On April 28, the Delaware Chancery Court issued a verdict in a shareholder derivative lawsuit against Tesla regarding the company’s 2016 acquisition of a solar company. At issue in the case was Tesla’s failure to address conflicts of interest among the company’s board members, several of whom had an interest in the company to be acquired.
The Court held that the deal was fair to the company and thus ruled in Tesla’s favor. In its ruling, the Court pointed out several best practices for dealing with director conflicts that Tesla failed to follow. However, it also pointed out several best practices that the board did follow.
First, Tesla failed to establish a special committee of independent directors. If a company’s directors have conflicts of interest, it is best for the company to establish a special committee consisting of independent directors to analyze the issue at hand (even if the committee only consists of one independent director).
Second, Tesla’s conflicted directors failed to recuse themselves from voting on the acquisition. Tesla CEO Elon Musk was a conflicted director but only partially recused himself and still participated in some meetings regarding the potential acquisition. Any conflicted directors should entirely recuse themselves from the conflicted transaction or decision so that the board’s independence cannot be questioned or challenged.
Third, Tesla’s conflicted directors were involved in the selection of independent advisors. While it is a best practice for a company to select independent advisors for advice, such as lawyers, CPAs, and financial advisors, the actual selection of the advisors should only be done by the non-conflicted, independent directors. If the conflicted directors choose which independent advisors to hire, the advisors’ “independence” may be subject to challenge.
The court pointed out three best practices for dealing with board of director conflicts to which Tesla did adhere. For one, Tesla allowed the independent directors and advisors to lead the acquisition negotiations. The court noted that Tesla’s lone independent director was in charge of the process and that the conflicted directors did not push back against the independent director and advisors. In the event that a company’s conflicted directors fail to recuse themselves, it is in the company’s best interest to allow any independent personnel to be in charge.
Also, Tesla created a “record of hard bargaining.” The court explained that Tesla negotiated a lower price for the acquisition following proper due diligence. A company should always keep appropriate records and minutes for board decisions, but it is particularly vital to do so in situations where the board’s independence and process could later be challenged or questioned.
Lastly, the court recognized Tesla’s decision to require the acquisition to be approved by its minority shareholders, despite there being no such requirement under Delaware law. Obtaining shareholder approval for any deals, not just those involving conflicted directors, can be a way in which a company can protect itself from potential shareholder litigation.
These best practices are an effective way to ensure that both a company and its shareholders get a fair deal and can help prevent litigation over the board of directors’ decisions or transactions. Following these practices could save a company a great deal of money and time.