In the battle unfolding this year in Delaware’s legislature over how best to preserve the state’s status as the premier legal home for companies incorporating in the U.S., the voices of industry titans such as Elon Musk and Mark Zuckerberg have thus far drowned out those of institutional investors.
But the day — if not exactly young — isn’t over yet.
Delaware's House of Representatives, the lower house of the state's bicameral legislature, could vote as early as this week on a bill that would broaden safe harbor protections for corporate owners and directors while narrowing shareholder access to company books and records. The vote, expected for March 20, was pushed back — a delay welcomed by critics who complained the process has been rushed.
On March 14, the proposed amendments to Delaware’s corporate law — known as SB 21, or Senate Bill 21 — were overwhelmingly approved in Delaware's upper house, with 20 votes in favor and only one abstention.
Critics say the legislation was put together at breakneck speed on the heels of a January report that Zuckerberg was mulling moving Meta Platforms’ state of incorporation to Texas from Delaware, roughly a year after Musk opted to do the same with Tesla.
Musk urged other companies to decamp from Delaware as well, against the backdrop of a legal grudge match with the state’s courts over their rejection of a $56 billion Musk pay package approved by Tesla’s board.
The court ruled that Musk “controlled” the company, effectively dictating the outcome of his own compensation package.
Lower house members, at a March 19 committee hearing on the bill, conceded that getting the formula right is a priority for Delaware, which relies on $2 billion in annual franchise fees from companies incorporated in the state to cover more than 30% of its budget outlays.
“It has been the goose that’s laid the golden egg for us for a long time, and I understand not wanting to kill that goose,” Maya Gorman, a representative for Delaware’s 23rd district, said at the hearing.
Proponents of SB 21 called the departure of Tesla and potential departure of Meta Platforms the tip of a much bigger iceberg and urged quick action to head off an exodus.
Amy Simmerman, a lawyer with Wilson Sonsini, a law firm which touts its work with technology pioneers, told the committee hearing that among the hundreds of public companies her firm works with, roughly 15 — all large filers that pay a lot of franchise taxes — are “getting ready to move or seriously thinking about it.”
If legislators wait to address the concerns of such companies until a hundred have re-incorporated, it could prove too late to nip that growing trend in the bud, Simmerman warned.
Institutional investors
By contrast, Jeroen van Kwawegen, a partner with law firm Bernstein Litowitz Berger & Grossmann, which represents individual and institutional clients, dubbed that “D-exit” argument a “false narrative.”
The data shows that in the 12 months since Musk’s decision to re-incorporate his companies in Texas, 85 more companies have incorporated in Delaware, van Kwawegen said in an interview.
Proponents of the bill “were trying to push it through so quickly that nobody had time to pay attention,” he added.
At the end of the day, legislators will have to decide which side of the corporate governance coin to favor — Delaware-registered companies with dominant controlling shareholders who could opt to leave in pursuit of friendlier state courts elsewhere, or institutional investors who could balk if shareholder protections are weakened.
Critics of SB 21 say the balance of risks favor paying more attention to what institutional investors such as the $538 billion California Public Employees’ Retirement System are thinking and less to high-profile captains of industry.
“Franchise taxes are capped at $250,000,” not driven by the size of a company, which makes Delaware a volume business, said van Kwawegen. With only a quarter of a million dollars in play, Meta’s re-incorporation to another state would mean nothing for the state's budget, he said.
The focus on companies with dominant owners such as Tesla and Meta belies that fact that such companies are a “very, very, very small percentage of the corporations incorporated in Delaware,” said Sophie Phillips, the Democratic representative for the state’s 18th district.
In a March 14 letter to Delaware legislative leaders, CalPERS archly spelled out its views on the balance of risks, saying “while we understand that the controlling stockholders of certain Delaware corporations have threatened to reincorporate their handful of companies out of Delaware, the legislation would cause much deeper harm to the brand of Delaware corporate law.”
Lawyers working with shareholders agreed.
“Delaware has always said, hey, we’ve got the best court and the best judges but if you’re going to say, oh, but whenever the judges do something that Elon Musk doesn’t like, we’re going to overrule them and change the law, then having good judges doesn’t really matter so much anymore,” said Michael Hanrahan, a director with law firm Prickett, Jones & Elliott.
“To date,” CalPERS’ letter continued, “we have opposed attempts to reincorporate out of Delaware. But if SB 21 passes, we will have to take a much more case-by-case view, because many states provide corporate law that is significantly more investor-protective than Delaware law would under SB 21, and those states do not have a history of statutorily overturning trial court decisions that go against rich and powerful corporate insiders before they are even decided on appeal.”
