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Have the Delaware Courts Become Pro-Plaintiff and Anti-Business?

Jonathan Macey has a new article, “Leaving for Las Vegas?," which posits that Delaware's historic dominance of the market for corporate charters is now threatened by a shift in both tone and outcome on the part of certain Delaware jurists. 

I argue that, while the Delaware judiciary remains, for the most part, talented and knowledgeable, the legislature remains responsive, and the Secretary of State’s office remains highly efficient, certain members of the Delaware judiciary appear to be adopting an attitude towards business that appears to be “suspicious or negative.” This change in judicial attitude marks a sharp break with historic practice, and it is a change that matters. It is generally difficult, and often impossible, for public companies to avoid being sued, and, understandably, directors and officers do not like being subject to ridicule and derision, as Elon Musk was in a recent decision generally deriding “superstar CEOs” and questioning their value-added. The perception that judges do not recognize or appreciate the contributions made to corporations by their officers and directors could lead companies to resist the historical proclivity to incorporate in Delaware.

Additionally, this Essay makes the point that the “suspicious and negative tone adopted towards corporate boards and management” by Delaware judges stands in sharp contrast to the veneration that Delaware judges have shown towards the plaintiff-side lawyers who sue these officers and directors. Certain Delaware judges appear to have lost sight of the fact that the same agency costs that plague corporate officers and directors similarly plague the plaintiffs’ lawyers who sue these officers and directors. In other words, just as officers and directors do not always act in the best interests of their shareholders, plaintiffs’ lawyers do not always act in the best interests of the shareholders they ostensibly represent.

. . . Simply put, certain judges are making Delaware corporations feel unwelcome, and are raising concerns that the plaintiffs’ side of the bar is entitled to more deference than the defense bar.

A Climate of Discontent

Macey’s central thesis is that Delaware risks alienating key constituents in the incorporation decision-making process: controlling shareholders, corporate advisors, and legal practitioners. Recent decisions by the Delaware Chancery Court have adopted a tone that some perceive as "suspicious and negative" toward corporate boards and management. This shift marks a departure from the historically collaborative spirit between Delaware's judiciary and its corporate constituents.

Controlling shareholders, for instance, increasingly feel under siege. Macey cites cases like Tornetta v. Musk, where judicial scrutiny of Elon Musk’s compensation sparked backlash despite the overwhelming approval of Tesla’s non-controlling shareholders. Such decisions, he argues, impose protections that minority shareholders neither seek nor value.

Anthony Rickey concurs with Macey's argument on that score:

While I don’t agree with everything in Jonathan Macey’s new article (including some harsh criticism of judges), it makes an important point: controlling and minority stockholder interests can be aligned, and the assumption that stockholders value draconian enforcement of the DGCL is contestable. I found it surprising that the Moelis opinion did not mention the possibility that some stockholders purchased shares in a company with Ken Moelis’s name on the door, and a fully disclosed contract giving him control, because they wanted to participate in a firm led by Ken Moelis over anyone else. The congruence of a Florida pension fund’s arguments with the beliefs of other stockholders was simply assumed.

... Moelis stockholders never asked to be championed by a Florida pension fund. It’s not even clear that the West Palm Beach fund itself was all that concerned by its supposed injury. I’ve read most of their public board minutes and I can’t find any mention of Moelis until the Fund’s board was approached by counsel a few days before the complaint was filed. 

I concur. It is an odd omission. A plaintiff lawyer found a theory, brought a suit that likely was not ripe, and was rewarded with an opinion that did more to advance the wealth of the plaintiffs bar than to make investors better off. As Rickey further observed:

Delaware law assumed that stockholders valued the disclosure settlements that used to plague Chancery’s docket. Its courts still assume that stockholders value the protections provided by representative litigation and appreciate paying class counsel 15 times a standard hourly rate (or more) for such benefits. Macey’s article usefully pushes back against that assumption.

Why It Matters

Delaware’s dominance has always depended on its ability to meet the preferences of those making incorporation decisions. Lawyers, investment bankers, and controlling shareholders value certainty, clarity, and deference to contractual arrangements. Macey contends that the state’s judicial temperament increasingly undermines these priorities, creating friction in the market for corporate charters:

In particular, recent decisions regarding controlling shareholders undermine the work of judges like Leo Strine and William Allen, who sought to simplify the corporate law of Delaware and to make clear the rules of the road. Instead, in recent years a mystifying shadow law for corporate controllers has emerged that practitioners, investors and controlling shareholders find frustrating and opaque. Decisions construing Delaware statutes and applying Delaware common law run hundreds of pages in length and provide far more nuance than clarity.

I pause briefly to plug my recent articles that speak to some of these same issues:

DExit Drivers: Is Delaware's Dominance Threatened?: This article provides both an empirical and a qualitative analysis of firms that reincorporated from Delaware to another state between 2012 and 2024. The number of reincorporations from Delaware remains minimal compared to the vast number of new incorporations Delaware attracts annually. Given the strong inertia behind the initial incorporation decision and the weak drivers for DExit, it is unlikely to become widespread soon. But the subset of firms with controlling shareholders may prove an exception, as Delaware law is increasingly skewed against controllers.

A Course Correction for Controlling Shareholder Transactions: This paper critically examines the evolving legal standards applied by Delaware courts to controlling shareholder transactions, highlighting the increasing constraints faced by controlling shareholders. Delaware courts increasingly exhibit a reflexive suspicion of transactions involving a controlling shareholder. This article contends that Delaware courts need a course correction. They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas. 

