As Tesla’s vehicle sales continue to drop, Elon Musk has claimed that Tesla is now an artificial intelligence (AI) and robotics company. However, he has also demanded that he be given 25% of the voting power in Tesla or else he will take his AI ball and play elsewhere.
In March 2023, Musk founded a new private company, xAI, in Nevada. In June 2024, news broke that he had diverted a large quantity of AI computer chips to this company and to X (nee Twitter) – but with the twist that Tesla had ordered these chips originally. Musk had told Tesla shareholders in a first quarter 2024 earnings call in April 2024 that Tesla would be increasing its stock of Nvidia’s H100 top line AI chips to 85,000 by the end of 2024. He also tweeted that Tesla would be upping its spending on AI since this was essential for the future competitiveness of Tesla.
Shareholders sue – the corporate opportunity doctrine
Hours before Tesla formally filed to reincorporate in Texas, a pension fund that is a large Tesla shareholder filed suit against Tesla’s board of directors as individuals and against Tesla itself. Since Tesla was ‘officially’ still a Delaware company at this time (at the time of writing, it’s not entirely clear if the redomestication to Texas will be allowed to happen by the Delaware courts), the case came once again before the Delaware Court of Chancery.
The gist of their case is that Musk is appropriating Tesla assets for the benefit of his private company xAI (and therefore Musk himself) which will be to the detriment of Tesla shareholders. This is alleged to not just be highly sought-after AI chips but also key staff from Tesla. The suit claims that Tesla’s directors again breached their fiduciary duty by turning a blind eye to this activity. This claim is made far easier to prove because of the ruling in Tornetta that the Tesla board was beholden to Musk and did not effectively challenge him.
The relevance of soft drinks to cars and AI – Guth v Loft
The complaint opens thus:
“Could the CEO of Coca-Cola loyally start a competing soft-drink company on the side, then divert scarce ingredients from Coca-Cola to the startup? Could the CEO of Goldman Sachs loyally start a competing financial advisory company on the side, then hire away key bankers from Goldman Sachs to the startup? Could the board of either company loyally permit such conduct without doing anything about it?”
These words are not chosen randomly. The classic Delaware case on this point is Guth v Loft, which the Delaware Court of Chancery ruled on as far back as 1939. In that case, Charles Guth was the president of Loft Inc – a confectionary and syrup manufacturer which sold Coca-Cola at fountains in its stores. (At this time, soft drinks such as Pepsi and Coca-Cola were typically sold by the glass at fountains in pharmacies and other stores where the bulk syrup was diluted with carbonated water – bottling and canning did not arrive until some years later.)
Guth wanted to purchase syrup from Pepsi after the Coca-Cola Company refused to give him a larger bulk discount as he felt it would be cheaper. Before he and his company Loft could conclude a deal Pepsi went bankrupt. Guth used his personal money to buy the bankrupt Pepsi-Cola Company and with it, the Pepsi syrup recipe. Guth set about selling Pepsi syrup to Loft Inc.
The shareholders of Loft Inc sued Guth on the grounds that the purchase of Pepsi would have presented a commercial opportunity to Loft Inc and its shareholders and that Guth had breached his fiduciary duty to Loft’s shareholders by denying them that opportunity. He had no right, they argued, to appropriate this business opportunity for himself when Loft Inc was in that line of business itself and could have easily accommodated Pepsi within its portfolio.
Musk’s hype is his own petard
The Delaware Supreme Court ruled in favour of Loft. Guth, they wrote, had breached his fiduciary duties to Loft’s shareholders in order to further his own private interests. This created within Delaware law the ‘corporate opportunity doctrine’ – as the Delaware Supreme Court explained in their ruling in Guth:
“..if there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake, which is, from its nature, in the line of the corporation’s business and is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and, by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of his corporation, the law will not permit him to seize the opportunity for himself.”
The relevance to Tesla and Musk is expanded on in the complaint, quoting Musk’s own words against him.
Musk is claiming that Tesla is an AI and robotics company and has persuaded major analysts and investors of the potentially massive commercial opportunities that AI presents. Musk has not only diverted the Nvidia AI chips away from Tesla but has also been poaching key staff from Tesla. He has also been encouraging noted AI researchers to join xAI rather than Tesla. This all came after Musk tried (and failed) to acquire industry leader OpenAI in 2018.
The complaint goes on to suggest that Musk is using xAI as his new power base following the ruling in Tornetta which rescinded what would have equated to some 11% extra shareholder control of Tesla. The Tesla board has done nothing to prevent Musk attempting to create “billions in AI-related value at a company other than Tesla”, allege the Tesla shareholders. The complaint notes that Musk’s own words confirm that Tesla “has the capability to operate an AI business, that AI and robotics ventures are within Tesla’s line of business, and that Tesla has an interest and expectancy in the opportunity”.
The parallels with Guth are striking. Musk’s only response to the allegations thus far appears to be that Tesla had nowhere to store the Nvidia chips. This in turn raises numerous questions about Tesla’s business competence: why order valuable assets if you have nowhere to put them? Why was Tesla not prepared to make use of the Nvidia chips when Musk claims it is “an AI and robotics company” yet xAI could accept delivery immediately? Why not rent a storage facility until Tesla was ready to deploy the chips?
The relief sought
The Tesla shareholder plaintiffs seek, amongst other remedies, to have Musk and his fellow Tesla directors found liable for breach of fiduciary duty, to have damages awarded to Tesla in the amount they claim Musk unlawfully diverted to xAI, to have xAI merged into Tesla without compensation to Musk and to have Court supervision of Musk’s interest in xAI.
On paper, the complaint looks exceptionally powerful. As of early October 2024 Musk and his fellow defendants have not filed a substantive reply to the allegations but the Court has permitted another Tesla shareholder to join the suit. Both the leading plaintiffs are pension funds that invested in Tesla as part of their portfolios.
One major question that will need to be resolved, aside from the legalities of the situation, is whether xAI is actually worth anything. Musk, as is his way, loves to aggrandise the potential of all his business operations. But internal leaks from within xAI indicate that it doesn’t have any proprietary technology: Musk (possibly justifiably) believes that due to intense competition there is a need to move quickly within the AI space. Reports are that xAI’s first chatbot release relied on underlying technology form Microsoft’s Bing search engine and Meta’s freely available Llama framework to rewrite queries.
The xAI lawsuit looks very dangerous for Musk. The allegations appear to be strong and substantiated. Should the plaintiffs prevail, it would significantly clip Musk’s wings and possibly have serious consequences for the corporate governance of Tesla. It’s definitely one to keep an eye on.
