(Reuters) - A Delaware judge on Tuesday ruled that Elon Musk's record-breaking $56 billion Tesla pay package could be tossed, calling the compensation "an unfathomable sum" that was not fair to shareholders, according to a court filing.
Shares of Tesla dropped 3.7% in extended trade.
The ruling swept away the largest pay package in corporate America. The judge found it was negotiated by directors who seemed beholden to their headline-making CEO and the promise of allowing him to share in the company's enormous growth.
"Swept up by the rhetoric of 'all upside,' or perhaps starry eyed by Musk’s superstar appeal, the board never asked the $55.8 billion question: Was the plan even necessary for Tesla to retain Musk and achieve its goals?" wrote Kathaleen McCormick of Delaware's Court of Chancery.
McCormick's opinion directed the Tesla shareholder who challenged the pay plan to work with Elon Musk's legal team on an order implementing the decision.
"Never incorporate your company in the state of Delaware," Musk said in a post on X, the social media platform he bought in 2022. Originally named Twitter, Musk moved its state of incorporation to Nevada from Delaware after his purchase.
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 in 2018.
The ruling can be appealed to the Delaware Supreme Court.
"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.
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."
Tesla's agreement with Musk contributes a significant part of his fortune, which is one of the world's largest.
Tesla directors argued during a week-long 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 side projects, like SpaceX and X.
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.
By Tom Hals, Kanishka Singh,
Eric Beech and Dan Whitcomb in Washington
Editing by Anna Driver
