Monday, April 13, 2009

Why Do So Many Businesses Incorporate in Delaware?

This topic came up (indirectly) at Cafe Hayek today. I posted the following two comments. (I copy them here because this is something I get asked so often.)

That Delaware corporate law is not "pro-management":

As a practitioner of Delaware corporate law, I've noticed this for years. The reason, based on my own observations, is that Delaware doesn't have a lot of powerful native industries (du Pont notwithstanding). Instead, a huge part of the state's economy, and of the state government's revenues, is based on the state's ability to attract entities. Delaware is selling a legal regime. Now, many have reasoned this far and then concluded that Delaware therefore caters to management. But the legal regime governing an entity must be attractive to more than just management -- it must be attractive also to the investors that management plans to draw. Thus, Delaware corporate law has for decades pursued a balance between directors'/managers' authority to run the business and investors' authority to protect their stake. Delaware corporate law is a product shaped by the wants of the people buying it -- both managers and investors.

Reasons for the pre-eminence of Delaware corporate law:

Some other states have in fact copied Delaware's corporate law (Nevada is the most aggressive example). However, they have not been able to make much of a dent in Delaware's market share for three reasons:

First, Delaware has about a century's worth of court decisions expanding upon its corporate law and how it applies in different factual situations. This makes it much easier to predict how Delaware law will be interpreted and applied when one is trying to decide on a course of action. Other states can (and sometimes do) SAY they will follow Delaware law, including its court decisions, but people will have a lot more certainty that Delaware law will be applied as expected by a Delaware court than by a court in another state. (In other words, you might as well go to the source, as long as the source is not charging too much in taxes and fees.)

Second, Delaware has an excellent judiciary. All Delaware judges are appointed, not elected, and the bar and governor realize how important it is that smart, knowledgeable practitioners be on the bench. Moreover, unlike most states, Delaware has a court of chancery that (1) does not use juries, (2) is willing to move quickly on important matters (such a whether to prevent an impending merger), and (3) focuses on business litigation (i.e., very little family-law cases, no criminal cases, no products liability / personal injury cases). The Chancellor and Vice Chancellors in Delaware are almost all distinguished former corporate-law practitioners.

Third, the state government derives so much of its revenue from corporations formed in Delaware that it is motivated to make its systems as user-friendly as possible. You can file papers by fax, you can get same-day service, the rules are easy to understand and follow, etc. Most other states are Kafka-esque by comparison.

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