States want to displace Delaware's dominance in company formation

Delaware has long been the top state for incorporating a business and is known for its highly developed Court of Chancery and comprehensive corporate law, which provides businesses with a predictable legal framework.

However, recent claims suggest that Delaware may lose its position as the dominant state for incorporating companies. Companies like Tesla and TripAdvisor have sought to relocate their headquarters out of Delaware to states like Texas and Nevada. These developments signal a change in the corporate landscape, make the relocation debate more complex, and suggest that other states may compete with Delaware's dominance in the corporate space.

Whether Delaware will concede significant ground to other states will likely depend in part on whether other jurisdictions can provide a judicial forum that is equal to, or even superior to, the reputation of Delaware's Chancery Court as a predictable forum for resolving corporate disputes.

Comparative environment

Delaware's long-standing reputation as the nation's leading court for business formation has naturally inspired other states to emulate its success, with more than two dozen states establishing commercial courts over the past three decades.

There are some significant legal differences between Delaware corporate law and the laws of other jurisdictions with respect to certain issues, including the legal standards governing transactions between interested directors and shareholder derivative actions.

Nevertheless, the similarities outweigh the disadvantages, and most states now offer shareholders essentially similar sets of business, governance, and procedural rights as Delaware. From a substantive corporate law perspective, incorporating a company in Delaware does not appear to offer any significant advantages compared to other jurisdictions.

It is also unclear whether there are any measurable economic benefits to incorporating a company in Delaware yet. It has long been believed that incorporating a company in Delaware could boost investor confidence and command a market premium due to the perceived value that companies gain from Delaware's respected legal system.

There is evidence that market participants perceive Delaware as a higher quality location compared to other jurisdictions and that larger and more complex companies as well as promising private equity and venture capital start-ups are more likely to choose Delaware.

Surprisingly, however, there is little evidence that companies actually gain measurable benefits from incorporating in Delaware. While some financial investors, institutional investors and other market participants continue to favor Delaware, the state's perceived reputational advantage does not necessarily translate into higher stock valuations or easier access to capital.

Tesla argued for re-domestication, acknowledging that Texas and Delaware have essentially equivalent corporate laws. Tesla's special committee also found no discernible valuation premium associated with incorporating in Delaware. Conversely, the report also found no discernible pattern of re-domestication having a positive or negative impact on stock value. The illusory concept of the “Delaware premium” could continue to erode if states continue to develop similar business court systems.

Although Delaware's preeminence may diminish in the long run as other states develop their own business court systems, those states are nonetheless doing so in Delaware's wake. For example, Texas will open a new business court system in September. However, those courts will likely continue to rely on Delaware jurisprudence as a persuasive authority in deciding disputes where Texas and Delaware laws converge.

The lack of jury trials in the Delaware Chancery Court may reinforce the perception that Delaware courts offer greater predictability than the jury-friendly courts in other states. While there is some optimism that the commercial courts in Texas and other states will succeed in providing a strong alternative forum for corporate litigation, it may take some time for these courts to command the same level of respect in the marketplace as Delaware's long-established commercial forum. Time will tell whether Texas and other states can overcome Delaware's perceived reputational advantage.

Cost considerations can also affect relocation calculations. Delaware has previously charged a franchise tax for the privilege of starting a business there. In contrast, states such as Nevada and Texas do not require companies to pay such payments, which could result in significant savings.

The vast majority of redomestication advocates have cited this cost difference as an argument for reorganizing outside of Delaware. On the other hand, redomesticating public companies is a time-intensive process that can result in legal fees and possible litigation, which could offset the cost savings from reorganization. Companies may be reluctant to reincorporate if they do not perceive a significant overall cost reduction.

Perception and advocacy

Companies relocating out of Delaware often cite the intuitive value of “home state integration” and executive autonomy, as well as greater corporate freedom in compensation decisions, strategic transactions, and stronger liability protections.

Tesla extolled the benefits of incorporating in its home state and was able to successfully lobby shareholders to approve the move back to Texas. In a letter to shareholders, the company said it was “valuable to litigate commercial disputes where Tesla is headquartered” because “the community is directly affected by court decisions affecting our company.”

However, some market participants and observers have argued that these benefits disproportionately accrue to management and incumbent directors rather than shareholders. Recently, the Delaware Chancery Court allowed a lawsuit challenging TripAdvisor's relocation from Delaware to Nevada to proceed as a damages claim, arguing that it was entirely possible that the greater liability protections for fiduciaries under Nevada law had affected the value of shareholders' investments.

It remains to be seen whether the proponents or the critics of relocation will prevail in future debates on these issues and whether these measures will trigger a wave of similar relocations among other companies in the future.

Companies may not find relocation cost-effective, and it may prove difficult for other jurisdictions to match Delaware's reputational advantage, built over many decades thanks to a sophisticated business court and bar. On the other hand, companies may find that Texas, Nevada or other states offer more flexibility at a lower cost.

In the short term, the number of redomiciled companies is likely to remain limited, but could increase significantly later as courts in other states gain experience in handling significant litigation with companies.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Information about the author

Debra Gatison Hatter is a partner at Norton Rose Fulbright and focuses on corporate securities, mergers and acquisitions, joint ventures and other business matters.

Peter Stokes is a partner at Norton Rose Fulbright and represents clients in securities, SEC enforcement, investigations, corporate governance and other matters.

Elie Krief is an associate at Norton Rose Fulbright and represents public and private companies, private equity sponsors and portfolio companies, financial advisors, and boards/committees in complex transactions.

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