The Delaware Chancery Court’s recent post-trial decision in In re Tesla Motors, Inc. Stockholder Litigation, C.A. No. 12711-VCS (April 27, 2022), includes a helpful discussion of the importance of fair price when analyzing a transaction under the entire fairness analysis. There, Tesla stockholders brought claims against members of Tesla’s board of directors and Tesla’s CEO and controlling shareholder Elon Musk related to Tesla’s acquisition of SolarCity Corporation. C.A. No. 12711-VCS (April 27, 2022). The Tesla plaintiffs alleged that controlling stockholder Musk “caused Tesla’s servile Board to approve the acquisition of an insolvent SolarCity at a patently unfair price following a highly flawed process.” Id. at 2. After a trial, the court found that Musk and numerous other members of the Tesla board were conflicted and that the negotiation process was “far from perfect.” Id. at 4. Nevertheless, the court held that — assuming the entire fairness standard applied — the acquisition was entirely fair because Tesla ultimately paid a fair price and “a patently fair price ultimately carries the day.” Id. at 72.
At the time of Tesla’s proposed stock-for-stock merger with SolarCity in 2016, Musk — Tesla’s-co-founder and CEO — owned 22% of Tesla’s common stock. He was also chairman of the SolarCity board of directors and their largest stockholder, owning approximately 22% of SolarCity’s stock. Musk was a vocal proponent of acquiring SolarCity — a solar company that was founded by Musk’s cousins — because he wanted to integrate solar panels and batteries into Tesla’s electric vehicles. At the time of the proposed merger, SolarCity was facing macroeconomic headwinds and liquidity problems that threatened its creditworthiness and its ability to remain compliant with its revolving debt facility’s liquidity covenant. After due diligence and negotiations, Tesla ultimately offered to pay 0.110 shares of Tesla stock for each share of SolarCity stock — representing an equity value for SolarCity of approximately $2.1 billion or $20.35 per share of SolarCity common stock. Although not required under Delaware law, the acquisition was conditioned upon the approval of a majority of Tesla’s disinterested shareholders. Tesla’s stockholders overwhelmingly voted to approve the acquisition, with approximately 85% voting in favor of the deal.
The plaintiffs alleged that the Tesla directors tasked with evaluating the acquisition had irreconcilable conflicts of interest based on their connections to the entity on the other side of the negotiating table. In fact, the Tesla plaintiffs alleged that all but one of Tesla’s seven directors at the time of the acquisition were conflicted based on their connections to SolarCity. Id. at 8. Tesla’s controlling shareholder Musk was conflicted because he was chairman of the SolarCity board of directors and the largest stockholder of SolarCity. Id. at 6. A second Tesla director previously served as SolarCity’s CFO at Musk’s request, did consulting work for SolarCity, owned SolarCity stock, and did not even qualify as an independent director under the NASDAQ rules. Id. at 8-9. A third Tesla director was Musk’s brother, held stock in SolarCity, and similarly did not qualify as independent under the NASDAQ rules. Id. at 12. Two other Tesla directors personally owned significant stock in SolarCity, owned venture capital firms that invested significantly in SolarCity, and had business partners that were on the SolarCity board. Id. at 9-12. Despite these conflicts, Tesla did not form a special committee to evaluate the proposed merger. The court noted that these “facts implicating the potential for self-interest or lack of independence” — e.g., “familial ties, personal friendships, ‘thick’ business relationships, cross-investments, etc.” — were “all similar to scenarios where Delaware courts have found a reasonably conceivable disabling conflict” at the pleading stage. Id. at 81, n.378.
The court found that these conflicts and Musk’s “apparent inability to acknowledge his clear conflict of interest and separate himself from Tesla’s consideration of the Acquisition” led to procedural flaws in the due diligence and negotiating process. Id. at 91. According to the court, the process of negotiating the acquisition was “far from perfect” because “Elon was more involved in the process than a conflicted fiduciary should be” and “conflicts among other Tesla Board members were not completely neutralized.” Id. at 4. For example, Musk “actively participated” in certain Tesla board discussions regarding the acquisition and “had several private discussions directly with the target (SolarCity) and with Tesla’s financial advisor for the deal without the knowledge of the Tesla Board.” Id. at 2.
However, the court also acknowledged several “redeeming features” about the negotiating process that suggested fairness, including: (1) the timing was right because solar companies were facing headwinds and trading at historic lows; (2) the acquisition was conditioned on the approval of a majority of disinterested stockholders; (3) Tesla selected an independent, top-tier financial advisor that performed “extensive diligence,” conducted valuation analyses, and ultimately concluded that the price was fair; (4) the financial advisor used the information discovered during its due diligence process to lower the price substantially; (5) in several instances, the Tesla board refused to follow Elon Musk’s wishes; (6) Tesla stockholders had ample information about the acquisition, which was well-covered by analysts; and (7) an indisputably independent director of the Tesla board led the due diligence and negotiations with SolarCity and “served as an effective buffer between Elon and the Tesla Board’s deal process.” Id. at 94-102.
Ultimately, despite the conflicts of interest and ensuing procedural flaws, the court held that “the Tesla Board meaningfully vetted the Acquisition” and that “the process did not ‘infect’ the price.” Id. at 103. The final price was critical to the court’s analysis. Indeed, the court explained that “[t]he linchpin of th[e] case … is that Elon proved that the price Tesla paid for SolarCity was fair—and a patently fair price ultimately carries the day.” Id. at 72 (emphasis added). The court held that the price “put the nail” in plaintiffs’ claims. Id. In doing so, the court equated the entire fairness standard to the idiom “all roads lead to Rome,” explaining that, “while there are necessary stops along the way, all roads in the realm of entire fairness ultimately lead to fair price.” Id. at 83.
The court held that the price Tesla paid for SolarCity was fair based on: (1) market evidence; (2) approval by a majority of disinterested stockholders; (3) the valuable cash flows that SolarCity has provided and will continue to provide to Tesla; (4) the independent financial advisor’s fairness opinion; and (5) the synergistic value created by the acquisition. Id. at 111-127. With respect to market evidence, the court relied on the fact that SolarCity’s stock price at the time of the acquisition ($21.19 per share) was higher than the price Tesla ultimately paid ($20.35 per share) and was a reliable indicator of fair price because the market was sufficiently informed about SolarCity’s financial condition. Id. at 112-14. In addition, the court noted that nearly 85% of Tesla stockholders were in favor of the acquisition, which was “compelling evidence” of a fair price. Id. at 116-117.