Elon Musk cannot keep $56 billion Tesla pay package as judge sides with shareholders

WILMINGTON, Del. — A Delaware judge on Tuesday ruled that billionaire Elon Musk‘s $56 billion Tesla pay package could be voided, calling the compensation “an unfathomable sum” that was not fair to shareholders, according to a court filing.

“The plaintiff is entitled to rescission,” the judge said in her ruling.

The court’s opinion directed the Tesla shareholder who challenged the pay plan to work with Elon Musk‘s legal team on an order implementing the judge’s decision.

Musk‘s lawyer did not immediately reply to an email seeking comment.

“Good day for the good guys,” said an email from Greg Varallo, an attorney for the Tesla shareholder Richard Tornetta who brought the lawsuit.

The ruling can be appealed to the Delaware Supreme Court.

The judge, Kathaleen McCormick of Delaware’s Court of Chancery, said the pay package did not meet the standard of a fair price.

“The incredible size of the biggest compensation plan ever — an unfathomable sum — seems to have been calibrated to help Musk achieve what he believed would make ‘a good future for humanity’,” wrote McCormick in her 201-page opinion.

Tesla’s agreement with Musk is by far the largest compensation deal ever for an executive and it contributes a significant part of his fortune, which is one of the world’s largest.

Tesla directors argued during a weeklong trial that the company was paying to ensure one of the world’s most dynamic entrepreneurs continued to dedicate his attention to the electric-vehicle maker. Antonio Gracias, a Tesla director from 2007 to 2021, called the package “a great deal for shareholders” because he said it led to the company’s extraordinary success.

Tornetta’s lawyers argued the Tesla board never told shareholders that the goals were easier to achieve than the company was acknowledging and that internal projections showed Musk was quickly going to qualify for large portions of the pay package.

The plaintiff’s legal team also argued the board had a duty to offer a smaller pay package or look for another CEO and that they should have required Musk to work full-time at Tesla instead of allowing him to focus on other projects.

Musk in 2022 bought social media company Twitter, which he renamed X, and he has founded several startups, including brain implant company Neuralink, tunneling venture the Boring Co and SpaceX, a rocket venture.

Musk testified during the compensation trial in November 2022 that the money would be used to finance interplanetary travel.

“It’s a way to get humanity to Mars,” he testified. “So Tesla can assist in potentially achieving that.”

The package grants stock option awards allowing Musk to buy Tesla stock at heavily discounted prices as escalating financial and operational goals are met.

He must hold the acquired stock for five years.

Musk qualified for all 12 tranches or performance targets in the plan. He was not guaranteed any salary.

The ruling will put the spotlight on Tesla’s next round of compensation negotiations with the CEO. Musk said in a post on X in January that he was uncomfortable leading Tesla unless he had 25% of the voting control. The billionaire owned around 13% of the company at the time.

Tesla’s value ballooned to briefly top $1 trillion in 2021 from $50 billion when the package was negotiated.

Amit Batish at Equilar, an executive pay research firm, estimated in 2022 that Musk‘s package was around six times larger than the combined pay of the 200 highest-paid executives in 2021.

In July, Tesla’s directors agreed to return $735 million to the company to settle shareholder allegations brought in a separate lawsuit filed in 2020 that they overpaid themselves. The lawsuit challenged options that were granted to directors starting in June 2017.

Who sued and why?

An investor named Richard Tornetta sued Musk and several Tesla directors in 2018, claiming Musk’s pay package was unfair. While Tornetta held just nine Tesla shares, the deal had also been criticized by major pension fund California State Teachers’ Retirement System (CalSTRS) and proxy advisory firms, who viewed the deal as too large.

Musk’s 2018 pay package gave him stock grants worth around 1% of Tesla’s equity each time the company achieved one of 12 tranches of escalating operational and financial goals. Tornetta argued that shareholders were not told how easily the goals would be achieved when they voted on the package.

Tesla achieved the financial goals, helping make Musk one of the world’s wealthiest people.

Tornetta claimed the pay was not necessary to incentivize Musk to achieve success for Tesla, as Musk already owned around 22% of the automaker’s stock.

What was Musk’s defense?

Tesla’s board argued in court filings that the pay package was needed to align Musk’s incentives with shareholders and to keep him focused on the company as it ramped up production of the Model 3. It argued that Musk did not receive any compensation other than the stock options and that if Tesla had not achieved the targets in the pay package, Musk would not have received any money.

Shareholders were told that the goals tied to Musk’s pay were “challenging” yet “attainable.”

What happens now?

Musk is likely to appeal, experts said. Before that can happen, the judge will have to finalize the ruling and decide on compensation for the lawyers who represented Tornetta on a contingency basis.

Even without the pay package, Musk benefited from his 22% ownership share of Tesla’s stock at the time the package was adopted in 2018. Since then, Tesla’s stock has risen about 10-fold, raising the value of his stake by more than $100 billion.

What can the board do?

Musk said in January that discussions on a new pay package with the board were on holding pending the outcome of the case over the 2018 package.

The plaintiff’s legal team has said in court documents that the board could adopt a new plan to pay Musk for his work for the last five years, saying that this plan would have to be reasonable.

Experts said any such payment would likely pale in comparison with the stock grant and could lead to more legal headaches.

Jesse Fried, an executive pay expert and professor at Harvard Law School, said that while Delaware courts sometimes allow boards to make modest “gift” payments to executives for past performance, shareholders could easily sue over such a payment to Musk, claiming it was a waste of corporate resources.

“Musk has already generated value for the shareholders. If they were to write a check to him now for $10 billion for past performance, what exactly do the shareholders get from that?” he said.

Includes Reuters