More Elon Musk Litigation – purchase of SolarCity in 2016

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.

Some more thoughts about bar exam question 5

I thought I would give you a little insight into my thought process in answering question 5. It a good lesson I think in how to answer a law school question and how practicing law really works.

I spent about 40 minutes I think doing the answer I uploaded, maybe a little longer. I changed my mind a bunch of times about the analysis, taking arguments out completely and adding new ones that kept coming to me, going back and forth between the various parts. Even discussing Betty made me think of arguments for or against Arnold so I went back and made changes. I always, always, review. review, review. Refine, refine, over and over.

I uploaded it and went for a walk. During my walk I thought about my answer. It occurred to me that I should have been more clear about the fraud analysis. The false statement was that Arnold told Betty he thought the patent was worth a $100,000. If he really thought that, it’s not a false statement. Plus a belief in something may not even be a statement at all. So the issue really was the failure to disclose the previous attempts to sell the patent. Failure to disclose is not a “false statement” and is fraud only if there is a duty to disclose. Until they were partners I’m not sure there was a duty to disclose. That’s what made me think of Rule 10b5. That has a duty to disclose which I think clearly applies.

The point of this is this is how it works in the lawyer world. You think about something, reach a conclusion, think some more, massage your analysis. There are rarely clear answers to anything. Good lawyers write want they want to tell the judge or the client, then set it aside and look at it again tomorrow. It’s so much more clear the next day.

The second point in this post is when I later reviewed the answer I uploaded I quickly found a typo. I put in the answer that a partnership is when “one or more persons” agree to operate a business. It’s obviously two or more. It’s a stupid mistake and I kick myself. If I had read that in one of your answers, I would have wondered if you knew what the rule was. I likely would have pointed out that it can’t be that one person can be a partnership. Typos happen but it is sooo important they be limited.

The point of my second point is that it is the rare student, from what I can see, that reviews his/her answer at all. That is such a big mistake! What you say in your answer matters. I only know what I am reading. The bar exam reader spends about 3 minutes per exam before giving it a grade. We are trying to figure out how well you know the subject matter by reading your words.

My third point is that when I thought about the answer to part 2 – Betty, I wondered what I would say. The answer is really the same. So I thought about what made the Betty answer different than the Arnold answer which I spent so much time on. Many students these days would have copied and pasted the entire answer re Arnold into the answer re Betty. That is such a bad idea! If Betty were sitting there in your office, you would not just literally repeat what you just told Arnold. You would say, “well Betty, your position is a little different.”

Oh well, the Kings game is about to start. I have to reread this before I upload it. JH

New case on the business judgment rule

Coley v. Eskaton (2020) 51 Cal. App. 5th 943

This is an action by a homeowner against the board of an HOA. The court awarded $2,300 in damages and $654,000 in attorneys fees! The plaintiff argued that the directors breached fiduciary duty and other claims, alleging directors approved actions of HOA for benefit of operators rather than HOA itself and homeowners. The court found directors breached fiduciary duty to HOA but declined to find directors liable in their personal capacities. The court of appeals reversed saying:

1 directors failed to establish HOA transactions were fair and reasonable;

2 directors had personal financial interest in transactions they approved that was distinct from interest of HOA members generally; and

3 directors breached fiduciary duty to HOA members by approving transactions in which they had material financial interest and which were not inherently fair to HOA and its members.

As to the BJR, theopinion says:

B. Application of the Business Judgment Rule

1The defendants’ next claim the court misapplied the business judgment rule. The business judgment rule is a policy of deference to a corporate board’s decisionmaking. (Lamden v. La Jolla Shores Clubdominium Homeowners Assn. (1999) 21 Cal.4th 249) But the trial court here found the rule inapplicable because the Eskaton entities’ employees who sat on the Association’s board had an “irreconcilable conflict of interest” that “preclude[d] the business judgment rule as a defense to liability in this case.” According to the defendants, rather than finding this conflict precluded the business judgment rule altogether, the court instead should have afforded the defendants an opportunity to reclaim the benefit of the rule by showing they acted in good faith after reasonably investigating material facts. We view the law differently.

1. Background law

California recognizes two types of business judgment rules: one based on statute and another on the common law.  Corporations Code section 7231 supplies the relevant statutory rule for nonprofit mutual benefit corporations like the Association. Under that statute, a director is not liable for “failure to discharge the person’s obligations as a director” if the director acted “in good faith, in a manner such director believes to be in the best interests of the corporation and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” (Corp. Code, § 7231, subds. (a)(c).) The common law business judgment rule is similar but broader in scope. It is similar in that it immunizes directors for their corporate decisions that are made in “good faith … to further the purposes of the [corporation], are consistent with the [corporation’s] governing documents, and comply with public policy.” (Nahrstedt v. Lakeside Village Condominium Assn. (1994) 8 Cal.4th 361, 374) And it is broader in that it also “ ‘insulates from court intervention those management decisions’ ” that meet the rule’s requirements. (Lamden, supra, 21 Cal.4th at p. 257.)

