By Tom Hals

DOVER, Delaware (Reuters) -Elon Musk’s lawyers will urge the Delaware Supreme Court on Wednesday to restore his $56 billion pay package from Tesla, as one of the biggest corporate legal battles enters its final stage nearly two years after a lower court judge rescinded the Tesla CEO’s record compensation.

The outcome could have substantial consequences for the state of Delaware, its widely used corporate law, and its Court of Chancery, a once-favored venue for business disputes that has recently been accused of hostility towards powerful entrepreneurs.

The January 2024 Court of Chancery ruling striking down Musk’s pay has become a rallying cry for Delaware critics. Chancellor Kathaleen McCormick ruled that the Tesla board lacked independence from Musk when it approved the pay package in 2018 and that shareholders lacked key information when they voted overwhelmingly in favor of it. As a result, she applied a demanding legal standard and found the pay unfair to investors.

The defendants, current and former Tesla directors, denied wrongdoing and said McCormick misinterpreted the facts and the law. Musk is not expected to attend.

COMPANIES SWITCH LEGAL HOMES

After the Musk pay ruling, large companies, including Tesla, Dropbox, and the venture capital firm Andreessen Horowitz, switched their legal homes to Texas or Nevada, where courts are friendlier toward directors. Delaware lawmakers responded to the corporate departures, a trend known as “Dexit,” by overhauling its corporate law.

If Musk loses the appeal, he will still reap tens of billions of dollars in stock from the electric vehicle company, which agreed in August to a replacement deal if his 2018 plan is not restored.

The company said the replacement award was meant to retain and focus Musk, who said earlier this year he was forming a new U.S. political party, on transitioning Tesla to robotics and automated driving. Tesla is now incorporated in Texas, where it is far more difficult for a shareholder to challenge board decisions.

Tesla’s board last month proposed a $1 trillion compensation plan, highlighting confidence in Musk’s ability to steer the company in a new direction, even as Tesla loses ground to Chinese rivals in key markets amid softening EV demand.

The five justices on Delaware’s high court will consider the appeal of the pay ruling as well as the $345 million legal fee that McCormick ordered Tesla to pay to the attorneys for Richard Tornetta, who held just nine Tesla shares when he sued to block the pay deal. The court typically takes months to rule.

Tesla estimated in 2018 the stock options plan would be worth $56 billion if the company met operational and financial goals, which it did. Because the stock continued to appreciate, the options are currently worth closer to $120 billion, by far the largest executive compensation ever. Musk is the world’s richest person with a fortune of around $480 billion, according to Forbes.

The defendants have argued that McCormick erred in finding social and business ties to Musk compromised their independence and said Tesla shareholders were informed of the economic terms of the pay deal before they approved the plan. The directors said she should have reviewed the pay package under the “business judgment” standard, which protects directors from second-guessing by courts.

The directors have long argued the pay package performed as hoped – it focused the attention of Musk, a serial entrepreneur, and he transformed Tesla from a startup into one of the world’s most valuable companies.

Several months after McCormick’s ruling, Tesla received shareholder approval a second time for the plan, which McCormick rejected as legally invalid. Tesla is also appealing that decision.

(Reporting by Tom Hals in Dover, Delaware;Editing by Noeleen Walder and Rod Nickel)