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Roula Khalaf, editor-in-chief of the FT, selects her favorite stories in this weekly newsletter.
The drop that occurred just before the Easter long weekend does not appear to be a coincidence. On Thursday, March 28, a group of powerful Delaware lawyers launched a plan to make a series of changes to the state’s primary corporate code, known as the Delaware General Corporation Law.
The attorneys are members of the Delaware State Bar, which usually makes such proposals to update the state’s corporate law. But this series of revisions was hasty and was, according to the plan, to be quickly approved by the Delaware legislature in order to take effect on August 1.
This has been no ordinary year in the First State. About two-thirds of U.S. businesses are incorporated in Delaware, drawn to the small mid-Atlantic state by its sophisticated legal system. But a series of highly technical rulings in recent months have apparently struck down long-standing legal provisions in merger and shareholder agreements, leaving them open to challenges in court.
That has angered lawyers who say the state’s reputation for predictability is eroding, potentially risking its status as America’s leading place to incorporate companies. The concerns expressed both privately and publicly were serious enough that the state bar sprang into action, proposing changes aimed at restoring that predictability.
Yet all of this would likely remain “inside baseball,” confined to legal conventions and newspaper articles, if it weren’t for one man: Elon Musk. The Tesla co-founder’s frustration with Delaware’s law has brought unprecedented attention to the state this year.
Musk has been lashing out at the state since late January, when a Court of Chancery judge struck down a $56 billion stock compensation package awarded to him in 2018. And last week, Tesla said it would ask its independent shareholders to vote in June to move its plan. home in Texas – writing in his proxy statement that Delaware corporate law “may be less predictable for an innovative company like Tesla.”
The elegance of Delaware’s law is that it has, for decades, struck a fair balance between the interests of corporations and those of shareholders. Both parties could then benefit if investors granted a premium to the companies incorporated there. But the state bar’s recent moves to amend the DGCL, which have been criticized by legal experts as rushed, arguably reflect signs of panic and insecurity.
Musk’s problem with Delaware comes from the state’s strictness on potentially self-interested deals by companies with dominant shareholders. In overturning his pay package, the court said Musk, who owns more than a fifth of the company, was too cozy with Tesla’s board and that the value of the package was unfair to others shareholders.
The three recently proposed changes to the DGCL have little to do with the doctrines that harmed Musk, but highlight lawyers’ angst about their state’s future in business. Of the three changes, the most controversial change aims to make it easier for boards to enter into direct agreements with a specific shareholder, a common practice to avoid proxy battles. The Delaware court this year invalidated such a practice at the investment bank Moelis & Co, which had given its founder veto power over almost all standard work carried out by a board of directors.
Several law professors have emphasized that boards of directors are expected to exercise judgment consistent with their duties to all shareholders. They can’t just make decisions to appease a specific shareholder. The professors’ argument is not that the DGCL should not be modified. Rather, the proposed changes address a fundamental question at the heart of what a corporation is: whether directors should use their judgment in making decisions or simply be told what to do through a contract. It is therefore unwise to rush to make changes to the company code.
And for all of Musk’s histrionic talk, there’s no sign that any other major public companies are about to flee to Texas, Nevada, or any other state. The vast majority of them will never have a contractual or fiduciary dispute of any significance, and irritating shareholders with a forum search gamble is certainly not worth it.
Still, Delaware, Inc is going to have to decide whether its brand should be based on an impartial, impartial system or something more business-friendly, designed to keep pace with a race to the bottom in regulation. Tesla argued in its proxy filing last week that incorporation status does not matter to shareholder value. We’re about to find out.