The prospect of CalPERS potentially approving the occasional proxy vote to switch some company’s registration from Delaware to another state, meanwhile, could be the least of the franchise’s problems should the bill be approved.
“What they really should be fearing is that ... the capital, the asset managers, the active owners understand now that if this bill passes, this is a license to steal by controlling stockholders from public investor money,” van Kwawegen said.
“Providers of capital are going to take a hard look at Delaware and say, well, do we have more attractive sources of investments,” he said, adding that European investors he met with this month were wondering if they should shift allocations from the U.S. to Europe or Asia.
It’s going to affect the price investors are willing to pay for companies incorporated in Delaware, Hanrahan said.
Instead of saying Delaware, even if imperfect, is better than anywhere else, there’s going to be a “Delaware discount,” reflecting watered-down protections for shareholders, he said.
Even backers of SB 21 concede that stepping on investors’ toes at this juncture could prove risky for the state.
Srinivas Raju the chair of the State Bar Association’s 27-member Corporation Law Council, which “strongly endorsed” SB 21 — suggested at the hearing that the state’s corporate law can’t afford to be seen as unbalanced in favor of corporate leaders. “At the end of the day, if Delaware has a jurisdiction where controllers can get away with it, you know what will happen? Investors will stop investing in Delaware companies, and that’s the surest way to kill the franchise,” he said.
But, Raju added, he has no evidence that SB 21 would illicit such a response, “nor do I have any belief that that will happen.” Raju declined a request for further comment.
CalPERS hasn’t been alone in sounding an alarm over SB 21.
New York state comptroller Thomas P. DiNapoli, overseer of the $275 billion New York State Common Retirement Fund, in a March 7 letter to Delaware’s governor and legislative leaders warned the bill would “significantly curtail shareholder rights for the benefit of corporate executives.
That same day, a letter signed by more than 45 U.S. based public pension and Taft Hartley funds predicted SB 21’s passage would result in a “substantial wealth transfer from our beneficiaries … to misbehaving fiduciaries,” and four days later, the International Corporate Governance Network, with members in more than 40 countries overseeing more than $90 trillion in assets, warned that S.B. 21 would “lower the safeguards that currently protect minority investors from potentially abusive acts.
Charles M. Elson, founding director of the Weinberg Center for Corporate Governance, launched in 2000 with the goal of protecting Delaware's franchise, told the committee that SB 21, far from protecting the franchise, could damage it "fatally" by alienating the institutional investors who are "the other half of the equation."
He predicted New York could be a prime beneficiary of companies defecting from Delaware.
If proponents of SB 21 have seemed to enjoy all of the momentum up to last week, with strong backing from the likes of Delaware Gov. Matt Meyer and Senate Majority Leader Bryan Townsend, critics said they have some reason to hope that a middle ground can be staked out before a final vote is held over the coming week.
“Almost everybody, except for the proponents, understand that the bill is deeply problematic, and I think they’re all looking for an off ramp,” said Christopher M. Foulds, a partner with Friedlander & Gorris.
Possible off ramp
An amendment offered last week by Representative Phillips to incorporate an opt-in mechanism for the bill, allowing each company and its shareholders to vote on the proposed changes rather than mandate them across the board, could be that off ramp, Foulds said.
CalPERS, in its March 14 letter, suggested grudging support for such a mechanism, writing “if the concern is specific companies wanting to opt out of Delaware altogether, this concern can be much more fairly addressed by letting individual companies, with stockholder approval, opt in to this extreme lack of accountability.”
A CalPERS' spokesman, asked if the proposed opt-in amendment would ameliorate CalPERS' concerns about SB 21’s proposed amendments to Delaware corporate law, said "we have nothing further to add."
Other institutional investors seem less open to splitting the difference when it comes to Delaware corporate law.
Severine Neervoort, global policy director for The International Corporate Governance Network, said in an email “we saw the amendment proposed by state Rep. Sophie Phillips, introducing the idea of an opt-in clause, which is an attempt to have a minimum safeguard for minority shareholders. Our recommendation to the Delaware Assembly legislators remains that they should avoid diluting minority shareholder rights and vote against the changes proposed in SB 21,” Neervoort said.
She reiterated that institutional investors around the world “believe the proposed changes in SB 21 would undermine the attractiveness of Delaware incorporated companies for investors and be detrimental to the state’s reputation.”
Phillips said with arguments being made on both sides of the issue that Delaware’s franchise is at risk, there’s growing openness to an opt-in mechanism as a compromise.
She said when the House of Representatives takes up the bill this week, they will vote on the amendment. If it passes, she said, the final bill would include an opt-in mechanism.
