Delaware by Default: New Threats to Delaware’s Dominance in Business Incorporation

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Delaware has long been heralded as the most business-friendly state, being the state of incorporation to approximately 300 of the Fortune 500 companies. As of late, however, certain big names have contested its dynasty as the “default” jurisdiction for incorporation. The below briefly highlights some of the legal rationale behind Delaware’s dominance, recent challenges to Delaware’s “go-to” status, and the key takeaways for businesses looking to incorporate or reevaluate their state of incorporation.

Why Incorporate in Delaware?

Delaware’s longevity as the corporate legal haven of the United States can be boiled down to three key factors: convenience, flexibility and predictability.

Compared to most other states, the composition of Delaware’s court system is quite unique. Delaware’s Court of Chancery is home to a host of corporate law experts who exclusively hear equitable disputes arising from corporate law. With history dating back to the late 18th century, the Court of Chancery has established a storied body of case law and various well-respected legal precedents, and as a result, the Court of Chancery offers an increased sense of predictability for corporate disputes unlike any other legal system in the United States. Another commonly cited benefit of the Court of Chancery is the general lack of a jury system; because disputes are primarily heard and decided by the bench, the litigation process is often considered more efficient and predictable than other venues.

Delaware’s legislation is also known to be corporate-friendly, with case law and statutory provisions often granting highly deferential standards to a company’s equityholders, directors, managers and officers. For example, Delaware’s “business judgement rule” generally (i) prevents Delaware courts from second-guessing the decisions of independent and disinterested directors who have acted with due care by instead focusing on the reasonableness of the decision-making process; and (ii) insulates officers and directors from liability on an informed business decision made in good faith, even if the decision impedes the success of the business. As a result of these favorable circumstances, many operating companies and institutional investors have historically favored Delawarean incorporation.

Recent Challenges to Delaware’s Throne

As of late, Delaware’s “default” status for incorporation has come under scrutiny by certain corporations, including household names like Tesla. To summarize, a Tesla stockholder recently brought an action against Tesla under Delaware law, challenging the reasonableness of Elon Musk’s compensation as CEO. Tornetta v. Musk, 310 A.3d 430 (Del. Ch. 2024). While the Court of Chancery ordered the $56 billion compensation package be rescinded, a stockholder vote later approved the executive’s pay. Later, Musk publicly voiced his displeasure with the Delaware court system, and Tesla has since reincorporated in Texas.

Why Texas? Texas, along with Nevada and Wyoming, are considered the three states that could pose a threat to Delaware’s reign. These three states (1) impose no corporate income tax on corporations, (2) have low regulatory standards, and (3) tend to protect corporate directors and officers from liability for business decisions made in good faith with reasonable care; however, none of these states currently offer an equivalent forum to Delaware’s Court of Chancery. Legal experts have noted that Texas and Wyoming are considering the implementation of similar courts that would specialize exclusively on corporate law issues, while Nevada has implemented a system of “business court dockets.” However, these states pale in comparison when it comes to their respective bodies of case law—a unique advantage of Delaware’s storied history in the space. If these states are to truly compete with Delaware in this respect, they need two things that state spending can’t buy: time and disputes.

Are Companies Really Leaving Delaware?

Practically, only a handful of companies have left Delaware in the last few years. For example, in 2018, TransPerfect – a language translation company – was the subject of a Court of Chancery action regarding the court-ordered sale of the company resulting from a dispute between the company’s co-founder and his former fiancée.  Unhappy with the disposition of the case, the co-founder reincorporated in Nevada, stating that “Nevada…now represent[s] [a] compelling alternative” to Delaware.

Additionally, large companies such as DuPont, Co., Ancestry.com and Dole have outwardly expressed a desire to reincorporate outside of Delaware in years past, expressing concerns that Delaware courts have become more enticed by stockholder actions and less deferential to the corporations. However, even after citing these concerns, none of the three have moved their state of incorporation out of Delaware.

Takeaway

While recent media headlines may have cast doubt on Delaware’s sustained dominance and highlighted other states’ initiatives to establish more corporate-friendly environments, Delaware will likely continue to be the jurisdiction best-suited for incorporation given its expansive body of legal precedent, and expertise, familiarity and consistency in corporate disputes that other states are unable to offer.

This content is made available for educational purposes only and to give you general information and a general understanding of the law, not to provide specific legal advice. By using this content, you understand there is no attorney-client relationship between you and the publisher. The content should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

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