Delaware: A Honeycomb for US Businesses

Lebanese American University

LLM 512 – Corporate Law

Submitted to: Jdg. Khaled Abdallah

Submitted by: Sara Kaddoura
ID: 201701860
Semester: Fall 2017
1. Introduction

2. Why Delaware
2.1 Flexibility of Delaware Law
2.2 Costs of Incorporation
2.3 A Highly Sophisticated System
2.4 Delaware as a Precedent setting Body for Other States
2.5 An Active Secretary of State Office
2.6 Delaware Incorporation and Firm Value

3. Conclusion

4. References

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1. Introduction:

It might not be a bold exaggeration to compare the formation and incorporation of a company to
the decision in which parents resolve to give birth on foreign lands. Indeed, by doing such acts,
parents ensure some privileges for their children that wouldn't have been available for them had
the parents done otherwise. Expanding this analogy further, we note that setting up a business in
the United States of America imposes an assortment of imperative questions about the state of
registration, the form of company, governing structure, as well as the legal and tax implications
of such acts. As such, whatever the form the business persons decide on as well as the state of
incorporation in case a corporate form is adopted, the implications of such acts are permanent
and propagate throughout the life of the company.

2. Why Delaware
Empirical studies nonetheless suggest that although the state of Delaware accounts for less than
1% of the total US population, this small state is the home or state of incorporation of around
60% of the total registered corporations in the US and more than half of the "Fortune 500"
companies. As such, scholars since the early 1900s have been baffled by the attractiveness of
Delaware for modern businesses as a state of incorporation despite many businesses' operations
being conducted outside the state.

Though the state is an attraction for several forms of companies such as limited liabilities,
limited partnerships, and statutory funds, this paper discusses the legal reasons that drive
companies to incorporate in Delaware rather than the remaining states. We start by highlighting
the flexibility of the Delaware Corporate Law with some comparisons to California Corporate
law. We then assert that this flexibility did not come at the expense of the stability and
predictability of the Delaware Corporate and case law. Later, we discuss the importance of the
Delaware Court of Chancery in unifying corporate case law, facilitating efficient and effective
litigation and registration, as well as the intricate role upheld by the Delaware Secretary of State
Office as well as the Delaware Superior Court's Complex Commercial Litigation Division
"CCLD". Finally we conclude by referring to numerical studies that quantify and study the
association of Delaware incorporation against firm value.

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2.1 Flexibility of Delaware Law

In his book "Why Corporations Choose Delaware", Lewis S. Black asserts that several reasons
have led to Delaware becoming a state attraction for registering companies. He recounts the
flexibility of the corporate structure and laws as one (Black, 2007). Black points out that
Delaware corporate law is flexible in nature and has the tendency to show bias against extreme
regulation. This attitude was adopted by the early framers when the state was still growing in
order to facilitate the formation and conduct of business. Further down the timeline, this has
become an attraction for companies that are seeking flexibility and some freedom in
management style.

Under Delaware Corporate law, companies may opt to limit directors' liabilities through
including exculpatory clauses in their articles of association. Such leeway along with the clauses
to indemnify directors and officers attract able business leaders to the corporation. Another facet
of flexibility in Delaware law is its insulation of directors "from monetary liability for breach of
fiduciary duty except in circumstances where a stockholder asserts and can demonstrate a breach
of the duty of loyalty, a failure to act in good faith, international misconduct, a knowing violation
of law, an improper personal benefit, or an illegal dividend or stock purchase" which is a facet
not present in California corporate law for example (Jarblum and Bollinger, 1999). Unlike
California corporate law, Delaware allows alternative independent board members to participate
and step in the position of incapacitated or disqualified independent board members. Jarblum and
Bollinger (1999) in "Incorporation Issues: Why Delaware" state that the state's law allows
corporations to have classified boards of directors, each having a term longer than 1 year. These
provisions unless the articles of incorporation state otherwise, prevent shareholders from
exercising arbitrary powers to remove directors for no due cause before the expiry of his or her
term.

As for the dissolution and the change in corporate structure, Delaware corporate law facilitates
and simplifies the procedures to change company structures such as switching between and into
corporation, Limited Partnership, Limited Liability Company or statutory trust structures. Where
many states required 50% or more voting power to authorise the dissolution of a company

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regardless of the board's resolution, Delaware corporate law requires 100% voting power to
approve such drastic resolutions unless the board approves the dissolution resolution. All these
provisions ensure the flexibility of the directors' powers and the stability of the corporate life and
the economy as whole (Jarblum and Bollinger, 1999). As such, we can conclude that the rich
history of Delaware corporate law helps enhance business planning without impeding the
flexibility.