45A director, however, cannot obtain the benefit of the business judgment rule when acting under a material conflict of interest. Deference under the business judgment rule is premised on the notion that corporate directors are best able to judge whether a particular transaction will further the company’s best interests. (Gaillard, supra, 208 Cal.App.3d at p. 1263, 256 Cal.Rptr. 702.) But that premise is undermined when directors approve corporate transactions in which they have a material personal interest unrelated to the business’s own interest. And it is particularly undermined when a majority of these directors approve transactions while having a material conflict of interest. Under those circumstances, the directors carrying this conflict of interest are precluded from seeking the benefit of the business judgment rule. (See Everest Investors, supra, 114 Cal.App.4th at p. 430, 8 Cal.Rptr.3d 31Gaillard, supra, 208 Cal.App.3d at p. 1263, 256 Cal.Rptr. 702.)

678But although the business judgment rule is inapplicable under these circumstances, that is not to say that corporate decisions affected by these types of conflicts are improper as a matter of law. As with the business judgment rule generally, statutory and common law requirements are again relevant in this context. Corporations Code section 7233 supplies the relevant statutory rule. It provides, among other things, that an interested director who casts a deciding vote on a transaction must show the “transaction was just and reasonable as to the corporation at the time it was authorized, approved or ratified.” (Corp. Code, § 7233, subd. (a)(3).) Section 7233, however, only applies to transactions “between a corporation and one or more of its directors, or between a corporation and any domestic or foreign corporation, firm or association in which one or more of its directors has a material financial interest.” (Corp. Code, § 7233, subd. (a).) The common law rule, as before, is similar but broader in scope. It is similar in that it requires interested directors to “prove that the arrangement was fair and reasonable”—a rigorous standard that requires them “ ‘not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein.’ ” (Tenzer v. Superscope, Inc. (1985) 39 Cal.3d 18, 31-32, 216 Cal.Rptr. 130, 702 P.2d 212 (Tenzer).) And it is broader in that, unlike Corporations Code section 7233, it is not concerned only with transactions between a corporation and either its directors or a business in which its directors have a material financial interest. (See Corp. Code, § 7233, subd. (a).) Rather, recognizing the potential for self-dealing may also exist outside this particular context, courts have found directors must also satisfy the common law requirements when they approve other transactions in which they have a material financial interest distinct from the corporation’s own interest.

Study Sessions

I am not going to do a study session this Saturday because of the exam answers that are due next Tuesday. As I said in class last night, I am willing to spend an hour to 90 minutes with students by Zoom one evening a week for the next five weeks – starting next week. I can do it at 5pm or at 7pm, any night obviously except Tuesday night. Please send me an email if you are interested in attending telling me which days and times you prefer. I will pick a time which the most people can attend. That is the best I can do.

What is an employee under California law?

We are going to spend Tuesday discussing agency law.  The issue comes up in two contexts:  1.  Is a principal liable for the contract entered into by his (or its) agent?  Answer, yes if the agent had authority.  2.  Is a principal liable for the torts of his agents?  Answer, yes if the agent is an employee, maybe (although probably not) if the agent is an independent contractor.

So what is an employee?  That could easily be an entire semester.  The question necessarily includes what is an employer?

The California Supreme Court has recently given us 85 pages of explanation (and history of the issue) of how to figure out whether a person is an employee or independent contractor.

In Dynamex Operations West, Inc., v. Superior Court, 4 Cal.5th 903 (2018), the Supreme Court summarized it with a three part test:

1. Is the worker free from the control and direction of the hiring entity in the performance of the work, both under the contract for the performance of the work and in fact?
2. Does the worker perform work that is outside the usual course of the hiring entity’s business?
3. Is the worker customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity?

It concluded that it is the employer’s burden to establish all three.  “The hiring entity’s failure to prove any one of these three prerequisites will be sufficient in itself to establish that the worker is an included employee, rather than an excluded independent contractor, for purposes of the wage order.”



Is wife liable for hubby’s debts?

NO!  Students (and even most lawyers) are always surprised when I say that my wife is absolutely not liable for my debts – and certainly not because she is my wife.

Property that she and I own may be liable for my debts (i.e., is probably liable for my debts).

A few California Family Code sections:


(a) *** the community estate is liable for a debt incurred by either spouse before or during marriage, regardless of which spouse has the management and control of the property and regardless of whether one or both spouses are parties to the debt or to a judgment for the debt.

(b) “During marriage” for purposes of this section does not include the period after the date of separation ***.


Continue reading

Insider trading issues

I received an email from a student re insider trading, specifically re what is a tippee.  Take a look at my post a couple of years ago on the Supreme Court case of Salman v. US.

The Supreme Court clarified that “a tippee’s liability for trading on inside information hinges on whether the tipper breached a fiduciary duty by disclosing the information.   A tipper breaches such a fiduciary duty, we held, when the tipper discloses the inside information for a personal benefit.”

The Supreme Court then said that a “close personal relationship” is enough as far a receiving a personal benefit.

Keep in mind that many cases require “scienter” i.e., bad intent, intent to avoid a law.  Keep in mind also that the information must be “material non-public information.”

The student also asked whether the same transaction could also violate general securities laws, i.e., a sale of a security that is not registered and not otherwise exempt.  Answer:  Of course and that must be considered.