A recent decision by the Delaware Court of Chancery explained that the doctrine of “inherent coercion” by a controlling stockholder survives beyond discovery, and plaintiffs need not identify actual evidence of coercion to counter a defendant’s ratification defense.1 The inherent coercion doctrine provides that interested transactions involving controlling stockholders (namely, stockholders with a majority of voting control or a combination of voting power and management control, such that the stockholder is deemed to have effective control of the board of directors without owning a majority of the company’s stock)2 must be reviewed for entire fairness – even when the transaction was approved by the minority stockholders – because the vote is presumed to be coerced.3
In re Tesla Motors, Inc. S’holder Litig. involved the plaintiffs’ challenge to the acquisition by Tesla, Inc. (Tesla) of SolarCity Corporation (SolarCity).4 SolarCity was partially owned by Tesla’s chairman of the board of directors, CEO, and largest stockholder, Elon Musk (Musk).5 Prior to the acquisition, Tesla’s board of directors sought stockholder approval for the acquisition, and that approval excluded Musk’s vote and the vote of other Tesla stockholders who served as directors and officers of SolarCity.6
Initially, the defendants, including Musk, moved to dismiss the suit, claiming minority stockholder approval made the acquisition subject to Delaware’s business judgment rule.7 However, the court rejected that defense because it was reasonably conceivable that Musk was Tesla’s controlling stockholder. Therefore, the transaction was subject to entire fairness review under the doctrine of inherent coercion.8
Following the close of discovery, Musk filed a motion for summary judgment. In his motion, Musk asserted that even if he was a controlling stockholder at the time of the challenged transaction, the plaintiffs failed to offer evidence that Musk actually coerced the minority stockholders into approving the merger.9 Without any evidence indicating actual coercion, Musk argued, the challenged transaction should be subject to the board of directors’ business judgment.10 The plaintiffs, on the other hand, asserted that no actual evidence of coercion is required for the presumption that a conflicted controller improperly influenced the minority vote.11
The court explained the necessary inquiry when analyzing conflicted transactions with controlling stockholders revolves around the “ability to dominate the corporate decision-making process.”12 At bottom, the court explained, “the ability to control, rather than the actual exercise of control, is the determinative factor in [Delaware’s] controlling stockholder jurisprudence.”13 The reasoning for this “ability” analysis is because “[e]ven when no coercion is intended, shareholders voting on a parent-subsidiary merger might perceive that their disapproval could risk retaliation of some kind by the controlling stockholder,” and thus the coercion is inherent in the transaction.14
The court also explained the theory of inherent coercion has been criticized, including by some former members of the Delaware Court of Chancery and Delaware Supreme Court. Those former jurists – including former Vice Chancellor (later Justice) Jack B. Jacobs, who first articulated the doctrine of inherent coercion – have stated that “experience has shown that th[e] concern (inherent coercion) is too insubstantial to justify a review standard that requires judges to second-guess a business transaction that rational investors have approved.”15
In its opinion, the court went as far as “acknowledg[ing] that [Musk has] raised a provocative argument” and commended Musk for his “ingenuity.”16 The court recognized that perhaps Musk’s theory may be correct given the “scholarly advocacy for doctrinal change that inherent coercion is a presumption” under Delaware law.17 Nevertheless, the Court of Chancery, being bound by Delaware Supreme Court precedent, rejected Musk’s argument that business judgment should be applied when there is no actual evidence of coercion, and in doing so, denied summary judgment.18 Thus, at least at the present time, no evidence of actual coercion is required under Delaware law to support the presumption of inherent coercion by a controlling stockholder for an interested transaction in either the pre-trial or trial stage.19
When controlling stockholders (either by majority of voting control or a combination of voting power and management control) are involved in a conflicted transaction, the entire fairness standard of review will apply at both the pre-trial and trial stage, even when no actual evidence of coercion exists to support the plaintiff’s claim.