Tesla is testing whether shareholders have the power to overrule a judge

Tesla’s ( TSLA ) court battle to restore Elon Musk’s pay raises an undecided question that could reshape the rules of corporate law: Can shareholders ever overrule a judge?

The electric vehicle maker says the answer is yes.

The company is asking the same Delaware business court judge who struck down Musk’s $56 billion CEO compensation pact in January to vacate his decision and replace it with the will of the company’s shareholders, who approved second payment in June.

“This has never been done before,” Judge Kathaleen McCormick of the Delaware Court of Chancery said at a hearing earlier this month.

Tesla’s lawyer agreed, but argued that the new shareholder decision should have the final say.

“This was shareholder democracy at work,” he said.

Corporate lawyers predict that the presentation will not be enough to change Chancellor McCormick’s decision.

They say the question at the heart of the case could continue on appeal all the way to the U.S. Supreme Court.

A “cleansing”

Tesla’s argument is that shareholders, not judges, should decide corporate transactions. Otherwise, the wider business world will lose confidence that they can rely on the deals they reach with their shareholders.

And, as a general rule, Delaware courts take shareholder votes extremely seriously, making them inclined to defer to the outcome of these accounts.

“I don’t see how Delaware law can tell the owners of a company that they can’t” set the CEO’s salary, Rudolf Koch, a lawyer for Tesla’s board of directors, said during the August hearing before Chancellor McCormick.

But what could be holding Tesla back is that it may have missed some steps that could have made the shareholder lawsuit moot.

Legal experts point to a series of cases in the state’s business court, known as the M&FW line of cases, that outline the path Tesla could have taken — but didn’t.

Decisions in those cases held that even when a corporate transaction involved a conflicted controlling shareholder — as a judge ruled was the case with Musk and Tesla — it was possible for a company to “clean up” the transaction with the correct type of shareholder vote.

But here’s the potential problem: case law shows that Musk must have met the cleanup conditions before he engaged in substantial negotiations with Tesla over his pay deal and made the deal conditional on shareholder approval, according to New York University law professor Marcel Kahan.

This will be difficult for Musk to prove. No further negotiations appear to have taken place before Tesla resubmitted Musk’s pay deal to shareholders in June.

The story continues

And yet there’s another problem: Even if Judge McCormick finds that Tesla’s second vote “cleansed” Musk’s pay deal, she may find that Tesla simply waited too long before supports the restoration vote.

The Delaware Court of Chancery considers the timeliness and reasonableness of corporate actions, corporate lawyers said, and may not tolerate Tesla waiting until after the judge has ruled against it to seek new shareholder approval.

Regardless of the outcome, Tesla could appeal a defeat to the Delaware Supreme Court. Those judges, according to Kahan, could rule that Musk was not a majority shareholder and the requirement to condition the payment agreement on shareholder approval does not apply.

Many companies, he added, don’t have to worry about how this case turns out because most adhere to good governance policies that protect them from a judge overturning their deals.

“So if I’m (JPMorgan CEO) Jamie Dimon and I’m reading (McCormick’s) opinion, I’m not at all concerned that my compensation package is going to be in jeopardy.”

Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on X @alexiskweed.

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