Chancery: Control and the Doctrine of Inherent Coercion Preclude Summary Judgment Based on Disinterested Stockholder Approval

The standard of review and who has the burden of proof are important issues in any trial of stockholder litigation. One instance where entire fairness is the standard of review is a merger where a controlling stockholder is on both sides of the transaction. Since the Delaware Supreme Court’s Kahn v. Lynch decision in 1994, Delaware law in that circumstance has mandated an entire fairness standard of review with the burden on the controlling stockholder and the proponents of the transaction to prove that the transaction was fair. But what happens when, after discovery, plaintiffs fail to adduce evidence that a purported controlling stockholder in fact coerced the minority stockholders into approving the transaction? The Delaware Court of Chancery answered that question in In re Tesla Motors Stockholder Litigation, Cons. C.A. No. 12711-VCS (Feb. 4, 2020), holding that disputed issues of fact remain to be resolved as to whether Elon Musk, as the owner of 22.1% of Tesla’s shares, was a controlling stockholder. The possibility that he might be a controlling stockholder invokes the potential for inherent coercion and therefore prevents summary judgment based on an informed Corwin-cleansing vote of a majority of the disinterested stockholders.

Background

On March 18, 2018, the Court of Chancery denied a motion to dismiss on the ground that the plaintiffs adequately had pleaded facts sufficient to conclude that Musk was Tesla’s controlling stockholder in a transaction involving the merger of Tesla and Solar City Inc., another entity in which Musk held a significant interest (the merger). This holding required the court to review the transaction under entire fairness. Discovery ensued and the defendants moved for summary judgment, contending that the plaintiffs failed to establish any evidence that Musk in fact coerced Tesla stockholders into approving the merger. Therefore, according to the defendants, the stockholder vote was fully informed and uncoerced, the stockholder approval resulted in business judgment review under Corwin v. KKR Financial Holdings, 125 A.3d 304 (Del. 2015), and the plaintiffs could not show the transaction was so inherently unreasonable that no rational stockholder could have approved it. Therefore, the defendants argued they were entitled to summary judgment as a matter of law. As explained below, the Court of Chancery disagreed, finding that disputed issues of fact prevented the entry of judgment on the ground of disinterested stockholder approval.

The Doctrine of Inherent Coercion Does Not Disappear After Discovery Closes