A recent Law 360 story by Jeff Montgomery, “Epic Tesla Fee Bid May Blaze Extraordinary Chancery Path”, reports that an unprecedented $5 billion-plus stock-based fee award sought by class attorneys who recently short-circuited Tesla CEO Elon Musk's 12-step, $51 billion compensation package has set up an equally unprecedented test for Delaware Court of Chancery fee guidelines and a potential award one law expert described as "dynastic wealth."

Class attorneys who have battled Tesla's compensation scheme for Musk since mid-2018 last week sought more than 11% of the 266,947,208 Tesla shares freed up Jan. 30, when Chancellor Kathaleen St. J. McCormick ordered rescission of the options that Tesla's board awarded to Musk in an all-stock compensation plan.  The value had been estimated initially at $5.6 billion, but would fluctuate with the value of Tesla's stock.

While the process of seeking a stock fee award instead of cash is not unprecedented, it is an unusual posture for Delaware Chancery litigation, and its scale is likely to reopen what were once considered settled questions over counsel risks, rewards, and just how much attorneys can command for corporate benefit fees, experts told Law360.

"Given the order of magnitude here, I suspect that the case will not set any records in terms of percentage of the recovery awarded to the plaintiffs attorneys, but in absolute terms it'll still amount to dynastic wealth," said University of Connecticut School of Law professor Minor Myers. He described the fee as "destined to be epic, if only because it involves the invalidation of a pay package that was itself comically large."

Chancellor McCormick put the fee in play with an order rescinding Musk's 12-tranche, all-stock compensation plan Jan. 30, after a week-long trial in November 2022.  The ruling cited disclosure failures, murky terms, conflicted director architects and Musk's own conflicted influence in Tesla's creation of an Everest-sized mount of fast-triggering stock options.

"Plaintiff won complete recission of the largest pay package ever issued," the fee motion, filed last week, said.  "Our research demonstrates that the court's decree of recission, conservatively valued, was the largest compensatory award in the history of American jurisprudence by multiples," driven by "the gargantuan size of the tort underlying this action."

But class attorneys are seeking an equally gargantuan fee, even after departing from calculation customs that Vice Chancellor J. Travis Laster stressed last year in declining to apply a size reduction to a nearly 27%, $267 million award to stockholders who challenged a Dell Technolgies stock swap in 2018.  In his fee ruling, the vice chancellor said the calls to reduce the Dell fee conflicted with court efforts to reward attorneys for going deeper into litigation and taking greater risks in pursuit of legitimate claims.

"Of course, everyone involved will try to fit this into an existing framework, but the reality is that a $5.6 billion fee award is staggeringly high, whatever factors are considered," said Lyman P.Q. Johnson, Robert O. Bentley professor of law, emeritus, at Washington and Lee School of Law.  "I think Chancellor McCormick will find a way to go a fair bit lower, while still providing the attorneys with a very high award of some amount."  Johnson added: "The shock of Musk's compensation, undone by the chancellor, is unlikely to be followed by what many would regard as a shockingly high $5.6 billion fee award."

Vice Chancellor Laster's most recent big fee ruling established, pending appeal, a $266.7 million fee last year for attorneys who secured a $1 billion settlement for minority stockholders who sued over a $23.9 million Dell Technologies stock swap in 2018.

In Dell, the vice chancellor rejected investor arguments that large "mega-fund" settlements justified throttling back on fee payouts because customary fee percentages can produce massive, windfall payouts.  Instead, Vice Chancellor Laster defended the use of customary, variable percentages, including 15% to 25% shares of awards for settlements after "meaningful litigation and motion practice" and up to 33% post-trial.  He also acknowledged the tension between successful plaintiffs' counsel seeking appropriate compensation and large investors working to minimize carve-outs from court awards.

In Tesla, class attorneys, wary of blowback over big recoveries borne of typical fee ratios, acknowledged the Dell ruling's guidance, but also pointed to an earlier ruling that produced the current largest court-approved fee, a $304 million award approved in 2011 by then-Chancellor Leo E. Strine and upheld by Delaware's Supreme Court a year later.

That decision required Grupo Mexico to return to Southern Peru Copper Corp. nearly $1.3 billion worth of Southern Peru stock — rather than cash — after finding that Southern Copper had been coerced by a conflicted, controlling stockholder into overpaying for a Grupo Mexico mine in 2005.  With pre- and post-judgment interest, the award reached more than $2 billion, with class attorneys awarded 15%, or $304 million, for fees and expenses.

Tesla class attorneys referenced the 15% fee carve-out approved in Southern Peru, but adjusted even that percentage downward — to just over 11% — to reflect value added by the absence of a holding period for any award of Tesla shares before they could be sold.  Case costs included more than $13.6 million in attorney fees and more than $1.1 million in expenses during the multi-year Chancery action.  Requested fees would equal a $288,888 hourly rate that the fee motion said was justified by the case's complexity, results and attorney skill levels, among other factors.

