13 May 2021

Court of Chancery Provides Reminder That Privilege Is Not Absolute

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Last week, Vice Chancellor Joseph R. Slights III issued a ruling in Tornetta v. Musk that serves as a reminder that the corporate attorney-client privilege is not absolute. Deciding a discovery motion in a stockholder derivative suit challenging the 2018 compensation deal for Tesla CEO Elon Musk, the Court ordered the defendants to produce a limited set of documents that reflected communications between Musk and in-house counsel, though it rejected the plaintiff’s request for additional communications between in-house counsel, the Board’s Compensation Committee, and outside advisors. The decision serves as a reminder to company counsel, both internal and external, that their communications may not always be protected from stockholder plaintiffs in shareholder derivative actions.

Factual and Procedural Background

In 2018, Tesla’s Compensation Committee and Board approved a 10-year compensation package for Musk, under which Musk may be awarded a potential $55 billion. The plaintiff, a Tesla stockholder, challenged the compensation package as unfair.

During discovery in this matter, the parties disputed whether at least two categories of documents were privileged: (i) communications between the General Counsel or Deputy General Counsel and the Compensation Committee or its advisors; and (ii) documents shared with the General Counsel or Deputy General Counsel that contained legal advice from the Compensation Committee’s advisors. The plaintiff moved to compel on the grounds that Tesla’s General Counsel and Deputy General Counsel acted as Musk’s agents in preparing a “pre-baked” package that served Musk’s interests rather than the company’s, and thus were counterparties to the Compensation Committee in the negotiation of the incentive package. In the midst of briefing on the motion, Plaintiff switched course and argued instead that in-house counsel acted on behalf of the Compensation Committee, and thus privilege had been waived as to any documents shared between the General Counsel or Deputy General Counsel and Musk. The plaintiff also argued that such documents were discoverable under the Garner exception to attorney-client privilege (explained below).

Waiver

The Court first considered the plaintiff’s waiver argument, and concluded that, because Musk was adverse to the company with respect to the negotiation of his compensation package, any privilege over communications in which Musk was involved had been waived. Accordingly, the Court ordered the defendants to produce communications between Tesla’s in-house counsel and Musk, including documents containing legal advice, that related to the negotiation and approval of the 2018 compensation package.

The Garner Doctrine

The Court next turned to the plaintiff’s argument that a broader category of documents should be produced under the Garner exception to the attorney-client privilege. Nearly a decade ago, the Delaware Supreme Court expressly adopted a narrow exception to the attorney-client privilege in the context of stockholder suits against a corporation or its controllers. Wal-Mart Stores, Inc. v. Ind. Elec. Workers Pension Tr. Fund IBEW, 95 A.3d 1264, 1278 (Del. 2014). This Garner doctrine — so called because it was first articulated in the Fifth Circuit Court of Appeals in Garner v. Wolfinbarger, 430 F.2d 1093 (5th Cir. 1970) — provides that stockholders seeking to prove fiduciary breaches by those in control of the corporation may invade the corporation’s privilege upon showing good cause. The doctrine strikes a balance between protecting stockholders and the corporation by providing a means of rooting out fiduciary breaches by corporate controllers on the one hand and protecting the public interest served by the attorney-client privilege on the other. To preserve the proper balance between these competing interests, Delaware courts have applied the Garner exception sparingly, and noted that the standard for invoking it “is narrow, exacting, and intended to be very difficult to satisfy.” Wal-Mart Stores, 95 A.3d at 1278.

The recent ruling in Tornetta is no exception. The Court rejected the plaintiff’s request for privileged communications among in-house counsel, the Compensation Committee, and the Committee’s outside counsel, concluding that the plaintiff had not satisfied the exception’s exacting standard. Delaware courts typically focus on three factors in determining whether there is good cause to invoke the exception: (i) whether the shareholders’ claim is colorable; (ii) whether the privileged information is necessary and unavailable from other sources; and (iii) whether the shareholders have identified the communications sought or are “blindly fishing.” Delaware courts may also consider whether a conflict of interest exists in connection with the alleged breach of fiduciary duty, but that consideration merely informs the application of the Garner factors and cannot supersede the factors themselves.

The Court determined that the plaintiff had satisfied the first and third factors: having survived a motion to dismiss, the derivative suit was at least colorable, and the plaintiff had identified a specific set of documents from the defendants’ privilege log to be produced. However, the plaintiff fell short of demonstrating that he needed privileged information to support his claims because he had access to non-privileged discovery from which he could discern Musk’s level of influence over the Compensation Committee and the approval process for the compensation package. The plaintiff’s conclusory assertion that he would be unable to obtain such information from other sources was insufficient to meet the Garner doctrine’s high bar. Accordingly, the Court determined that there was not good cause to pierce the privilege between in-house counsel, the Compensation Committee, and its outside legal advisors.

Conclusion

The Tornetta decision underscores that the corporate attorney-client privilege is not bounded by a bright-line rule. In the context of executive compensation and other issues in which executives have interests adverse to the company, privilege may be waived or disregarded in the interest of stockholders under some circumstances, providing stockholder plaintiffs with ready access to otherwise protected communications.