Judge who voided Musk’s pay package faces tough call on $7bn legal fee

Tesla Motors CEO Elon Musk. Picture: Reuters

Tesla Motors CEO Elon Musk. Picture: Reuters

Published Jul 10, 2024


THE JUDGE who voided Elon Musk’s record-setting Tesla Inc. pay package must now make another momentous decision – whether the lawyers who took the case to trial should be paid what may be the largest fee in the history of US litigation.

Attorneys from four firms who claimed Musk’s 2018 compensation plan for running the electric-vehicle maker was excessive are asking to be awarded 29 million shares of Tesla stock – worth about $7.3 billion (R132bn). Musk lawyers oppose that argument, claiming only a tiny fraction of that amount is justified.

On Monday, Delaware Chancery Court Judge Kathaleen St J McCormick heard testimony from experts on both sides, but she isn’t expected to issue an immediate order. That’s because McCormick must tackle an even bigger issue – whether to reinstate Musk’s pay package now that Tesla shareholders have voted overwhelmingly to re-ratify it.

The shareholder proxy vote at Tesla’s annual meeting in June, doesn’t require McCormick to undo her ruling in January that Musk’s pay plan was tainted by conflicts of interest among the board members who adopted it. But she has said she will consider the vote at a separate hearing.

“We are in uncharted waters here,” said Larry Hamermesh, a retired University of Pennsylvania law professor who specialises in Delaware corporate disputes. “There’s no clear guidance in the law for a fee like this.”

The unprecedented court case has drawn world-wide attention and prompted more than 8 000 Tesla shareholders to send letters to McCormick sharing their opinions on her pay ruling and the fee request.

At the annual meeting, more than 70% of Tesla shareholders backed reinstating Musk’s pay plan and moving the company’s state of incorporation from Delaware to Texas. Tesla’s attorneys contend they’ve fixed the flaws in Musk’s compensation plan and McCormick should rescind her earlier decision.

When McCormick issued her January 30 ruling, the pay plan that was structured to deliver several rounds of options allowing Musk to buy about 304 million shares was worth almost $56bn (about R1 trillion). At Friday’s close, the value of the package would be closer to $69bn.

Tesla shares lost about a quarter of their value during the first four months of 2024, but have come roaring back. The company reported second-quarter deliveries that beat Wall Street expectations, boosting its market cap and restoring Musk’s position as the world’s richest person.

The lawyers who challenged the pay plan argue that their unusual request to be compensated in stock rather than cash benefits Tesla because it doesn’t take money off the company’s balance sheet.

They said they would have gone unpaid if they lost the trial and haven’t received any pay for more than six years of work. The suit “would have gone unprosecuted absent plaintiff’s counsel’s willingness to incur substantial” risk, they said in a court filing.

Investors Benefit

New York University law professor Robert Jackson, testifying for the Tesla investor who successfully sued, told the judge on Monday, that shareholders benefited when Musk’s pay package was blocked.

Giving Musk so many vested stock options would have diluted holdings of existing investors, Jackson said. And the judge’s decision provided Tesla’s board with guidance about improving corporate governance and eliminating the conflicts of interest that led to the controversial pay plan, he said.

While it’s “challenging to value” such benefits in a financial sense, they are a boon to Tesla shareholders that provides “a positive effect” on its shares, Jackson said.

But Daniel Fischel, a University of Chicago law professor testifying for Musk, said blocking the payout “saved Tesla nothing” and that there was no quantifiable benefit to investors. Fishel said the plaintiff’s lawyers were seeking an “unjustified windfall” for their victory in court, while Musk had helped to create Tesla’s “economic miracle,” which led to an increase in market value of more than $500bn.

Cash Alternative

If McCormick doesn’t want to approve a stock-based fee award, lawyers for the plaintiff said they’d accept more than $1.4bn in cash. By comparison, the handful of law firms that spearheaded lawsuits over the US opioid epidemic negotiated for $2.3bn in legal fees after reaching settlements worth more than $26bn with drugmakers, distributors and retailers.

Tesla’s legal team says that even if the plaintiffs’ lawyers are credited with uncovering flaws in the process by which Musk’s pay package was adopted, the billionaire is still owed significant compensation for his leadership while shares rocketed over the last several years. The company’s lawyers argued in a court filing that the fee award for their adversaries should be capped at slightly more than $13.6 million.

A 29-million share payout for the plaintiffs’ lawyers would “be 17 times larger than any award in Delaware history and exceed by more than three-fold the University of Delaware’s endowment” of $1.78bn, Tesla argued in a court filing, adding that it would also make the plaintiffs’ lawyers “the third largest non-institutional owner of Tesla common shares.”

Hamermesh said McCormick will need to first resolve whether she rescinds her January ruling before she can set a reasonable fee for the lawyers.

“It would take a lot of brass to say the Tesla shareholder vote is meaningless here,” Hamermesh said.

But other legal experts – including retired University of Delaware professor Charles Elson – say McCormick would be within her legal rights to declare the proxy vote is irrelevant. He said she would be justified concluding the pay package was a waste of corporate assets in light of her original findings that the plan was the product of sham negotiations with directors who were not independent of Musk and that shareholders were given misleading and incomplete disclosures about it.

Some Tesla shareholders have expressed outrage at the legal fee request in letters to the judge – which she is ethically bound to ignore.

“It is unfathomable to suggest any financial benefit derived from this case could justify such exorbitant fees for plaintiff attorneys,” Liang Guo of Fort Lee, New Jersey, wrote to McCormick.

Brian Lecher of South Carolina voiced a similar sentiment.

“Instead of honouring the wishes of shareholders and rewarding the hard work of the CEO, it seems that the court is rewarding lawyers who did nothing for the company or shareholders.”

The case is Tornetta v Musk, 2018-0408, Delaware Chancery Court (Wilmington).