2.2 Costs of Incorporation

Among the reasons that attract investors and business owners to incorporate in Delaware are the
inexpensive incorporation costs, low tax burdens and the limitation of appraisal rights and anti-
takeover statues which promote fairness and efficiency in the negotiations or mergers and
business consolidations. Also, there are no state income taxes for Delaware corporations
operating out of state, no inheritance taxes on stock held by non-Delaware residents, no state
sales taxes on intangible personal property and share of stock owned by non- resident alien
corporations. Furthermore, Jiraporn and Gleason (2007) conclude that statistical studies support
the hypothesis that incorporating in Delaware reduces the severity of agency conflict costs in
terms of earning management in comparison to other states. The study published in 2007 in the
Journal of Applied Finance concludes that "the company's domiciliation matters with respect to
earnings management and that Delaware's legal rules do not appear to make agency conflicts
more severe, at least, as far as earnings management is concerned."

2.3 A Highly Sophisticated System

Black (2007) asserts that the Delaware case law is highly developed to meet the contemporary
needs of modern businesses relative to the set in stone "The Delaware Corporate Law". Slights
and Powers (2015) claim that one of the most attractive facets of Delaware corporate law is the
richness of the state's case law. The authors attribute this to the Delaware Court of Chancery that
took upon itself the role of looking into matters of equity since the early 1792. "In today's
practice, the litigation in the Court of Chancery consists largely of corporate matters, trusts,
estates, and other fiduciary matters, disputes involving the purchase and sale of land, questions
of title to real estate, and commercial and contractual matters in general
(10 Del. C., 369)". In addition, this court invests highly in maintaining the predictability and

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flexibility of the state corporate case law (Black, 2007). As such, the court of chancery has
answered a myriad of questions relating to both old and contemporary aspects of doing business.
Furthermore, Black asserts that the court has undertaken the role to facilitate lines of
communication between the Delaware legislators and lawyers; ensuring an effective and efficient
exercise of legislative powers that both serves the stability of the economy as well as the
predictability of the legal environment.

As Former Chief Justice William Rehnquist of the United States Supreme states "corporate
lawyers across the United States have praised the expertise of the Court of Chancery, noting that
since the turn of the century, it has handed down thousands of opinions interpreting virtually
every provision of Delaware’s corporate law statute. No other state court can make such a claim.
[…] The economies of scale, created by the high volume of corporate litigation in Delaware,
contribute to an efficient and expert court system and bar" (Black, 2007). Furthermore, "problem
solving courts" a term keyed by Slights and Powers along the Delaware court of Chancery and
Delaware Superior Court's Complex Commercial Litigation Division (CCLD) have proven
themselves resistant to conventional solutions (2015). The court filings which usually utilise
judges rather than juries fasten the procedures of litigation and drafting an opinion. Many
complex corporate cases can be settled in a couple of months thanks to the specialisation of the
Delaware Chancery Court as well as CCLD (Reed, 2001). As a result, Delaware case law has
shown conservatism towards damage awards whereas post trial disappointment is with low rather
than high damage rewards (Slights and Powers, 2015) which was a factor in attracting companies
that want to do business in the United States.

2.4 Delaware as a Precedent setting Body for Other States

Furthermore, although the precedents set by Delaware courts is not binding towards other states,
studies have shown a trend by which courts from other states would rely, apply or get inspired by
Delaware case law in situations where their own state laws fall short. Black (2007) claims that in
such cases, Delaware's corporate history and precedents make it an attraction for freshly
established companies that aim to reduce litigations costs associated with litigating cases in
states where the corporate law is not as advanced as Delaware. As such, Delaware corporations
benefit from relying on a rule of bodies set by the Delaware corporate code and case law that is

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renowned and respected not only in the United States but also abroad (Black, 2007). Also,
although many states have attempted to duplicate the Delaware court system and procedures,
such attempts have fallen short with respect to the lack of specialised or sophisticated courts tha
would hear such disputes and veteran litigators capable of attending to the most complex cases
(Daines, 2001). As such, unlike regular judges, Delaware Chancery court judges are trained and
exposed to complex business cases on a regular manner which empowers them to resolve both
factual and legal questions, ultimately reducing the litigation processing time and providing a
well backed and seasoned opinion in complex litigations; consequently, eliminating or mitigating
the delay and uncertainty associated with litigating in states with no properly established and
seasoned state corporate judges or case law (Daines, 2001).

