A legislative clash over changes to Delaware’s vaunted corporate law ended last week in a victory for captains of industry, seeking expanded safe harbor provisions, over minority shareholders.
Amendments to state corporate law, which included a narrowing of shareholder access to company books and records, sailed through Delaware’s Legislature in what was seen as a win for industry titans such as Tesla's Elon Musk and Meta Platforms's Mark Zuckerberg.
Institutional investors, by contrast, were widely seen as the losers, both in terms of the outcome as well as the legislative process that led to it.
Organizations such as the Council for Institutional Investors and the International Corporate Governance Network, representing close to $100 trillion of public capital, "unanimously opposed the bill as ... detrimental to stockholder rights and protections, and their concerns and warnings were completely ignored," said Mark D. Richardson, a partner in Delaware with law firm Labaton Keller Sucharow.
Both sides had argued that a loss would undermine Delaware’s status as the premier legal home for companies listed in the U.S. — a franchise that brings the state more than $2 billion a year in registration fees, or roughly 30% of annual expenditures.
Now, with the legislative fight concluded, the focus could shift to how much substance there was in institutional investors' warnings that the amendments, signed into law by Gov. Matt Meyer on March 25, could prompt them to push their portfolio companies to re-register in states offering better shareholder protections.
On that score, Meyer said in an interview he’s confident institutional investors don’t have anything to worry about from the latest amendments.
“Delaware courts and Delaware general corporation law is and will remain the gold standard, protecting the rights of stockholders, protecting the rights of institutional investors and retail investors as it has for generations,” he said.
Still, he said, if certain institutional investors nonetheless feel Delaware law no longer provides clarity, predictability and fairness, then there’s more work to do, not only in communicating why the state remains “the preeminent place to be a stockholder in a company but also making sure we understand the substantive deficiencies that they see and working to address them."
Going it alone
Critics note that that willingness to work with institutional investors was notably absent among the legislative leaders who led the charge to amend Delaware’s corporate law in the space of six short weeks. The starting gun for that abbreviated legislative run, they contend, was an article in The Wall Street Journal in late January suggesting Zuckerberg was mulling shifting Meta's registration to Texas from Delaware, a year after Musk did the same with Tesla.
The normal amendment process — where everyone is consulted, time is taken to hammer out compromises and the resulting bill can be widely embraced — was replaced by a “closed process” that largely dismissed or ignored inputs from institutional investors, said Charles M. Elson, retired professor of the Edgar S. Woolard Chair in Corporate Governance at the University of Delaware.
Despite the governor’s assurances, some big institutional investors remain skeptical.
Matthew G. Jacobs, general counsel for the $538 billion California Public Employees’ Retirement System, in a March 14 letter to Delaware’s legislative leaders, said should the amendments pass, CalPERS' previous opposition to attempts by portfolio companies to reincorporate out of Delaware would give way to a “much more case-by-case view because many states provide corporate law that is significantly more investor-protective than Delaware law."
On March 27, after Meyer signed the bill into law, CalPERS CIO Stephen Gilmore expressed disappointment with Delaware’s decision to reduce governance rights for minority shareholders, saying the move will heighten institutional investors’ focus on private markets offering more latitude to hammer out better governance provisions.
Likewise, Severine Neervoort, global policy director with the International Corporate Governance Network, which reports members from more than 40 countries with combined assets under management of $90 trillion, called Delaware’s move to weaken the safeguards protecting minority investors from potentially abusive acts or transactions involving interested parties “very disappointing.”
At the end of the day, though, the question will be whether those expressions of concern from institutional investors result in nothing beyond a primal scream or instead lead to more substantive changes, with enough defections to catch the attention of Delaware political leaders.
Incremental or catastrophic change?
In either case, competing claims over the past month as to whether an up or down vote would prove worse for Delaware’s franchise will now give way to a verifiable tally.
On that score, for the near term at least, most observers say any changes to Delaware’s allure as a magnet for corporate registrations will likely be incremental, even if some believe the franchise will prove newly vulnerable over the longer term.
