Post Update on Director Independence

Vice Chancellor Slights, of the Delaware Court of Chancery, included a slightly self-effacing, and only slightly humorous, note in his recent opinion in a fiduciary claim against the directors of Tesla, Inc., to the effect that the defendants have reason to believe that they drew the wrong judge in the case.

The case relates to the 2018 incentive compensation award to Tesla’s CEO, Elon Musk, that caps out at about $55 billion (that “b” is not a typo).  The footnote concerns, in part, Vice Chancellor Slights’ determination, in a separate recent claim alleging fiduciary breaches by the Tesla board, that members of Tesla’s board were not independent.

Vice Chancellor Slights’ footnote and his opinions in the Tesla cases provide a useful occasion to recap a topic of recent interest in the Delaware courts: the law regarding director independence.  In particular, the Delaware courts have focused on the circumstances in which personal relationships impact independence.  The courts have wrestled with a facts and circumstances test, which creates practical challenges for practitioners.

Corporations regularly establish special committees in situations where a board’s decision may be tainted by the actual, perceived or potential conflict of interest of a director, officer or controlling stockholder.  If properly constituted, a special committee can help to ensure that fiduciary claims concerning the decision can be dismissed at the pleading stage before trial, thus providing significant legal and practical benefits.  But establishing a special committee entails certain costs, including the financial expense of separate financial, legal and possibly other advisors for the special committee and the non-financial risks that arise from a special committee process.

This note reviews the recent caselaw on director independence.  We think that the review should raise sensitivities about independence determinations in certain contexts.  We suggest that special committees be seriously considered in connection with any transaction in which the overlapping business or personal relationships of a director may taint the independence of that director to withstand a claim of demand futility under Delaware law.

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