On November 21, 2016, Tesla purchased 100% of the outstanding shares of SolarCity Corp. Tesla paid for the shares with Tesla stock, giving SolarCity shareholders Tesla stock valued at about $2.6 billion. A few Tesla shareholders sued the seven-person Tesla Board of Directors (“BOD”) for breach of their fiduciary duties. The shareholders argued in part that the shares of SolarCity were worthless when acquired, or at least worth a lot less than the amount paid.

At first blush, the business judgment rule (“BJR”) would make the court’s task easy. The directors win if they did their due diligence, i.e., made an informed decision, and there was no conflict, fraud, waste or bad faith. Suffice it to say they did a lot of due diligence.

But let’s dig a little deeper into the facts. Elon Musk was the largest shareholder of both Tesla and SolarCity owning about 22% of the publicly traded stock of each. He was also Chairman of the Board of SolarCity which he founded with his two cousins, Peter and Lyndon Rive. Elon, his brother Kimbal Musk, and one other person, Antonio Gracias, sat on both boards. Three other Tesla directors owned some SolarCity stock directly or indirectly. Hmm? Conflicts maybe? Loyalty issues?

So a huge portion of the amount paid for SolarCity went into Elon’s pocket. Other amounts went to his brother and four of the other Tesla directors. Only one Tesla director, Robyn Denholm, was completely disinterested financially.

But digging a little deeper still, this time focusing on the process of getting to the price Tesla paid, the Tesla BOD did not form a committee and did not exclude Elon from the negotiations. But it did hire an expert to opine on the valuation. Further, when it reached the purchase price, it submitted the issue to the disinterested shareholders. The disinterested shareholders approved the deal which closed the next day.

The unhappy shareholders, i.e., the plaintiffs here, argued that Elon dominated the BOD and since their directors had their own conflicts anyway (being shareholders of SolarCity), the BJR did not apply and therefore the matter must go to trial to determine if they used appropriate care, i.e., good faith business judgment and care of a reasonably prudent person under similar circumstances. They argued further that since six of the directors were putting money in their own pockets, the court must have a trial to determine if the price paid was fair to Tesla. Lastly, they argued that Elon, as a controlling shareholder, dominated the disinterested shareholders so the vote of those shareholders should carry no weight or any favorable presumption.

The crux of the matter then is whether the transaction was fair to Tesla and its shareholders. The Delaware court set the issue of care to the side at the outset. If the transaction was fair to the now-diluted Tesla shareholders, there are no damages and care would not be an issue. As to fairness, the court noted that the analysis is two-fold. It observed:

“The concept of fairness has two basic aspects: fair dealing and fair price.‘  Fair dealing (or fair process) ‘“’embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.’  Fair price ‘relates to the economic and financial considerations of the proposed merger, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic or inherent value of a company’s stock.’” The burden of persuasion lies generally with the defendants.

The court conducted an 11-day trial. In a very lengthy and detailed memorandum, it concluded that the price was intrinsically fair to the Tesla shareholders and entered judgment in favor of the defendants. As to the process, the court found that “Elon was undoubtedly involved in the deal process in ways he should not have been, but fortunately, the Tesla Board ensured nevertheless that the process led to a fair price. For example, it said no to the proposed merger twice at the outset. And Elon did not push back against them—there were no threats, fits or fights.  While involved, Elon did not impede the Tesla Board’s pursuit of a fair price.”

As to the price, it found that the price was intrinsically fair. It considered the testimony of various parties and experts and concluded the price was fait to Tesla. It commented also that “approval of a merger by disinterested stockholders is ‘compelling evidence that the price was fair.’  Here, nearly 85% of the votes cast by Tesla stockholders—largely extremely sophisticated institutional investors—were in favor of the Acquisition.”

The court therefore did not rule on the duty of care since there could not be any breach when the process getting to the purchase decision was fair, i.e., what was done was something a reasonably prudent person would have done under similar circumstances. Also again, since the price was fair, there could not be any damages.