Elson apparently needed no less than three metaphors to get his arms around the scale of the damage he expects from the state’s political intervention in Delaware’s business courts: It has opened “a can of worms or Pandora’s box, better put, and I think you’re never going to get the genie back in the bottle,” he said.
Others, while acknowledging a serious setback for minority shareholders, pointed to the enormous regard Delaware’s courts are held in as a reason for companies not to make a precipitous exit from the state.
“I have serious concerns that this bill will do what it was intended to do, which is to reduce the ability of public investors to hold corporate managers accountable and to protect their investments through litigation, inspection rights and the deterrent effect that those things bring,” said Labaton's Richardson.
Even so, Richardson said, he counselled against companies “pulling up stakes immediately,” because the Delaware Court of Chancery remains “the best in the world. They apply the law fairly. They’re good public servants. They’re apolitical. They’re subject matter experts” and they may just get it right despite having to contend with a clunkier statutory framework, Richardson said.
Justin Reliford, managing partner of the Wilmington office of Scott + Scott, a law firm focused on institutional clients, struck a similar note, saying while it's beyond dispute that the latest amendments leave minority shareholders more vulnerable, “it’s a little early now, without having cases that go up to the court on (just-passed Senate Bill 21), to say exactly what the total ramifications are for stockholder actions in Delaware.”
“I’m a big believer in our Court of Chancery in Delaware (and) I believe they will police the line that has been drawn by the legislature and still try to capture that balance of protecting stockholder rights while working within the constructs of the new law,” he said.
"That calculus can change," of course, if cases that previously would have netted institutional clients considerable damages for questionable actions by fiduciaries go unchallenged, said Reliford.
But “that is a question that’s going to play out over the next few years, rather than immediately,” he said.
For the nearer term, the percentage of companies coming to market with initial public offerings that opt to register in Delaware could prove to be one of the better indicators as to which way the wind is blowing.
“I think you’ll see that trend first in the IPO market, as market participants really talk behind the scenes about what kind of protection stockholders want before they put money into a new public company," Reliford said.
Meyer said his team monitors Delaware's share of IPO company registrations "pretty closely" as well, citing the drop in that number to about 80% last year from a percentage in the low 90s in prior years as one of several factors that led him to back this year's amendments to state corporate law.
Jeff Mahoney, general counsel for the Council of Institutional Investors, said in an interview that an updating of CII's policies on incorporation and reincorporation, approved overwhelmingly by members on March 10, could weigh on Delaware's IPO share going forward.
With Delaware's legislature deliberating in the background, CII extended to domestic situations its previous call on U.S. companies not to reincorporate to offshore locations with weaker governance and less accountability to shareholders. The revised policy now calls on companies not to "reincorporate in jurisdictions where corporate governance structures are less robust than their current jurisdiction of incorporation ... or adopt new articles of incorporation or bylaws which diminish investor rights and protections in conjunction with reincorporation."
In the past, for investors having discussions with companies in the pre-IPO stage about where to incorporate, Delaware would have stood out as the likely choice but going forward, with the state now seen as offering fewer protections for investors, it's going to be a "much tougher call," Mahoney said.
A bigger threat?
Longer term, a number of plaintiff lawyers said a bigger threat to Delaware’s franchise is federalization — the prospect that the federal government will step in for the first time to set fiduciary standards that have traditionally been hammered out on a state-by-state basis.
“To me, the biggest threat to Delaware is the risk of federalization,” Richardson said. The backdrop to the value of Delaware’s franchise is that the federal government doesn’t regulate fiduciary duties as between investors and the directors and officers of the corporations they invest in, which has left companies from other states willing to pay a franchise tax to gain access to Delaware’s well-developed, balanced corporate law, he said.
If the latest amendments effectively tipping the balance of Delaware law strongly in favor of corporate insiders accelerates a race to the bottom, that would raise the odds of the federal government — admittedly not under the present administration but under a future administration — stepping in at some point to offer shareholder protections nationwide. When that happens companies will have no reason to pay franchise fees of up to $250,000 a year to access Delaware courts, Richardson said.
