A Delaware judge on Friday questioned lawyers for Tesla about why the company asked shareholders to vote on a $55 billion pay package for its chief executive, Elon Musk, after she had struck it down in January.
The judge, Chancellor Kathaleen St. J. McCormick of the Delaware Court of Chancery, noted at a hearing in Wilmington that there was no legal precedent for the company’s decision, which led to an overwhelming shareholder vote in favor of the compensation package in June.
“This has never been done before,” she said in an exchange with a lawyer representing Mr. Musk and Tesla’s directors. “There is no Delaware law on this, correct?”
The lawyer, David E. Ross, acknowledged there was no exact precedent for having shareholders overturn a judge’s decision in similar cases. But he asserted that the June vote showed that Tesla’s shareholders were willing to award Mr. Musk the package even after being provided a lot more information about how it had been devised.
”This was stockholder democracy working,” Mr. Ross said.
The back and forth over legal precedent is important because it could help determine whether Mr. Musk gets to keep stock options worth tens of billions of dollars. Tesla and Mr. Musk have said that the June shareholder vote addressed the problems that Chancellor McCormick cited in her decision to void the package and that it should be reason enough for her to reverse her decision.
Mr. Musk’s pay package, first approved by Tesla shareholders in 2018, was widely regarded at the time as the largest ever made by a public company. The package was set up to give Mr. Musk billions of dollars in stock options only if Tesla’s profits, sales and stock market value increased significantly.
Though the company achieved all those performance goals, ultimately enabling Mr. Musk to earn all the options and helping to make him the richest person in the world, a Tesla shareholder sued in the Delaware court, contending that the company’s board had not acted independently when putting together the package.
After a trial in 2022, Chancellor McCormick in January rescinded the package, ruling that Mr. Musk had effectively overseen his own compensation plan, and that Tesla failed to disclose, among other things, the personal and business ties between board directors and Mr. Musk that could lead to conflicts of interest. She also said the package was excessive.
Tesla set up a special board committee to respond to the judge’s decision. It decided to keep the pay package and put it to another shareholder vote. The committee recommended attaching the judge’s 201-page decision, which detailed her criticisms, to Tesla’s proxy statement, so that shareholders had more information about Mr. Musk’s relationships with board members, and how the package was drawn up.
Even with the judge’s criticisms at hand, “Tesla’s disinterested stockholders still overwhelmingly voted to affirm the 2018 agreement as in their own best interests,” Mr. Musk’s lawyers argued in a recent brief that asked the chancellor to revise her ruling.
Lawyers representing the shareholder who originally sued Tesla, Richard J. Tornetta, argued in their own brief that Mr. Musk had in effect “coerced” the vote by threatening to “divert A.I. and robotics opportunities away from Tesla unless given 25 percent of the company.”
On Friday, in a courtroom packed with lawyers, Chancellor McCormick seemed less concerned by what shareholders knew than by the prospect of investor votes that overturn trial judgments. “The real question is whether stockholders can ratify an adjudicated breach of the duty of loyalty,” she said. A breach of a duty of loyalty occurs, say, when a director acts in her own interests at the expense of shareholders.
Rudolf Koch, another lawyer for Tesla, said that many cases were relevant and that he was not asking the chancellor “to make new law.”
Chancellor McCormick asked lawyers for Tesla and its directors if shareholder votes aimed at overturning a ruling could occur at any time in the legal process.
“When does it end in your world?” she asked.
Some legal scholars shared her apparent concern.
“Normally there are rules about when you can take action to correct mistakes. It respects the court; it preserves the court’s resources. It prevents parties from dragging out disputes endlessly.,” Ann M. Lipton, a law professor at Tulane University, said in email on Friday.
But other legal experts said it was unlikely that Tesla’s June shareholder vote would pave the way for companies to exploit the legal system.
“I don’t think that defendants have incentives to do things that are flawed under Delaware law,” Jonathan R. Macey, a professor at Yale Law School, said in an email on Friday. “Litigating is expensive, and shareholders are not going to act against their own best interests in any subsequent ratification vote.”
It is not clear if Chancellor McCormick will change her ruling and when she will respond to the arguments made on Friday. Whatever she decides, legal experts said they expected the case to end up before the Delaware Supreme Court.
Tesla shareholders also voted in June to move the company’s state of incorporation to Texas from Delaware. Legal experts said the move would not enable Tesla to approve the 2018 plan under Texas law, but it could award Mr. Musk a new compensation package in Texas. On Friday, Chancellor McCormick agreed with that, saying her ruling would not bar Tesla’s board from awarding Mr. Musk a new pay deal.
The stock options in the disputed pay package represent just over two-fifths of Mr. Musk’s 20.5 percent stake in Tesla, according to its proxy statement.
His shares in Tesla are only part of his wealth. Bloomberg estimates that his stake in SpaceX, the rocket company, is worth $80 billion, but it would be harder for Mr. Musk to sell those shares because they are not traded on a stock exchange. He has used his Tesla shares as collateral for personal loans, and he sold billions of dollars of Tesla stock in recent years, in part to finance his purchase of Twitter, now called X.