused on the entire fairness test. The  Supreme Court, after a detailed review of the extensive trial record, ruled that the Court of  Chancery committed no reversible error in applying the entire fairness test.  

Both appellants and amicus curiae contended that the Court of Chancery based its ruling  “almost exclusively on the unaffected June 21, 2016, stock price of SolarCity, which they  say was unreliable due to material, nonpublic information that was not factored into the June  21 stock price.” Although the Court of Chancery erred in this portion of its analysis, it was  not the Court of Chancery’s sole basis for its price determination, and any error in this regard  was not worthy of reversal. Other bases were sufficient to support the opinion, especially  with the collapse of the appellants’ insolvency theory. Affirmation was also driven, in part,  by “the numerous unchallenged credibility and factual findings underpinning the trial court’s  determination that certain process flaws did not predominate or cause the process either to  be unfair or to infect the price.” 

The appellants did not argue for their insolvency opinion on appeal. “Instead, they now  accuse the trial court of ‘rote reliance’ on market price, applying a bifurcated entire fairness  test, refusing to consider the trial experts’ discounted cash flow (‘DCF’) analyses in  determining fair price (even though they disclaimed reliance on this methodology at trial),  and improperly relying on Evercore’s ‘flawed’ analyses and on the stockholder vote in  support of its determination that the transaction was entirely fair. We reject each of these challenges.” 

The parties.

The appellants were certain Tesla stockholders the Court of Chancery selected  to serve as co-lead plaintiffs in the action. Defendant and appellee Musk was co-founder of  Telsa and its largest stockholder. The Court of Chancery noted Tesla’s reliance on Musk and that his departure would likely disrupt operations among other things and negatively  impact its business. 

The nominal defendant, Tesla, was a well-known electric vehicle design sales and manufacturer. SolarCity, a nonparty, was a publicly traded Delaware corporation Musk’s  cousins founded in 2006. They developed and sold solar panels. Musk was the chairman  and its largest shareholder (21.9%).  

Nonparty SpaceX “bought $255 million in SolarCity corporate bonds—termed ‘Solar  Bonds’—between March 2015 and March 2016.” All seven Tesla board members were  named as defendants, but they all settled, except for Musk, for $60 million funded by  insurance. All of the Tesla board members were conflicted in some manner regarding the  acquisition and SolarCity. 

Tesla’s master plan. In 2006, Musk wrote the “Tesla Motors Master Plan,” wherein he  publicly declared that “Tesla’s mission is to accelerate the world’s transition to sustainable  energy” and “to help expedite the move from a mine-and-burn hydrocarbon economy  towards a solar electric economy.” SolarCity was to be a part of a vertical integration of the  master plan. 

Tesla prior to the acquisition. In addition to its EV production and sales, Tesla also built a  plant to manufacture lithium-ion batteries (Gigafactory (located near Reno, Nev.)). With the  factory in production, Tesla had the opportunity to move forward with its plan for solar energy  storage for residential and commercial use. It launched Tesla Energy in 2015. 

SolarCity prior to the acquisition. 

SolarCity’s business. Founded in 2006, it brought solar panels to market. Because of the  high cost of the panels, SolarCity would pay for installation and finance the balance over 20 to 30 years. This took capital that SolarCity was able to obtain with a sophisticated capital  markets team. “The Solar Bonds, which SolarCity mainly sold to SpaceX and Musk, were  another key component of the capital raising plan.” SolarCity was very successful and had  a total U.S. market share of 15%. 

SolarCity’s financial outlook. For several reasons, by 2015, SolarCity could soon face a  liquidity crisis. “But management predicted that cash levels could fall to just $35 million, and  SolarCity’s war chest of cash—which was $1.1 billion in January 2015—was expected to be  just $200 million by 2015’s end.” SolarCity used a plan of cash equity transactions in  December 2015 to help with liquidity. Initially, it proved successful. “By the second quarter  of 2016, SolarCity had accumulated what it estimated to be $2.2 billion (net present value  or ‘NPV’) in retained value.” But it still lacked the needed capital to meet the four-year plan. The company’s credit rating was downgraded by the end of 2016. Nevertheless, the Court  of Chancery found SolarCity to still be a valuable company in 2016. 

Musk’s initial pitch for the acquisition. After a February 2016 emergency meeting to discuss  cash-flow issues, Musk approached Lyndon Rive, Musk’s cousin and SolarCity founder,  suggesting that Tesla should perhaps acquire SolarCity. At a Feb. 29, 2016, meeting,  Tesla’s CFO, at Musk’s request, gave a presentation on a potential merger between the two  companies, noting that SolarCity’s stock traded at a historically low price. 

While not approving moving forward on SolarCity, the Tesla board did “authorize  management to gather additional details and to further explore and analyze a potential  transaction with SolarCity or other related businesses.” 

