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Court of Chancery Finds Possibility of Actual Control and the Doctrine of Inherent Coercion Preclude Summary Judgment Based on Disinterested Stockholder Approval

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February 19, 2020
By: Lewis H. Lazarus
Delaware Business Court Insider

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 Court of Chancery answered that question in In Re Tesla Motors, Inc. Stockholder Litigation, Cons. C.A. No. 12711-VCS (February 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.


On March 18, 2018, the Court of Chancery denied a motion to dismiss on the ground that 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 defendants moved for summary judgment, contending that 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 Fin. Holdings LLC, 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, 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 

Fundamental to the Court’s holding was his review of Delaware Supreme Court precedent mandating entire fairness review in controlling stockholder transactions, even when approved by minority stockholders, due to the concern for “inherent coercion.” In Kahn v. Lynch, the Delaware Supreme Court adopted the reasoning of the Court of Chancery in Citron v. E.I. DuPont de Nemours & Co. that “[t]he controlling stockholder relationship has the potential to influence, however subtly, the vote of [ratifying] minority stockholders in a manner that is not likely to occur in a transaction with a non-controlling party.” Id. at 13 (citations omitted to Kahn and Citron). The Supreme Court reaffirmed this view in Kahn v. Tremont Corp. in 1997 in writing that “[t]he risk is thus created that those who pass upon the propriety of the [interested merger] transaction might perceive that disapproval may result in retaliation by the controlling stockholder.” Id. at 14. While recognizing that some scholarly commentators have criticized the doctrine, the Court observed that Supreme Court precedent is clear that “transactions involving conflicted controllers must be reviewed for entire fairness, even when the transaction is approved by stockholders, because, in such instances, the stockholder vote is presumed to be coerced.” Id. at 16.

Court Finds Issues of Fact Remain as to Whether Musk was a Controlling Stockholder 

Delaware law recognizes that a substantial minority stockholder, when coupled with other factors, may have the capacity to dominate corporate decision-making. Among the factors that may affect that determination are managerial supremacy, and public statements by the company that the person’s departure would have a material effect on the company’s business and operations and that the person has a significant influence over the company. The Court read applicable precedent to hold that it is the ability to control, rather than the actual exercise of control, that is the determinative factor as to whether a minority stockholder is a controller. The Court held issues of fact remain to be determined at trial as to whether Musk in fact was a controller. 

Lessons Learned 

If factual issues remain as to whether a party is a controlling stockholder, then a defendant cannot rely at summary judgment on a Corwin-cleansing stockholder vote to subject the transaction at issue to business judgment review. This is because Delaware Supreme Court precedent has endorsed the doctrine of “inherent coercion” which makes the court unwilling to accept an otherwise fully informed stockholder vote as uncoerced when a controlling stockholder is on both sides of the transaction. That is by no means a death knell for Defendants. In this case, Musk could establish at trial that he is not in fact a controlling stockholder. Alternatively, even if at trial the Court concludes he was a controller, he could also prove the fairness of the process and price of the Merger transaction.

Delaware Business Court Insider l February 19, 2020 

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