The writer is a professor of law at the University of Nevada
Delaware’s new governor Matt Meyer has recognised that things will need to change in his state after a number of companies decided to shift domicile from it. At the same time, he warns against “going to Vegas and rolling the dice”. He’s wrong.
For many corporations, Nevada offers a much safer bet than Delaware. And this bet just became easier to place. Delaware’s Supreme Court recently cleared companies to leave the First State. A stockholder had tried to stop Tripadvisor from shifting to Nevada without paying shareholders for the loss of their special “Delaware” rights.
The Delaware Supreme Court rightly reversed the Chancery court judgment in that case, finding that the decision to leave Delaware for Nevada shouldn’t trigger special scrutiny. It also agreed with Nevada’s argument that companies, not courts, should conduct the cost-benefit analysis of what state offers a better deal.
Hedge fund manager Bill Ackman recently pushed his chips towards Nevada when he announced that he was reincorporating the management company of his firm Pershing Square to the state. Pershing will join other recent movers including Dropbox and The Trade Desk. These all share a crucial characteristic — a founder still owns or controls much of the corporation’s voting shares Corporate law often classifies these companies as “controlled” because “controllers” may have enough votes to decide much of the corporation’s affairs.
Delaware law treats controlled companies differently from other corporations, making them easier to sue and take to trial. Stephen Bainbridge, a leading corporate law expert at UCLA School of Law, recently wrote that Delaware treats controlled companies with a “reflexive suspicion” whenever they do business with a controlling shareholder. Delaware courts have also been willing to classify persons owning less than 50 per cent of a company’s voting shares as controlling shareholders — including Elon Musk in the case of Tesla despite him holding a minority stake. For founder-led companies, getting their pay package approved under Delaware law comes with headaches and uncertainty.
Such companies must also hire lawyers and implement special processes to “cleanse” deals with a controlling shareholder. Even when they disclose and sanitise these transactions under Delaware law, they may still end up litigating for years. Controlled businesses must consider whether Delaware is worth the drama. The state’s benefits appear weak. A study by Steven Davidoff Solomon, professor at UC Berkeley Law, found the last five large controlled companies leaving Delaware did not attract a “negative premium” on the stock market. Another study found that “controlled Delaware firms are on average worth 4.9 per cent less” than similar ones incorporated elsewhere.
To be sure, controlled companies differ from other corporations. Controllers might use their power to enrich themselves at the expense of other shareholders. Yet controllers also have more skin in the game than more diversified shareholders. Controllers have an intense, personal interest in ensuring that their stock price remains high — something that will not happen if the company gets a reputation for abusing its shareholders. In the future, Delaware might leave more of these issues to the market. Its legislature will consider legislation to ease the burden for controlled companies at its next session.
Still, despite the flaws in Delaware’s system, governor Meyer should be proud of its advantages. It has a deeply competent judiciary capable of swiftly resolving shareholder disputes and a well-funded secretary of state office providing first-class service in creating corporations.
Nevada must upgrade its legal infrastructure to continue to compete. For decades, lawyers have told clients that Delaware’s courts make it unique and a preferred jurisdiction. Texas recently created its own appointed business court. Nevada’s legislature is now considering a constitutional amendment this session to authorise appointed business courts. Nevada already has a dedicated “business docket” for listing and assigning cases. Yet maintaining its advantage will require a specialised forum.
Offering a competitive package matters to Nevada. Delaware state collects about a third of its general revenue from incorporation fees — well over $2bn annually. As Nevada rises and offers an alternative, it stands to benefit by thoughtfully competing and offering a fair forum.
Joe Dalia, assembly member of the Nevada legislature, contributed to this article