SolarCity’s worsening financial outlook. SolarCity’s cash position continued to deteriorate.  By the end of April 2016, SolarCity was in jeopardy of violating its loan covenants. It experienced employee turnover as a result of the cash position. In a May meeting, Lyndon  told Musk he wanted to move forward with a merger. Musk and Lyndon discussed and  agreed to a needed bridge loan to SolarCity. 

The acquisition’s negotiating process. 

Tesla retains independent advisors. In March 2016, Tesla retained Wachtell, Lipton, Rosen  & Katz as deal counsel. It also engaged Evercore Partners as financial advisors. As it moved  forward toward the deal, the Tesla board decided that Musk and board member Gracias  should not be allowed to vote because of conflicts but could take part in the discussions. 

Evercore advised that the market favored a stock-for-stock transaction. The Tesla board  noted the “significant synergies” that a SolarCity merger provided. “Evercore recognized the  need to pay a premium [over the trading price], and recommended a price of $25-$27 per  share. Musk appeared to have suggested a $28 price per share. Musk was not keen on  exchange rates but Denholm [Tesla board member leading the discussions] was in favor of  them.” 

Tesla’s initial offer. The Tesla board, absent Musk and Gracias, “made an offer to acquire  SolarCity at an exchange ratio approved by the Tesla Board of 0.122 to 0.131 shares of  Tesla stock per share of SolarCity stock (the ‘Initial Offer’). This equated to a 21% to 30%  premium over SolarCity’s trading price at the time.” A majority of the minority provision was  included. A bridge loan was not included in the initial offer. Reactions to the initial offer were swift, as the Tesla stock dropped 10% on its announcement. Tesla’s stock eventually  rebounded, but the market’s gut reaction was clear. SolarCity’s credit rating was  downgraded, and it finished the second quarter with a $216 million negative cash flow. Bank  of America continued to lend to SolarCity during this period, and financing counterparties  continued to participate in financing transactions during this period when the appellants  considered SolarCity to be insolvent. 

SolarCity’s special committee (for the acquisition) retained Lazard as financial advisor for the acquisition. “Lazard expressed concerns that the company teetered on the edge of  breaching the Liquidity Covenant and would be operating with little margin of error until  October 2016.” 

Tesla’s negotiating strategy. Tesla’s board chose to vest negotiating power in Denholm  rather than a special committee. “The trial court found Denholm’s mastery over the  negotiations to be critical.” The Tesla board and Evercore remained opposed to a bridge  loan. 

Tesla’s advisors uncover SolarCity’s financial issues. Courtney McBean of Evercore  discovered that Lazard was unaware of SolarCity’s risk of breaching its liquidity covenant  and discussed this with Musk, who was also surprised. To hasten diligence, Musk set up  daily meetings with Evercore. SolarCity’s financial risk became the focus of Evercore.  Evercore, on July 19, 2016, told the Tesla board that SolarCity could violate its covenants  as soon as July 30. Musk then published his Master Plan, Part Deux to communicate directly  with shareholders that Tesla needed a solar company in order to meet its mission. Musk  agreed that SolarCity’s financial situation warranted a lower price but that the deal still made  sense for Tesla. Tesla then offered a lower price with an exchange rate of 0.105 shares. 

The acquisition’s terms and public announcement.

“The final acquisition consideration—0.110 Tesla shares for each share of SolarCity stock—resulted in Tesla  paying an equity value of $20.35 per share of SolarCity common stock or approximately  $2.1 billion at closing.” Risk of a liquidity covenant default before closing still existed. Musk  and the two Rive cousins purchased $100 million of 6.5%, 12-month Solar bonds, which solved the short-term cash needs of SolarCity. 

The Tesla stockholder vote.

Three sets of financial projections of SolarCity performance  were presented in the proxy statement for the merger. They included SolarCity’s base case,  an Evercore sensitivity analysis, and a Lazard base sensitivity analysis. Institutional  Shareholder Services (ISS) advised shareholders to vote in favor, and Glass Lewis and Co.  called it a thinly vailed bailout of SolarCity and advised shareholders to vote against it. 

“[Musk] demonstrated the Solar Roof in a joint Tesla/SolarCity presentation on October 28,  2016, showcasing a future combination of the Solar Roof, solar storage through the  Powerwall, and Tesla EVs powered by solar.” The resulting vote was overwhelmingly (85%)  in favor of the merger. 

Closing.

At closing, SolarCity brought substantial value to Tesla as verified by KPMG and  the fact that Tesla booked an $89 million gain on the acquisition. After closing in early 2017, Tesla faced more challenges. Production delays hampered the rollout of the Tesla EV Model  3. The solar energy was, thus, put on hold. But, as indicated in the master plan, Tesla  became the first vertically integrated sustainable energy company. 

