The recent post-trial decision of the Delaware Chancery Court in In re Tesla Motors, Inc. Shareholder dispute, CA No. 12711-VCS (April 27, 2022), includes a helpful discussion of the importance of fair pricing when analyzing a transaction as part of the comprehensive equity analysis. There, Tesla shareholders filed lawsuits against Tesla board members and Tesla CEO and majority shareholder Elon Musk over Tesla’s acquisition of SolarCity Corporation. CA No. 12711-VCS (April 27, 2022). the You’re here the plaintiffs alleged that majority shareholder Musk “pushed Tesla’s slavish board to approve the acquisition of an insolvent SolarCity at a grossly unfair price through a very imperfect process. Identifier. at 2. After a trial, the court found that Musk and many other Tesla board members were at odds and the negotiation process was “far from perfect.” Identifier. at 4. Nonetheless, the court held that – assuming the entire standard of fairness applied – the acquisition was entirely fair because Tesla ultimately paid a fair price and “a demonstrably fair price ultimately wins.” Identifier. at 72 years old.
At the time of Tesla’s proposed stock-for-stock merger with SolarCity in 2016, Musk — co-founder and CEO of Tesla — owned 22% of Tesla common stock. He was also Chairman of the Board of SolarCity and their largest shareholder, owning approximately 22% of SolarCity’s stock. Musk was a strong supporter of acquiring SolarCity – a solar company founded by Musk’s cousins - because he wanted to integrate solar panels and batteries into Tesla’s electric vehicles. At the time of the proposed merger, SolarCity was facing macroeconomic headwinds and liquidity issues that threatened its solvency and ability to remain compliant with the liquidity covenant of its revolving credit facility. After due diligence and negotiations, Tesla ultimately offered to pay 0.110 Tesla share for each SolarCity share, representing a net worth to SolarCity of approximately $2.1 billion or $20.35 per SolarCity common share. Although not required by Delaware law, the acquisition was conditional on the approval of a majority of disinterested Tesla shareholders. Tesla shareholders voted overwhelmingly to approve the acquisition, with around 85% voting in favor of the deal.
The plaintiffs alleged that the Tesla directors tasked with evaluating the acquisition had irreconcilable conflicts of interest because of their ties to the entity on the other side of the negotiating table. In fact, the You’re here The plaintiffs alleged that all but one of Tesla’s seven directors at the time of the acquisition were in conflict because of their ties to SolarCity. Identifier. at 8 years old. Tesla’s majority shareholder, Musk, was in conflict because he was chairman of SolarCity’s board of directors and SolarCity’s largest shareholder. Identifier. at 6. A second Tesla director previously served as SolarCity’s CFO at Musk’s request, did consulting work for SolarCity, owned SolarCity stock, and didn’t even qualify as an independent director according to NASDAQ rules. Identifier. at 8-9. A third Tesla director was Musk’s brother, owned shares in SolarCity and also was not considered independent under NASDAQ rules. Identifier. at the age of 12. Two other Tesla directors personally owned significant shares in SolarCity, owned venture capital firms that had invested significantly in SolarCity, and had business partners who served on SolarCity’s board of directors. Identifier. at 9-12. Despite these conflicts, Tesla did not form a special committee to evaluate the proposed merger. The court noted that these “facts involving potential self-interest or lack of independence” – for example, “family ties, personal friendships, ‘thick’ business relationships, cross-investments, etc. ” — were “all similar to scenarios where Delaware courts have found a reasonably conceivable invalidating conflict” at the pleading stage. Identifier. at 81, no. 378.
The court found that these conflicts and “Musk’s apparent failure to acknowledge his clear conflict of interest and separate himself from Tesla’s review of the acquisition” resulted in procedural flaws in the due diligence process. and negotiation. Identifier. at 91. According to the court, the negotiation process for the acquisition was “far from perfect” because “Elon was more involved in the process than a conflicted fiduciary should be” and “conflicts between the other members of Tesla’s board of directors were not completely neutralized”. Identifier. at 4. For example, Musk “actively participated” in certain Tesla board discussions regarding the acquisition and “had several private discussions directly with Target (SolarCity) and with Tesla’s financial advisor for the agreement without the knowledge of Tesla’s board of directors”. Identifier. at 2 o’clock.
However, the court also recognized several “redemptive features” of the trading process that suggested fairness, including: (1) the timing was right because solar companies were facing headwinds and trading at historic lows ; (2) the acquisition was conditional on the approval of a majority of disinterested shareholders; (3) Tesla selected a leading independent financial advisor who performed “thorough due diligence,” conducted valuation analyzes and ultimately concluded that the price was fair; (4) the financial adviser used the information discovered during its due diligence process to significantly reduce the price; (5) in several instances Tesla’s board of directors refused to follow Elon Musk’s wishes; (6) Tesla shareholders had plenty of information about the acquisition, which was well covered by analysts; and (7) a director who was unquestionably independent of Tesla’s board of directors led the due diligence and negotiations with SolarCity and “served as an effective buffer between Elon and the Tesla board’s transaction process.” Identifier. at 94-102.
Ultimately, despite the resulting conflicts of interest and procedural flaws, the court found that “Tesla’s board of directors duly approved the acquisition” and that “the process did not “infected” the price. » Identifier. at 103. The final price was critical to the court’s analysis. Indeed, the court explained that “[t]he is the linchpin of th[e] case…is that Elon proved that the price Tesla paid for SolarCity was fair—and a demonstrably fair price ultimately wins out.” Identifier. to 72 (emphasis added). The court ruled that the price “set the nail” in the plaintiffs’ claims. Identifier. In doing so, the court equated the entire standard of fairness with the “all roads lead to Rome” idiom, explaining that “although there are necessary stops along the way, all roads in the realm of total equity ultimately lead to a fair price”. Identifier. at 83 years old.
The court found that the price paid by Tesla for SolarCity was fair based on: (1) market evidence; (2) approval by a majority of disinterested shareholders; (3) the valuable cash flow that SolarCity has provided and will continue to provide to Tesla; (4) independent financial advisor’s fairness opinion; and (5) the synergistic value created by the acquisition. Identifier. at 111-127. With respect to market evidence, the court relied on the fact that SolarCity’s stock price at the time of acquisition ($21.19 per share) was higher than the price Tesla ultimately paid ( $20.35 per share) and was a reliable indicator of the fair price because the market was sufficiently informed of SolarCity’s financial situation. Identifier. at 112-14. Additionally, the court noted that nearly 85% of Tesla shareholders favored the acquisition, which was “irrefutable proof” of a fair price. Identifier. at 116-117.