Is Delaware Really THE State to Incorporate In?

Delaware’s law no longer provides an advantage in major areas of corporate law over states that have adopted the Model Corporations Act. The only advantage left for Delaware’s corporate law is at the margins of corporate law. Most other statutory areas of corporate law have converged and now quickly follow Delaware’s lead in adopting new rules and standards as unique situations arise. However, those new adoptions are at the judicial level, as Delaware has become slower in passing new corporate governance statutes. Delaware has allowed other states to experiment, and then take what works best.
Most (as did I until recently) assume that Delaware is the leader in corporate law because of its superiority. While true in some aspects, such as its early, mid-20th century innovation, and the ability to maintain a large body of corporate law expert judges, Delaware seems to have fallen behind, and it is only because of its current monopoly position that it remains the jurisdictional choice for incorporating firms. The natural monopoly suggested by the authors does seem to ring true – after all, the vast majority of the Fortune 500 has incorporated there. Thus, new companies willing to compete with the larger, established corporations will likely follow suit and copy. Those lawyers that corporations (both established and newly formed) hire to advise them basically have two choices: the laws of their home state or of Delaware. While the article suggests that the laws of the home state may be superior, or, at least newer, than that of the DGCL, the poor performance of the home state courts and their lack of corporate expertise swing the decision to incorporating in Delaware.
The Delaware Chancery Court’s existence does seem to swing the decision of which state to incorporate in towards Delaware and its arguably more obsolete statutory code. This is surprising, especially since the Delaware Courts have seemed to muck up the clearness of Delaware’s laws to a point where more litigation is likely to occur. Furthermore, the Delaware Supreme Court’s frequent overturning of the Chancery Courts (twenty-five percent of Chancery decisions are overturned or remanded) adds more confusion as their self-imposed lack of dissent leads to major swings. Different panels of Supreme Court judges possess different corporate law experience and philosophies, and the decisions by those panels tend to show exaggerated shifts in philosophy, thereby reducing the ability of Delaware law to be consistently interpreted. Furthermore, even the chancery court has propagated non-brightline rules that make it difficult for transactional lawyers to advise their clients with any confidence. Those rules and standards that the Delaware courts do publish are more in line with the judge’s litigation backgrounds and evoke terms such as “fundamental fairness” that require litigants to argue about meaning, instead of more bright line rules.
The “corporate expertise” of Delaware Chancery and Supreme Court judges may be overstated as well, thus adding another reason why Delaware should not maintain its dominant legal position. Vice Chancellor Strine has admitted that Delaware judges do not even adopt common finance definitions for “fair market value” and instead consider policy when interpreting share value. This has led to perverse economic results, where some shareholders have purchased shares after a deal was announced (which would ordinarily immediately capture all of the value to the current shareholders) and still making 325% returns. Thus, it seems that even after a “great deal” was announced, activist shareholders, or at least those willing to buy and engage in litigation, could drive up the costs of the deal and profit, while punishing the acquirer who would be forced to pay more than the deal was though to cost.
Outside of the courts, the cost of incorporation seems akin to the excess value captured by monopolists from the mere fact of their dominant position. Franchise fees and taxes in Delaware run into the hundreds of thousands of dollars, and can be as high as .5% of a company’s value. Corporations in other states, such as Kansas, in contrast, pay as little as $40 in franchise fees. One could argue that you get what you pay for – if you want the benefit of Delaware statutes and its court system, you have to pay for it. However, what I have written above concerning the author’s positions does make a compelling case that a corporation is not receiving the benefit of its consideration. Instead, Delaware Corporations are paying for the comparative benefit that Delaware possessed ten, twenty, even fifty years ago, over other states. Delaware, if indeed in a monopolist position, can continue to exact these large rents while not providing cutting edge, innovative legal products to its corporate customers.
Overall, it appears that Delaware will continue to maintain its dominant position over other states in spite of all the reasons why it should not, or at least not undergo a massive restructuring. “Clearing house,” so to speak, of all previous and confusing Delaware decisions and starting over with a new code seems appealing, but is not practical. After all, Delaware is not faced with significant competition, even though some of the products that its competitor states are offering in terms of statutory clarity may be superior. If Delaware were to “start over,” it would then not have any legitimate reason to charge its corporate customers absurdly high franchise fees because those corporate customers could obtain similar statutory services in other states.