“The court found that ‘[t]he preponderance of the evidence suggests that the acquisition was  and is synergistic.’ It also found that Tesla realized approximately $1 billion in nominal cash  flows and conservatively expected to realize at least $2 billion more from the legacy SolarCity systems. Tesla also achieved significant cost and revenue synergies.” 

Proceedings in the Court of Chancery.

The Court of Chancery determined that the  plaintiff’s burden to plead Musk’s status as a Tesla controlling shareholder was reasonably  conceivable. The Court of Chancery provisionally established entire fairness as the standard of review. Summary judgment was denied, and the case proceeded to trial. All defendants  other than Musk were settled by an insurance payment of $60 million. 

Trial testimony. The appellants provided testimony from three experts: Ronald Quintero,  Murray Beach, and Jeurgen Moessner. A common theme emerged, that of insolvency. The  appellants based their entire case on Quintero’s testimony. He relied on a single valuation  theory: insolvency. Other experts for the appellants did not opine on value. 

Musk presented four experts: Dan Reicher, Jonathan Foster, Frederick Van Zijl, and Daniel  Fischel. Musk’s experts discussed the strategic rationale behind the acquisition, focusing on  the master plan and the acquisition’s ability to catapult Tesla to the next level. Van Zijl  rebutted the insolvency issue, and Fischel testified that the price paid was fair. 

The trial court’s fair dealing findings. The Court of Chancery found that “any control [Musk]  may have attempted to wield in connection with the acquisition was effectively neutralized  by a board focused on the bona fides of the acquisition, with an indisputably independent  director leading the way.” The Court of Chancery found that Musk did not exercise his  purported control as it related to the acquisition. The Court of Chancery listed 11 factors  (Editor’s note: consult the opinion for the listing and discussion of these factors) where Musk  participated in the deal process more than he should have. It then listed six positive factors  in the process, the most positive being the work Denholm did and her excellent testimony  thereon. The appellate court observed that the implication of the Court of Chancery’s opinion  was that the flaws did not overcome the positive factors.  

The Court of Chancery found that the “Tesla Board meaningfully vetted the acquisition” and  Musk “did not impede the Tesla Board’s pursuit of a fair price.” 

The trial court’s fair price findings. The Court of Chancery found that Musk prevailed in  establishing that the price was fair. The Court of Chancery pointed to six factors it used in  determining that the price was fair: 

1. The Court of Chancery found that SolarCity was not insolvent, even though the  appellants had put all of their eggs in the insolvency basket; 
2. Proffered DCF models by Quintero and Fischel were discarded as unhelpful;
3. The Court of Chancery considered market evidence supporting the price; 
4. The Court of Chancery considered SolarCity’s current and future cash flows, noting  the cash flows Tesla had already realized from SolarCity and would likely realize in  the future; 
5. The Court of Chancery relied on the Evercore fairness opinion; and 
6. The Court of Chancery found that potential synergies weighed in the favor of a fair  price. 

The price was entirely fair in the truest sense of the word. 

Contentions on appeal.

The appellants challenged the vice chancellor’s application of  Delaware’s entire fairness standard of review. They raised three arguments: “(1) the court  ‘failed to find that Musk had not met his burden to prove fair dealing[,]’ (2) the court focused  its entire fairness analysis exclusively on fair price, and (3) the court ‘erroneously found that  the unfair process did not affect the fairness of the price.’” The appellants put forth five  arguments on why the Court of Chancery committed legal error (see opinion). The appellate  court rejected the appellants characterization of the Court of Chancery’s opinion. 

Analysis.

The Court of Chancery applied the “entire fairness” standard even though it  assumed without finding that the standard applied. On appeal, the parties did not dispute  that entire fairness applies. The appellate court also applied that standard. The burden of  proof was on the defendant to prove that the transaction was entirely fair to the stockholders.  The appellants argued that the Court of Chancery functionally shifted the burden to the  appellants to prove that every aspect of the process was unfair. Musk presented credible  testimony that the price was fair, while the appellants provided only incredible evidence of  insolvency. 

The Court of Chancery did not err in its fair dealing analysis. “This Court has held that  arm’s-length negotiation provides ‘strong evidence that the transaction meets the test of  fairness.’” A fair process usually resulted in a fair price. The appellants did not challenge  any of the factual findings of the Court of Chancery. 

The factual findings support a determination of fair dealing. 

The trial court made a finding of fair dealing that was supported by the record. The  Weinberger factors formed the core of a court’s fair dealing analysis. The Court of Chancery did not organize its opinion in that manner. “[W]e believe the trial court’s opinion can only  reasonably be read as finding that, despite the process flaws, Musk carried his burden of  establishing fair dealing.” The appellate court concluded that the record supported a finding  of fair dealing. 

