Tesla May Need New Blood on Its Board of Directors

Tesla May Need New Blood on Its Board of Directors

Legal experts say Tesla’s current directors could run into new problems if they let shareholders decide on a Texas reincorporation

A Delaware judge knocked Tesla (TSLA) board members for not being independent enough from CEO Elon Musk.

That perceived lack of autonomy could make it more difficult to give Musk what he wants: a move from Delaware.

Musk advocated for his electric-vehicle maker to be reincorporated in Texas after Delaware Chancellor Kathaleen McCormick invalidated the billionaire’s $56 billion pay package, with the billionaire vowing to move “immediately” for a shareholder vote on a potential exit.

Roughly three weeks later, there has been no public notice of such a vote. One major reason, according to legal experts, is that Tesla’s current directors are ill-suited, at least legally, to recommend the change because they aren’t independent enough from Musk.

“The first thing is they need to appoint new directors,” said Case Western Reserve University School of Law professor Anat Alon-Beck. “You need new blood.”

Without new independent directors, Alon-Beck added, a shareholder vote on Tesla’s reincorporation could risk being undone by the same type of claims that invalidated Musk’s compensation deal.

McCormick voided the performance-based pay plan because directors had not been transparent about their personal ties to Musk. The six board members responsible for approving the package breached their fiduciary duties, McCormick concluded.

If those same directors sign off on a shareholder vote to move Tesla to Texas, according to legal experts, Tesla’s board could face similar claims of self dealing — a reference to when company executives or directors engage in company transactions for personal benefit.

Delaware law allows shareholders to sue over such a claim and its Chancery Court has the power to undo such transactions.

“I would advise someone in Mr. Musk’s position to make sure the cosmetics look a lot better, and that you have one or two more independent directors,” Columbia University law professor John Coffee said.

The focus on Tesla’s board is bringing new attention to chair Robyn Denholm, who joined the company’s compensation committee as an independent director in 2014. She replaced Musk as board chair after a separate Tesla settlement with the Securities and Exchange Commission forced Musk to relinquish the position.

Chancellor McCormick criticized Denholm’s participation in Musk’s pay package negotiations, characterizing her obligation to overseeing the process as “lackadaisical.”

The Enron effect

The importance of greater autonomy for the people governing large public companies has gained steam in the last two decades — especially in the years following the 2001 collapse of energy giant Enron.

The company’s meltdown revealed governance weaknesses. Some directors at Enron received consulting fees from the company and were linked with organizations that received donations from Enron’s charitable foundation, according to a 2003 Senate report.

One attempt to bolster governance across corporate America came soon after in 2003 when the New York Stock Exchange and Nasdaq began requiring companies listed on the exchanges to ensure that the majority of their directors were independent.

These requirements had an impact over time. By 2018, roughly 85% of all directors at S&P 500 companies were considered independent, according to data provider Esgauge. That count was 86% as of 2023.

An ‘unlikely’ move

But defining director independence has long been a thorny matter of debate. Even if Tesla did add new board members, there’s uncertainty about whom a judge would consider independent enough from the company and from Musk.

A new, independent compensation committee also doesn’t assure a shareholder win. Some Tesla shareholders could see reincorporation in Texas as a benefit to the company, while others may view it as detrimental.

In order for Tesla’s management to hold a vote on reincorporation in Delaware, it would need an independent committee of directors to advise shareholders of the benefits and risks of subjecting the company to the laws of Texas. A majority of Tesla’s minority shareholders would then need to vote ‘yes’ on the matter.

“The question is can you defend yourself in court,” Alon-Beck said. “There’s always going to be a shareholder who says the change is oppressing the minority shareholders.”

If an independent committee decides to recommend the change and a vote at the company’s annual shareholder meeting, Tesla would need to give shareholders plenty of advance notice to comply with SEC and Delaware rules. Last year’s meeting was held on May 16.

“The major issue for reincorporation is that shareholder approval is needed,” added Northwestern University law professor Bernard Black. For that reason, he said, “an actual move to Texas seems unlikely to me.”

A ‘preference for Delaware’

Management proposals to change a company’s state of incorporation are rare. And when they do happen, they tend to propose moving to — not away from — Delaware.

Between 2020 and mid-February this year, management teams for approximately 70 companies included in the Russell 3000 index asked their shareholders to approve a change of domicile, according to ISS-Corporate, a provider of data and analytics,

Among those proposals, 90% requested a move to Delaware and all but one succeeded. The single failure, for Marathon Digital Holdings (MARA) in 2023, was due to low voter turnout.

“Shareholders generally have a preference for Delaware,” ISS-Corporate’s managing director Jun Frank told Yahoo Finance.

Not that an exit from Delaware can’t be done. Five management teams for companies included in the Russell 3000 index asked shareholders to exit the state since 2020. And four of those five measures were approved.

On Tuesday, a Delaware Chancery Court judge decided that online travel company TripAdvisor (TRIP) could reincorporate from Delaware to Nevada, over the objection of some company shareholders who sued to block it.

They alleged that the CEO of TripAdvisor’s parent company, Greg Maffei, sought out Nevada to reduce his potential for liability claims. Maffei is a controlling shareholder of that parent company, Liberty Media, which also controls voting power over TripAdvisor.

The Delaware judge who signed off on the move also let shareholders maintain their lawsuit because they may be entitled to monetary damages if the move causes financial harm to the company.

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