Settlement in Excessive Director Compensation Suit Against Tesla Requires Corporate Governance Changes | Practical Law

Settlement in Excessive Director Compensation Suit Against Tesla Requires Corporate Governance Changes | Practical Law

Tesla, Inc., its CEO, and several non-employee directors have entered into a stipulation of settlement filed with the Delaware Chancery Court to settle breach of fiduciary duty and unjust enrichment claims related to director compensation. The directors agreed to return approximately $735 million in compensation, and Tesla agreed to make corporate governance reforms.

Settlement in Excessive Director Compensation Suit Against Tesla Requires Corporate Governance Changes

by Practical Law Employee Benefits & Executive Compensation
Published on 18 Jul 2023 • USA (National/Federal)
Tesla, Inc., its CEO, and several non-employee directors have entered into a stipulation of settlement filed with the Delaware Chancery Court to settle breach of fiduciary duty and unjust enrichment claims related to director compensation. The directors agreed to return approximately $735 million in compensation, and Tesla agreed to make corporate governance reforms.
Tesla, Inc., its CEO, and several non-employee directors have entered into a stipulation of settlement filed with the Delaware Chancery Court to settle breach of fiduciary duty and unjust enrichment claims related to director compensation (
The Police and Fire Ret. Sys. of the City of Detroit v. Musk, et al., No. 2020-0477
(July 14, 2023)). The settlement requires:
  • The directors to return approximately $735 million in compensation.
  • Tesla to make corporate governance and other internal control changes.

Background

The dispute in this case arose out of compensation Tesla paid to non-employee directors beginning in 2017. In 2020, the plaintiff — a city retirement system that held Tesla stock — filed a shareholder derivative complaint against Tesla, Elon Musk as CEO and director, and its then-current and former directors, asserting claims for breach of fiduciary duty and unjust enrichment. Plaintiff alleged that the directors awarded themselves unfair and excessive compensation. Plaintiff sought disgorgement of the directors' option awards, a declaratory judgment that directors had breached their fiduciary duties, and changes to Tesla's director compensation practices.

Stipulation of Settlement

The stipulation of settlement requires:

Directors Must Return $735 Million in Compensation

The settlement requires the directors to return approximately $735 million in compensation to Tesla in the form of:
  • Cash.
  • Unrestricted common shares of Tesla's stock.
  • Unexercised options.
The settlement sets out the methods that must be used in determining the value for each form of compensation. The number of authorized shares available under Tesla's 2019 Equity Incentive Plan must be increased for the total number of options that are returned (and then canceled).
In addition, the settlement provides that the director defendants agree to permanently forego all automatic annual grants of option awards under Tesla's Outside Director Compensation Policy, as well as any other compensation, for their service on Tesla's board of directors for 2021 and 2022 (to the extent they served as directors during that period), and the current directors agree to permanently forego all compensation for their service on the Tesla board for 2023.
The director defendants do not admit to any wrongdoing as part of the settlement.

Tesla Must Implement Corporate Governance Reforms

Under the settlement, Tesla must make certain corporate governance reforms, including that, for five years after final court approval of the settlement:
  • The Tesla compensation committee must amend its charter to state that it is responsible for:
    • conducting an annual review and assessment of non-employee director compensation, including cash and equity-based compensation;
    • engaging annually an independent compensation consultant to advise on the annual director compensation review and assessment; and
    • making recommendations to Tesla's board of directors regarding non-employee directors' compensation.
  • The Tesla board must review annually:
    • non-employee directors' compensation; and
    • the compensation committee's recommendation concerning compensation for non-employee directors.
  • Tesla must submit annually the proposed compensation for non-employee directors to its stockholders for approval by a majority of Unaffiliated Tesla Stockholders present and entitled to vote. The settlement defines Unaffiliated Tesla Stockholders as all stockholders of record other than the defendants (which includes Elon Musk) and any other current or future Tesla directors serving on the board that are not among the defendants.
  • Before submitting the proposed compensation for stockholder approval, Tesla must provide proxy disclosures that describe:
    • its compensation philosophy for non-employee directors;
    • its decision-making process for setting non-employee director compensation, including information regarding the role and analysis of the independent consultant and any relevant peer group or comparative data; and
    • the proposed compensation for each non-employee director (including the cash and equity value).
  • Tesla must:
    • review its internal controls related to non-employee director compensation and make any necessary changes regarding the appropriate administration of non-employee director compensation; and
    • continue to review annually its internal controls related to non-employee director compensation and report the results of this review to the audit committee. The audit committee minutes must reflect that this report was provided.

Practical Implications

While the Tesla directors do not admit to any wrongdoing as part of the settlement, the settlement is an important reminder that:
  • Director compensation decisions are heavily scrutinized by shareholders, and compensation that appears excessive can lead to costly litigation.
  • Companies should have robust corporate governance processes in place to ensure that director compensation is reasonable and can withstand scrutiny.
For more information on director compensation, including resources addressing case law related to excessive director compensation, see Director Compensation Toolkit.