The appellate court, using the Weinberger factors, considered the appellants’ challenges. 

Initiation of the acquisition. Musk did not force the hand of any director, and initially the board  did not consider the acquisition. Evercore researched the solar industry before making a  recommendation. The Court of Chancery, after examining evidence and testimony, rejected  the appellants’ contention that Musk exerted domination and control over the process. The  court’s overarching determination that Musk did not impose any inherent coercion was adequately supported by factual findings. 

Timing of the acquisition. The Court of Chancery found the timing process to be a positive  as to fairness. The trial court found that “there was no bailout and the facts illustrate the  timing was right for Tesla.” 

Structure of the acquisition. The Court of Chancery found the majority of the minority voting  provision was a strong indicator of fair dealing, and the appellate court agreed that was an  appropriate indicator of fairness. The appellants contended that the lack of a special  negotiating committee by Tesla was an indicator of unfairness. The majority of the minority  provision, under Weinberger, allowed the burden of proof to shift to the plaintiff to show  unfairness. However, the lack of a special committee put the process in jeopardy that could  have been avoided had a committee been established. The appellate court discussed that  and the MFW (Kahn v. M & F Worldwide Corp.) case, which provided the background. “Thus,  Appellants’ theory that both MFW mechanisms were needed to neutralize Musk was tested  in the trial arena, and the court rejected it. The record supports the trial court’s conclusion,  which, we note, is heavily dependent upon unchallenged fact and numerous credibility  determinations.” 

Negotiation of the acquisition. The Court of Chancery noted that “[t]he Tesla Board’s process  included several redeeming features that emulated arms-length bargaining to the benefit of  Tesla stockholders.” Topping that list was the testimony of Denholm, who led the  negotiations for Tesla. The Court of Chancery noted that she was “an extraordinarily credible 

witness.” Additionally, both Evercore and Watchtell, advisors to Tesla and Denholm, were  found to be independent and very helpful in their advice. Information discovered in the due  diligence process helped to significantly lower the price on the second offer. 

Musk did meet frequently with Evercore outside of the board meetings, but it was not to  influence the process but to speed up the process. Per the Court of Chancery, Denholm  “served as an effective buffer between [Musk] and the Tesla Board’s deal process.” Denholm  unequivocally endorsed the acquisition. 

Approval of the acquisition. The appellate court found that there was no error in the Court  of Chancery’s determination. The directors, following Denholm’s rigorous negotiation  process, were not dominated nor controlled by Musk when they voted to approve the  acquisition. 

The trial court’s finding that the stockholder vote was informed was supported by the record.

The appellants contend the Court of Chancery erred in relying on the stockholder  vote for five reasons: 

1. Musk’s involvement was not properly disclosed to stockholders; 
2. Tesla’s disclosures about Solar Roof were misleading; 
3. Evercore’s warning about SolarCity’s liquidity covenant was not disclosed; 
4. Solar City’s credit downgrades were material to the stockholders; and 
5. “[S]everal institutional stockholders held shares of both Tesla and SolarCity, raising  questions of their disinterest and a reliance on their votes.” 

A fact was material if it would likely be important in a shareholder’s decision on how to vote. 

As to Musk’s involvement, the Court of Chancery found that the definitive proxy “did disclose  that [Musk] and Lyndon” Rive—Musk’s cousin—had conversations, including in February  2016, about Tesla acquiring SolarCity. As to Musk and Evercore, the appellate court noted that a single disclosure problem might not affect the total mix provided to the shareholders.  The Court of Chancery noted that the Evercore discussions were not to impede the process,  and the appellate court found no reason to disturb that finding. 

The Court of Chancery found no disclosure violations in connection with the Solar Roof.  Also, according to the Court of Chancery, “[t]he market generally understood SolarCity’s  liquidity challenges” and “expert witnesses, Moessner and Beach, conceded that market  participants were aware of the risk that SolarCity might breach its Liquidity Covenant.” These  facts were unchallenged in the Court of Chancery record. 

As to the credit downgrades to SolarCity, the Court of Chancery observed that, if SolarCity’s  largest lender was not deterred by the credit downgrades, then the market was likely not to  be deterred also. The appellate found no reason to disturb the Court of Chancery’s finding. 

As to the cross-holdings of many of the institutional investors, the Court of Chancery concluded that “[e]ven with these issues in mind, however, I cannot, as factfinder, conclude  that such a large majority of Tesla’s stockholders would have voted to approve a transaction  whereby Tesla would acquire an insolvent energy company, as [the appellants] would have  me believe.” 

Conclusion.

The appellate court affirmed the rulings of the Court of Chancery.