Jill E. Fisch, Saul A. Fox distinguished professor of business law at the University of Pennsylvania Carey Law School, said use of stock for attorney fees was once "kind of frowned upon," but is not unprecedented.  "They are repeat players" in Delaware's courts, Fisch said of the attorney teams that prevailed in the Tesla case.  "They want credibility before the court.  The numbers, I think, reflect the benefit and risk of this kind of litigation, and traditionally, Chancery Court has acknowledged those risks."

The suit, led by stockholder Richard Tornetta, branded Musk's compensation package as unprecedented and unfair, noting that Musk had already qualified for some $20 billion in awards by the time the suit was filed, "making him one of the richest men on Earth" at the time.  It alleged in part that he relied on two in-house Tesla attorneys for work on the plan before the board's conflicted compensation committee took up the issue.

Ann M. Lipton, the Michael M. Fleishman associate professor in business law and entrepreneurship at Tulane University Law School and associate dean, pointed to another Tesla- and Musk-related case to illustrate the risks stockholder attorneys take.

Last year, after about seven years of litigation, Delaware's Supreme Court upheld a post-trial dismissal of a suit filed by stockholders of rooftop solar venture SolarCity, seeking damages tied to Tesla's $2.6 billion purchase of the company, for which Musk was CEO and also held a big share of company stock.

At one point during the case, the SolarCity stockholders suggested a damage award amounting to a $13 billion giveback of Tesla stock Musk received for his SolarCity shares. Dismissal of the case and rejection of class claims, however, wiped out class attorneys' hopes for a share of a big award.

In the more-recent scuttling of Musk's Tesla stock awards, Lipton said, shareholders benefited from the stock award cancelations by being dramatically less diluted in their holdings.  "That the attorneys are asking for a little bit of dilution" through their fee, "but far less than the shareholders would otherwise have suffered, seems like a real benefit that was provided, from a financial point of view."

Lipton said she was not familiar enough with the current Tesla fee motion to comment on the percentage sought, but cited the enormous risk and stockholder counsel loss in SolarCity and said that "attorneys deserve to be compensated" when they prevail.

University of Michigan Law School professor Gabriel Rauterberg said the fee bid in Tesla appears excessive, despite the importance of fee as a motivator.  "It seems to me extremely implausible that an award this large is necessary to provide the right incentives, given that plaintiffs attorneys' fixed costs for investigating lawsuits, conducting research, and prosecuting cases can be significant but not on this scale," Rauterberg said.  "It seems like a windfall to me. You can give the attorneys a large award, while still falling short of billions."

Counsel for the Tesla stockholders have pointed out that Delaware's Supreme Court has in the past declined to replace the current fee approach with declining percentages.  "Under Delaware law, the unprecedented size of the benefit conferred does not alter plaintiff's counsel's entitlement to 33% of that benefit," attorneys for the Tesla stockholders wrote.  They also pointed to voluntary concessions reducing the total ask to around 11%, with features that reduce the cost to the company.

Some of the sting felt by Tesla, the brief indicated, could be taken away by federal tax law terms that will make 21% of the fee award cash tax-deductible, reducing the post-tax fee award cost from $5.63 billion to $4.45 billion.  State corporate income tax and payroll tax deductions and allowances also could offset the share payout.

UConn's Myers said the Tesla stockholder attorneys won a landmark victory and "deserve to be compensated handsomely" for taking a risky case through trial, while also predicting that the court will "take a hard look at the magnitude of the benefit actually achieved here — that may be a figure in some dispute."  The case nevertheless also stands as an example of "how the Delaware system effectively harnesses the efforts of folks like the plaintiffs attorneys to generate powerful incentives for good governance at public companies," Myers said.

A recent Law 360 article by John Bair, “What Attorneys Should Know About Fee Deferral,” reports on attorney fee deferrals.  This article was posted with permission.  The article reads:

With current high-profile lawsuits like those involving product liability claims stemming from the use of Johnson & Johnson talc powder and 3M Co. earplugs, any dollar amounts plaintiffs are ultimately awarded in settlement will be widely publicized and discussed.  And rightfully so — monetary verdicts or settlements are a major win for those affected by any defective products.  Lawyers, however, will likely also have another dollar amount on their minds: attorney fees.

It's common knowledge that for every corporate defendant brought to justice, the plaintiff trial lawyers who went up against them have earned themselves a payday in the form of attorney fees.  But what may not be such common knowledge is the fact that the IRS has afforded contingency fee attorneys the ability to make their fees work for them with attorney fee structures.  And even if you've heard of this strategy before, read on, because the fee-structuring landscape is ever-changing.

What is an attorney fee structure?

An attorney fee structure is an investment strategy that allows contingency fee attorneys to decide how and when they receive their fees.  By implementing a pre-planned schedule of periodic payments, attorneys can elect to defer all or a portion of their fees, which are not taxed until receipt.  Attorneys can defer an unlimited amount or portion of fees into an attorney fee structure, affording them tax advantages and income control.

For the purposes of this article, attorney fee structure, fee deferral and all variations of the like are synonymous.  Traditionally, attorney fee structures have been executed in the form of fixed indexed, traditional and/or secondary market annuities.  While these are still viable and stable options for fee structures, new options have been gaining popularity in recent years, including investment-backed structures, permanent whole life insurance and even private wealth portfolios.  Each option touts unique benefits based on an attorney's personal goals.