2.5 An Active Secretary of State Office

In "Why Incorporate in Delaware" Black claims that the state's Secretary of State Office has
adopted an attitude and appetite towards efficiency and facilitating the registration of business in
the state. As such the office is granted the authority to maintain official documents of
incorporation, collection of corporate franchise taxes, as well as registering foreign business
entities. In addition, applicants track their application status through an online database and
application system which utilises cutting edge technology that enables registrants to file,
incorporate or register and follow up on company status' in an efficient and effective manner. As
such, some incorporation procedures may be completed online without having to step into the
state. The office also offers 24 hour services for areas that are time sensitive and as much as a
three – day time frame to fully register a corporation in Delaware. Furthermore, the
entrepreneurial attitude as Black notes has set the Delaware Secretary of State Office apart from
other states' offices, one that accommodates the registrant's myriad needs such as effectiveness
and timeliness while capitalising on its staff's double shift working system as well as
commitment to quality and efficiency.

2.6 Delaware Incorporation and Firm Value

Delaware corporations are worth more than similar firms incorporated in other states. Daines
(2001) argues in his research study "Does Delaware Law Improve Firm Value" that there is an
economic, financial and statistical significance between a corporation's registration in Delaware

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and firm value. Through a statistical study of 4,481 exchange traded US corporations between
1981 and 1996 and the Tobin Q ratio for the approximation of a company's value, Daines
concludes that his findings are consistent with the hypothesis that Delaware law increases firm
value. Daines (2001) along Romano (1985) and Klausner (1995) suggest that incorporating in
Delaware eases transaction costs for litigation, managerial entrenchment and helps protect
minority shareholders. Furthermore, Delaware case law facilitates business acquisitions and
reduces the costs associated with such transactions which are expected to increase shareholders'
value (Daines, 2001).

3. Conclusion

Throughout this paper, we have discussed the major points that resulted in Delaware being a
honeycomb for companies aiming to do business in the US. We have recounted the flexibility
and predictability of the law offered by the Delaware legislation and case law as well as the rich
history of resolving corporate complexities. Furthermore, we discussed the imperative role
undertaken by the court of chancery and the CCDL along with statistical studies that correlate
firm value and incorporation in Delaware.

Yet in light of the public outcries raised in the recent years relating to the over facilitation of
registration in the state of Delaware and the lack of imposed laws to properly identify beneficial
right owners in the formed companies, several questions are raised regarding whether or not such
lax regulations that have previously attracted investors and companies have over-exposed
Delaware to risks of money laundering, fraudulent activity and terrorism financing. In light of
what Transparency International, a Berlin based NGO refers to Delaware as "a place where
extreme corporate secrecy enables corrupt people, shady companies, drug traffickers, and
fraudsters to cover their tracks", one can't help but take a step back and assess if the lax company
formation regulations have resulted in weakening the supervisory and regulatory sight and nature
of the Delaware legislature in a modern business environment that battles money laundering,
fraudulent activities, and terrorism financing on global fields.

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References:

Broughman, b. J., & Ibrahim, D. M. (2015). Delaware's Familiarity. San diego law review, 52(2),
273-311.

Cheffins, b. R. (2015). Delaware and the Transformation of Corporate Governance. Delaware

journal of corporate law, 40(1), 1-76. Retrieved from:
https://search-proquest-com.ezproxy.aub.edu.lb/docview/1729731354?accountid=8555

Daines, R., Does Delaware Law improve firm value?, in journal of financial economics, volume
62, issue 3, 2001, pages 525-558, issn 0304-405x. Retrieved from:
http://www.sciencedirect.com/science/article/pii/s0304405x01000861

Jarblum, w., & Bollinger, bernard d,,Jr. (1999)."Incorporation Issues: Why Delaware?".
American bankruptcy institute journal, 18(8), 6. Retrieved from:
https://search-proquest-com.ezproxy.aub.edu.lb/docview/208013726?accountid=8555

Reed, J. L., & Noyes, F. E. (2001). Incorporate in Delaware? Yes. Directors & boards, 25(2), 33-
36.

Slights, Joseph R., I.,II, & Powers, E. A. (2015). Delaware courts continue to excel in business
litigation with the success of the complex commercial litigation division of the superior court.
The business lawyer, 70(4), 1039-1058.
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https://search-proquest-com.ezproxy.aub.edu.lb/docview/1725533500?accountid=8555

Stone, G. R. (2006). Why firms file bankruptcy in Delaware: An Agency Theory Perspective of
Forum shopping (order no. 3216090). Retrieved from:
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