Musk’s War on Delaware Spurs Bill to Hang On to Businesses (1)

Elon Musk went to war with Delaware over its corporate laws after a judge shot down his massive Tesla pay package, moving his companies out west. Now the First State is responding with a legislative overhaul to keep other moguls from following him.

State legislators are proposing seismic changes to Delaware’s business statutes following recent defections by Musk’s companies and others moving their incorporation to Texas or Nevada in search of friendlier legal treatment. Spurred by the state’s new governor, Matt Meyer, a Democrat, they introduced the bill this week.

Delaware Governor Matt Meyer

Source: State of Delaware

The bipartisan legislation, Senate Bill 21, awaits approval by the Delaware House and Senate but is expected to pass. It’s the state’s effort to stanch a growing number of corporate departures, and an answer to critics — among the ranks of US executives and lawyers — who say Delaware has turned hostile to controlling shareholders. They say the state unfairly limits corporate directors’ authority in their oversight of executives, among other complaints.

The bill would alter the balance of power between minority shareholders and hard-charging corporate leaders like Musk, giving individual investors less leverage in court in many cases. That has drawn its own share of criticism.

‘Capitulation’ to Musk

“The bill appears to be a total capitulation to Mr. Musk and other controlling shareholders who are similarly situated,” said Charles Elson, a retired University of Delaware professor who formerly headed the school’s Weinberg Center for Corporate Governance. “This is terrible for the state and its incorporation business.”

Neither Musk nor officials of Tesla Inc. or his social media platform X immediately responded to emails Wednesday seeking comment on the legislation.

Delaware has a lot at stake in protecting its commanding lead in the nation’s incorporation business, whose fees generate over a fourth of the state’s more than $6 billion annual budget. It is the corporate home to more than 2 million businesses, including more than 60% of Fortune 500 companies. The bill comes as Nevada and Texas have begun to cut into that advantage by offering corporate statutes that give directors more investor lawsuit protections and corporate titans like Musk more say in organizing and running their companies.

If signed into law, the bill would change the way the state’s business court judges evaluate the independence of corporate directors from controlling shareholders when deciding legal issues such as mergers and executive compensation plans. It also would spell out what defines a controlling shareholder.

The move follows Dropbox Inc.’s and fund manager Bill Ackman’s recent decisions to shift their incorporation out of Delaware. It’s all part of the fallout from a Delaware Chancery Court judge’s decision last year to reject Musk’s multibillion-dollar Tesla Inc. compensation deal, which had been backed twice by the electric vehicle company’s investors.

Elon Musk

Photographer: Stefani Reynolds/Bloomberg

Overreaction or Restoration?

Defenders of the state’s existing corporate approach say the proposed changes are an overreaction to complaints from Musk and other business leaders. They warn that the legislation would permanently damage the state’s reputation for fairness and balance in adjudicating corporate governance disputes.

Jill Fisch, a University of Pennsylvania corporate law professor who specializes in Delaware cases, said the legislation was imprecise and excessive, driven by fears of further corporate defections from Delaware.

“I think some of the changes have been proposed in a hasty, sloppy way and they are overbroad to address the problems” critics have identified with recent Delaware decisions, Fisch said. She added: “It’s not a good look for the state.”

In a statement, the lawmakers said the changes were necessary to restore “the balance and consistency that has been the key” to the state’s corporate laws and to redeem Delaware’s business-friendly reputation.

The bill’s sponsors are led by Senate Majority Leader Bryan Townsend and Representative Krista Griffith, both Democrats, along with Republicans including Senate Minority Whip Brian Pettyjohn and House Minority Leader Tim Dukes, according to the statement. Democrats control both legislative chambers, as well as the governorship.

Lawmakers moved quickly on the bill because “we believe ourselves to be in an urgent situation where swift action is necessary,” Townsend said in an interview. He is also a lawyer who handles Chancery cases for both companies and shareholders.

The Delaware Legislative Hall in Dover.

Photographer: Kent Nishimura/Getty Images

Musk vs. Delaware

Musk, the world’s richest person, launched his online assault on Delaware’s status as the nation’s most popular incorporation site after Chancellor Kathaleen St. J. McCormick found that conflicts of interest among Tesla directors had tainted their decision to award the billionaire the largest corporate pay package in history. Musk yanked Tesla’s and his other companies’ incorporations from Delaware and sent them to Texas, which recently opened a new business court system, and Nevada.

Read More: Musk’s Multibillion-Dollar Tesla Payout Is Gutted by Judge

Richards, Layton & Finger, a Wilmington-based law firm, was among various parties that made suggestions to a panel that drafted the new legislation. Rudy Koch, one of the firm’s partners, is listed in court dockets among those representing Tesla in appealing McCormick’s pay decision to the Delaware Supreme Court.

The firm said in a statement that it has “played critical roles in drafting and amending many of the state’s business statutes, including the original Delaware General Corporation Law” and that it was “proud to have been part of a group, including highly respected lawyers, professors, and former jurists, assembled by elected officials to recommend language included in the proposed legislation.” It said it made its proposals based on issues that go back years and not on behalf of any client.

In an interview, retired University of Pennsylvania law professor Larry Hamermesh, one of the panel’s members, said that Musk’s criticisms of Delaware law didn’t drive the panel’s discussion and that some of the proposed changes had been recommended more than a decade ago.

“The real motivation here is not to make Mr. Musk happy, but to address the concerns of major corporate law firms and their clients,” he said. He noted that since Musk had moved his companies out of the state, he wouldn’t benefit from the changes.

In addition to Hamermesh, the legislation was drafted by former Chancellor William B. Chandler III and former Delaware Supreme Court Chief Justice Leo Strine. Chandler is a partner in the Delaware office of Wilson Sonsini, where he advises clients in connection with corporate governance and other matters. Strine is of counsel at Wachtell, Lipton, Rosen & Katz. Both declined to comment.

What’s in the Bill

Under the new legislation, McCormick and other Chancery judges must presume corporate directors are independent when shareholders challenge their actions. That presumption could be overcome only by “substantial and particularized facts” showing close personal ties to a controlling shareholder or dynamic CEO, according to a copy of the bill.

The bill also takes aim at a Delaware Supreme Court decision last year endorsing heightened scrutiny of “insider transactions” to bolster protections for minority investors.

The decision was heavily criticized for shifting too much sway to investors in merger-and-acquisition cases by widening the number of deals subject to shareholder protections, rather than limiting it to transactions in which minority investors are forced to sell their stakes at a price set by a controller. The new legislation would restore that limit to so-called cash-out deals.

And the proposed changes would limit controlling-shareholder status to one who owns at least a third of a company’s shares and exercises effective control over the company. That status can limit a businessperson’s legally permitted acts over corporate transactions and pay.

(Updates with other members of the drafting panel in fourth section. A previous version of this story was corrected to show that Koch’s client is Tesla.)

To contact the reporters on this story:
Jef Feeley in Wilmington, Delaware at jfeeley@bloomberg.net;
Jennifer Kay at jkay39@bloomberg.net

To contact the editors responsible for this story:
Misyrlena Egkolfopoulou at megkolfopoul@bloomberg.net