Attorney fee structures are made possible for all contingency fee attorneys in the U.S. due to a series of court rulings in the 1990s, including the 1996 ruling in Childs v. Commissioner of Internal Revenue from the U.S. Court of Appeals for the Eleventh Circuit.  Their feasibility is based around the concept of constructive receipt — until an attorney physically receives her fees, they are not taxable as income.

In order to structure her fees, an attorney must ensure that the terms of settlement include the creation of a periodic payment obligation for some or all of the attorney's contingency fee, as well as direction for the fee to be paid into a previously established qualified settlement fund, or QSF.  As long as the money is initially directed to this fund, the attorney can plot out how and when she'd like to receive her income in the years to come.  Once the funds are issued directly into the QSF, the fee is considered deferred.  And while it sits in the QSF waiting to be distributed, it can be invested and can grow tax-free.

Why should attorneys consider fee deferral?

There are countless benefits to structuring your attorney fees.  First, as mentioned above, it allows for unlimited tax deferral and, ultimately, the ability to pay less taxes.  Until the money is physically received in the attorney's bank account, she is not taxed on that income.  Structuring out a given fee into a years-long payment plan enables the attorney to stay in her existing tax bracket every year and never be taxed on the gross lump sum.

Another benefit is access to professional or self-directed investment management.  As the money sits in the QSF awaiting distribution, attorneys can designate a financial adviser to manage and invest the funds into a diversified portfolio made up of equity-backed assets — think Apple Inc. or Google Inc. stock, the S&P 500, etc.

A final benefit of structuring attorney fees is the prioritization of security over assets.  Note that the nuances of this benefit may vary based on the protections your financial adviser puts in place.  Some things to look out for include the ability to cancel or void your agreement should you ever need to, as well as protections in the case of a debt event.

Are there instances where an attorney fee structure is not advisable?

Let's start with the caveat that it is always prudent to consult with your financial adviser when exploring a new wealth management strategy.  Only they — and you — know your complete financial picture and are able to make recommendations and decisions accordingly.

Next, it's important to note that fee deferral is best suited for attorneys with excess income.  If you need your fees now or in the immediate future to pay off bills or pay down debts, a fee deferral or structure likely isn't for you at this time.  Structuring your fees means exchanging liquidity for tax deferral, a unique option that all attorneys should know about, but only those who are financially established can truly take advantage of it.

Finally, if you are receiving a fee that is on the smaller side and would not catapult you into a higher tax bracket for the year, it may make sense to take the lump sum instead of deferring and structuring.  Remember, this is a wealth and tax management strategy and should be utilized as such.

What do you need to know when exploring attorney fee structures for yourself?

If you are receiving a larger fee, the questions you're asking should be more about what type of attorney fee structure would best help you meet your goals.  It's important to identify your personal and professional aspirations and use that information to inform your decision-making.

Here are some points to consider when determining which fee structure option would best suit you: If you have a specific financial adviser you've used for years and love, consider a fee deferral in the form of a private wealth portfolio.  With this option, you can retain your long-term financial planner and engage an administrator willing to work in professional collaboration.

Permanent whole life insurance could be your best deferral option if you're financially established and want to begin setting aside wealth for your children and grandchildren.  You can incorporate your estate plan and reap the benefits of permanent whole life insurance's dividend-paying histories.

If you're a conservative investor with the luxury of time, consider fixed indexed, traditional or secondary market annuities as your strategy.  This approach relies on advantages inherent in the marketplace, making it both a low-risk and low-maintenance wealth planning option.

In conclusion, proper implementation of attorney fee structures can help firms and their attorneys achieve long-term financial freedom, security and success.  Often, the greatest barrier to adoption is lack of knowledge that this option exists.

John Bair is the founder and CEO of Milestone Consulting LLC.

A recent Law 360 story by Asha Glover, “Calf. Appeals Court Rejects Atty Fees for LA Theater in Tax Row” reports that a Los Angeles theater isn't entitled to attorney fees after successfully challenging its property taxes, a California appeals court said, overturning a decision from a lower court.  A lower California court erred in awarding attorney fees to Chinese Theatres LLC, a California appeals court said in a published decision.  The court rejected Chinese Theatre's argument that state law allows an award of attorney fees in any case where a court finds that the county board's findings are deficient or arbitrary, regardless of whether the court remands the measure to the local assessment appeals board with directions to make new findings.

The court said that Chinese Theatre's argument ignores an entire phrase of the statute requiring the case to be remanded and essentially asks the court to rewrite the statute.  The court rejected the theater company's contention that the Los Angeles County Assessment Appeals Board failed to make the finding that it was required to make.  The court pointed to the board's finding that half of the theater naming rights agreement granting the right to name the theater the TCL Chinese Theatre was an intangible asset — a finding that was one of the primary reasons the company filed the lawsuit.

The court also said that the lower court's sole purpose of remanding the case to the board was to excise the taxable value of the agreement from the property's assessment and to make necessary corrections to the tax roll.  The board did not need to make any new findings to explain how it valued the property once the revenue generated by the agreement was deducted from the tax assessment, according to the opinion.