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The Delaware court of chancery dates to the 18th century and has faced many challenges in its time. Few have been quite as boisterous as that posed by Elon Musk, founder of Tesla and SpaceX, who reacted to a ruling against him last week with typical defiance: “Never incorporate your company in the state of Delaware,” he told his 171mn followers on his social network X.
Musk was furious about a judgment by Kathaleen McCormick, the court’s most senior judge, rescinding his 2018 award of options over 12 per cent of Tesla’s equity. He had demanded a hefty financial incentive to grow the value of the electric-car maker, and it worked: Tesla became one of the world’s most valuable companies and his options ended up being worth $56bn.
McCormick negated the decision, deciding that several members of the eight-person board were too close to Musk (some had taken family holidays with him) and did not fulfil their duty to negotiate the chief executive’s pay independently of what he desired. The package was approved by shareholders, but she ruled that their vote was not sufficiently informed.
The chancery court is one of the most influential institutions in the world’s largest economy: as one study put it, “the Delaware brand is to corporate law what Google is to search engines”. Companies decide in which state to incorporate legally, often separately from their head office locations; many pick Delaware because of the small court’s dominance and its reputation for pragmatism and legal expertise.
Musk wants to disrupt this. He is not Tesla’s chair: that job is held by Robyn Denholm, a technology investor who received $280mn from exercising Tesla options in 2021 and 2022. But as chief executive he has promised a shareholder vote on moving Tesla’s incorporation to Texas, which has formed a business court. Delaware has been accused in the past of being over-friendly to boards; it now faces a fresh judicial challenge.
The US tradition of legal competition among states is distinctive. The fact that companies choose between them, with shareholders’ approval, could be an incentive to locate in a jurisdiction that tolerates misbehaviour and executive entrenchment. Criticism of Delaware reached a peak in the 1980s when it sanctioned some “poison pill” defences against hostile takeovers.
In practice, the court tries to balance the interests of investors and boards with its “business judgment” rule. If directors act in good faith, they can make decisions they believe are good for a company without being legally second guessed (investors who disagree can mount proxy challenges to replace them). It seeks to intervene only when boards fail to oversee and reward executives appropriately.
But even when it has criticised boards over executive pay, as in a case involving Walt Disney two decades ago, the court has not acted with similar force. McCormick surprised many by reversing an award that was approved by shareholders. The case was brought by lawyers on behalf of one small investor; others who gained along with Musk disagree. It is not the end of the affair: Tesla can appeal, and could propose a new pay deal, this time more carefully.
Expert as Musk is at disruption, Delaware’s incumbency will be hard to dislodge. The court has more than 200 years of history, a circle of expertise in Wilmington, and a hard-earned reputation for impartiality in corporate disputes. Texas has a long way to go to match it, and the southwestern state’s judges would not gain credibility if they merely did the bidding of wilful entrepreneurs. Extraordinary though Musk’s achievements have been, a board must be more than a fan club.
