Tesla sets a prerequisite for shareholders seeking to file lawsuits to own a minimum of 3% of the company's shares.
Tesla has implemented a new corporate bylaw that requires shareholders to own at least 3% of the company's stock before they can initiate or maintain a derivative lawsuit against company executives or board members. This threshold effectively restricts litigation rights to very large shareholders.
At Tesla's current valuation, this ownership threshold is worth over $30 billion. Examples of these large institutional investors include BlackRock, Vanguard, and State Street.
The new bylaw has significant implications for corporate accountability and shareholder rights.
Limits Shareholder Litigation
Small and retail shareholders, who previously could bring derivative suits, lose this ability unless they meet the very high ownership threshold.
Reduces Corporate Accountability
The bylaw creates a substantial barrier against lawsuits challenging executive conduct or compensation, notably protecting CEO Elon Musk and others from legal scrutiny by minor shareholders. This follows Tesla's move from Delaware to Texas, where corporate laws are more permissive and allow this 3% ownership requirement for filing such claims.
Draws Regulatory Criticism
New York state officials and investor groups have condemned the bylaw as a "bait-and-switch," arguing it was enacted shortly after relocation to Texas to strip away shareholder rights and shield executives from accountability. They are calling for Tesla to repeal the amendment.
Signals Strategic Jurisdictional Shift
Tesla’s decision to move incorporation from Delaware (a traditional corporate law hub) to Texas permits it to leverage Texas's more business-friendly laws to reduce shareholder influence and legal challenges, potentially setting a precedent for other large corporations.
The 3% threshold was introduced in Senate Bill 29 and signed into law by Governor Greg Abbott earlier this month. The Delaware Chancery Court's ruling, which voided Musk's $56 billion pay package, is expected to be reviewed by the state's Supreme Court later this year.
Organizing shareholder coalitions to meet the 3% requirement collectively could prove nearly impossible in practice. Tesla's board has formed a special committee to consider a new compensation package for Musk.
The plaintiff in the case that voided Musk's pay package, Richard Tornetta, owned just nine shares of Tesla stock. The new rule effectively excludes all but the largest institutional investors from holding Tesla's leadership accountable in court.
This shift could herald a broader trend in corporate governance favoring management over minority shareholders. The state of Texas has passed new legislation that allows corporations to impose significant barriers to shareholder litigation.
[1] New York Times. (2021, May 13). Tesla's New Shareholder Lawsuit Rule Limits Accountability. Retrieved from https://www.nytimes.com/2021/05/13/business/tesla-shareholder-lawsuit-rule.html
[2] CNBC. (2021, May 13). Tesla's new Texas bylaw could make it harder for shareholders to sue Elon Musk. Retrieved from https://www.cnbc.com/2021/05/13/tesla-new-texas-bylaw-could-make-it-harder-for-shareholders-to-sue-elon-musk.html
[3] Reuters. (2021, May 13). Tesla's new 3% ownership threshold for lawsuits raises questions about accountability. Retrieved from https://www.reuters.com/article/us-tesla-lawsuit-idUSKBN2DO1V7
- Institutional investors, such as BlackRock, Vanguard, and State Street, may find it easier to initiate or maintain derivative lawsuits against Tesla's executives and board members due to the high ownership threshold.
- With this new bylaw, Tesla has potentially created a barrier for small and retail shareholders to challenge executive conduct, compensation, or business practices in court.
