Is the Delaware Chancery Court a Guardian or a Bully?

Two recent cases have cast the Delaware Chancery Court into the spotlight. For as long as I can remember (and I am 78), corporations have flocked to Delaware to incorporate. A promo for Delaware online1 lists the advantages to incorporating in Delaware. Those advantages include: tax benefits, privacy, expediency and simple structure, and a special corporation court. That court, the Delaware Court of Chancery, has recently issued two decisions that bring into question whether this court is an advantage or a detriment to incorporating in Delaware.

In the first case, Palkon v. Maffei,2 involved a lawsuit where minority shareholders challenged the conversion of two Delaware corporations3 into Nevada corporations with the controlling shareholder delivering the deciding vote the admitted purpose of which was reducing potential liabilities for directors and officers. This particular case dealt with a motion to dismiss the defendants made. The Court of Chancery characterized the transaction as a self-interested transaction on the part of the controlling shareholder. As such, the action triggered the “entire fairness” standard of review by the court. The court noted that the outcome depended on the standard of review. The court determined that the defendants were not able to establish that the conversions were entirely fair, so the motion to dismiss was denied. The court determined that monetary damages would be sufficient so that the court declined to enjoin the closing of the conversion.

However, in my opinion, determining monetary damages will be a monster task. The court’s concept is that the damages should be equal to the decline in the publicly traded market price before and after the conversion to Nevada. What if the price goes up after the conversion instead of down? What other factors might impact the increase or decrease in the value of the stock? So did the court simply create a problem that did not exist?

In the second case, Tornetta v, Musk,4 the Delaware Chancery Court once again invoked the “entire fairness” standard of review “where [Musk’s] 21.9 percent equity stake, his status as the paradigmatic Superstar CEO who held some of the most influential corporate positions, thick ties with the directors tasked with negotiating on behalf of the corporation, and domination of the process that led to board approval of the compensation plan meant that he controlled the corporation.”5 The issue was Musk’s compensation plan, which potentially would have earned Musk as much as $55 billion, if certain stock value benchmarks were met.

Ultimately, the court, having decided that Musk controlled Tesla, ordered a rescission of the entire Musk compensation plan. The opinion is exceptionally long and detailed, but it follows a trail that leads from the control issue to a decision that the disclosures relating to a shareholder vote of “non-interested shareholders” were misleading, to then a breach of fiduciary duty. It appears that the case will be appealed to the Delaware Supreme Court.

Both of these cases were decided by a single judge without a jury, which is the structure of the Delaware Chancery Court. This formula has worked for years, but my observation, based on these two cases, is that the formula might be fraying at the edges. Judge McCormick, the chancellor in the Musk case, had the following statement: “This decision dares to ‘boldly go where no man has gone before,’ or at least where no Delaware court has tread.”6 Is this the statement of an impartial jurist or the bias of an individual that should be impartial?

Realizing that the Supreme Court has the final say in both of these cases,  it is nevertheless troubling to me that, in both cases, a single judge appeared to perhaps have stretched to get to a control conclusion so that the “entire fairness” standard could be used to punish the defendants. Musk has already threatened to move Tesla’s domicile out of Delaware to Texas. In the Palkon case, the court did not restrict a move to another state, Nevada, but exacted its one-person applied penalty to the company on the way out.

Is Delaware losing its luster as being the “corporate friendly” state? Is Delaware the guardian or the bully?

1 Why Incorporate in Delaware? Benefits & Considerations.
2 Palkon v. Maffei, 2024 Del. Ch. LEXIS 48; 2024 WL 678204 (Feb. 20, 2024).
3 While there were two separate corporations, it was really one business, Trip Advisors.
4 Tornetta v. Musk, 2024 Del. Ch. LEXIS 27.
5 Ibid.
6 In reference to claiming that Musk was a control shareholder with a 21.9% interest in Tesla.