The Costs of Chancellor Kathaleen McCormick Ruling Against Elon Musk

Chancellor Kathaleen McCormick is the person who oversaw a complaint about Elon Musk’s pay package with Tesla, eventually ruling that the $55 billion he was owed was too much. But that decision ultimately had an impact on the entire state of Delaware with concern among many that Musk’s decision to reincorporate his businesses in Texas might signal a trend. Here’s how it all began.

In January 2018, Tesla’s board of directors proposed a new compensation package for Musk. It consisted of stock options, with no salary and no cash bonuses, and would fully vest only if he raised Tesla’s market capitalization by $600 billion and hit other targets. Musk stood to earn around $55 billion, a record payout — by far — for the head of a publicly traded company. At the time, Tesla itself was worth $59 billion. In a proxy statement filed with the S.E.C., the company indicated that the giant award was necessary to ensure that Musk would “continue leading the company over the long term.”

Two months after Tesla announced the compensation plan, the company’s shareholders approved it. But in June 2018, an investor named Richard Tornetta filed a lawsuit in Delaware seeking to block the deal. He claimed that Tesla had deceived investors by exaggerating the difficulty of meeting the targets it had set for Musk. He also claimed that Musk had stacked Tesla’s board with people who had close personal and financial ties to him and that he had dictated the terms of the pay package.

The resulting case, Tornetta v. Musk, went to trial in November 2022. It hinged in part on Tornetta’s assertion that Tesla was a “controlled” company.

A controlled company is one in which one person or a small group has voting power over the entire company. Usually that means having a significant share of the company stock. In Musk’s case, he owned 22% of Tesla’s stock at the time Tornetta filed his lawsuit, but his lawyers argued that was more than enough.

The judge who heard Tornetta v. Musk, Chancellor Kathaleen McCormick, determined that Musk’s large equity stake in Tesla, as well as his influence over the company’s board and his status as a “superstar C.E.O.” with a cultlike following among investors, made him a controlling shareholder, at least when it came to his compensation. Her ruling, handed down in January 2024, said that board members, who included Musk’s brother, were beholden to Musk; that he had pushed the board to grant him the enormous payout; and that his power and celebrity had created what she called a “distortion field” that made it impossible to rebuff his demands…

Eric Talley, a law professor at Columbia University, says that McCormick delivered “a textbook decision” if Musk was indeed a controlling shareholder. But he adds that the “superstar C.E.O.” designation was “very subjective” and could reasonably be construed as “a charisma tax.” Some observers were also troubled by the fact that McCormick rendered a verdict with such far-reaching consequences in a lawsuit filed by a plaintiff who owned barely any Tesla shares.

Richard Tornetta owned 9 shares of stock when he filed his lawsuit. Chancellor McCormick not only deleted Musk’s pay, she would grant Tornetta’s side a payout of $345 million dollars.

Musk took the step of putting his pay package before the shareholders again after the ruling and they approved it by a 3:1 margin. However, Chancellor McCormick shrugged off this demonstration of the fact that shareholders were in favor of the pay package and said it was too late to alter the facts of the case. And that really angered Musk who reincorporated his businesses in Texas and asked others to follow his lead. 

That created a bit of panic in Delaware because these courts of chancery are in fact a huge portion of Delaware’s annual income as a state. 

A number of companies have since joined Musk in leaving Delaware, including Andreessen Horowitz, the venture-capital giant; Coinbase, the cryptocurrency exchange; and Dropbox, the cloud storage provider. Most have moved to Texas or Nevada. Eager to take advantage of the incipient revolt against Delaware, the two states have signaled, through legislation and public messaging, that companies can expect gentler treatment in their respective jurisdictions, and the pitch seems to be working. “Delaware’s dominance appears more in doubt than at any time in memory,” the Yale Law School professor Jonathan R. Macey wrote in a recent paper.

In Delaware, the possibility of an exodus has caused alarm. The state is heavily dependent on revenue from corporate chartering, which is referred to locally as “the franchise.”…

Above all, the goal is to ensure that Delaware remains corporate America’s preferred jurisdiction.

For the state of Delaware, that is an existential necessity, because corporate chartering is a critical source of revenue. Although Delaware charges relatively modest fees — large companies pay only $250,000 per year — it adds up to around $2 billion annually, which accounts for roughly one-third of the state’s budget.

Chancellor McCormick’s ruling were eventually overturned by the Delaware Supreme Court which reinstated Musk’s entire pay package and cut the aware to the plaintiffs down to about $50 million. But the concern isn’t this one case, it’s whether or not Musk will start a trend. There are some signs that he has. The number of companies who have moved so far is small, but some of the ones leaving are sizeable. Next week, Dell shareholders will vote on a move to reincorporate in Texas.

In order to prevent this trend from accelerating, Delaware enacted a new bill called S.B. 21 that limits the freedom of chancellors like McCormick to interpret the rules as they wish. Whether or not this will stem the tide of exiting companies remains to be seen, but the outcome of the Musk case has certainly put the state on notice.

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