Returning to Macey, he argues that legislative interventions to "correct" judicial decisions, while effective in addressing immediate concerns, cannot alter the perception that Delaware courts are becoming less predictable. If this sentiment grows, companies may explore alternative states, shaking the foundations of Delaware’s corporate dominance.

A Broader Perspective

Despite these challenges, Macey remains cautiously optimistic. He notes that Delaware’s competitors face their own hurdles, and the state’s advantages—efficiency, legal expertise, and a comprehensive statutory framework—remain unmatched. As long as Delaware can maintain its reputation as marginally better than its alternatives, it will likely retain its position at the top.

Future Directions

Macey’s analysis offers a rich vein for scholarly exploration. Legal writers could investigate whether Delaware’s challenges represent a broader trend in corporate governance or if they are unique to the state’s peculiar role in U.S. corporate law. Similarly, examining the long-term implications of judicial-legislative friction in maintaining a jurisdiction’s appeal could yield valuable insights for other states vying for a slice of Delaware’s market. As Macey observes:

Vice Chancellor Laster and Chancellor McCormick have expressed displeasure with Delaware statutes that they likely will be called upon to construe. A reasonable corporate planner thinking about how a statute will be interpreted and applied would expect that the judges’ disdain for a statute inevitably would affect these interpretations and applications.

In short, Delaware is not "leaving for Las Vegas," but Macey's essay reminds us that even the mightiest players in law and policy must adapt to maintain their edge. So I highly recommend reading Macey's essay. 

CLS Blue Sky Blog post summarizing A Course Correction for Conflicted Controller Transactions

I've got a short summation of my article A Course Correction for Conflicted Controller Transactions up at CLS Blue Sky Blog.

A Reply to Anthony Rickey's comment on my article "A Course Correction for Controlling Shareholder Transactions"

Anthony Rickey recently posted some comments on my article A Course Correction for Controlling Shareholder Transactions, for which I am grateful. 

I am glad that Anthony found the piece thought-provoking, and I appreciate the depth of his commentary on its implications and its intersections with broader debates in corporate law. So let me briefly address some of the points he raised.

The Impermanence of Judicial Solutions

Anthony's concern about the durability of a reinvigorated Sinclair Oil test is well-taken. Judicial standards can indeed evolve—or erode—over time. However, my argument rests on the premise that Delaware’s jurisprudence thrives on its adaptability. By adopting a more predictable threshold for triggering entire fairness, we provide a stronger foundation for controllers and minority stockholders alike. While I acknowledge that this foundation may not be eternal, the legal community—particularly transactional attorneys—can help fortify it through practice norms and contractual safeguards.

His observation about Nevada’s statutory approach is also well-taken. While I did not wholly ignore the implications of competitive federalism, my focus in this article remained on Delaware’s unique position in corporate law. I did, however, briefly discuss Nevada’s statutory protections in my article DExit Drivers: Is Delaware's Dominance Threatened?:

It is not clear that reincorporating out of Delaware will provide controllers with significant liability protection. Nevada’s fiduciary duty statute applies only to directors and officers, leaving controller liability to case law. See Nev. Rev. Stat. § 78.138 (“The fiduciary duties of directors and officers . . ..”). But there is very little Nevada case law on point. In Cohen v. Mirage Resorts, Inc., 62 P.3d 720 (Nev. 2003), the Nevada Supreme Court held that minority shareholders could seek damages for breach of fiduciary duty if a “merger was accomplished through the wrongful conduct of majority shareholders,” citing a Delaware case as support for that proposition. Id. at 727 (citing Parnes v. Bally Entertainment Corp., 722 A.2d 1243, 1245 (Del.1999)). See also Guzman v. Johnson, 483 P.3d 531, 538 (Nev. 2021) (discussing fiduciary duty of controlling shareholder in connection with a merger). The court offered no guidance as to the definition of a controlling shareholder or the standard of review applicable to conflicted controller transactions.

In Peddie v. Spot Devices, Inc., 2019 WL 13324088, at *6 (Nev.Dist.Ct.), the court discussed the definition of controlling shareholder, citing Delaware precedents for the proposition that “a minority shareholder exercising actual control over a corporation may be deemed a controlling shareholder with a concomitant fiduciary duty to the corporation and other shareholders.” Id. at *6. In doing so, the court noted that “Nevada courts frequently look to [Delaware law to] determine corporate questions.” Id. The court did not specify the standard of review applicable to conflicted controller transactions.

The U.S. District Court for the District of Nevada predicted that the Nevada Supreme Court would look to Delaware law for guidance on conflicted controller transactions. See Brown v. Kinross Gold U.S.A., Inc., 531 F. Supp. 2d 1234, 1245 (D. Nev. 2008) (“Because the Nevada Supreme Court frequently looks to the Delaware Supreme Court and the Delaware Courts of Chancery as persuasive authorities on questions of corporation law, this Court often looks to those sources to predict how the Nevada Supreme Court would decide the question.”). The transaction before the court involved a tender offer by a controlling shareholder for all of the corporation’s outstanding preferred stock. Id. at 1239. Citing Delaware precedents, the court predicted Nevada would apply the entire fairness standard if the offer were deemed coercive. Id. at 1245.

In sum, the case law does not support the proposition that Nevada law is more protective of controlling shareholders than is Delaware law. To the contrary, it suggests that Nevada courts are likely to apply the Delaware standards with respect to who is a controller, what standard of review is applicable to conflicted controller transactions, and how such transactions may be cleansed. The paucity of pertinent case law also calls into question the extent to which Nevada law can compete with that of Delaware on factors such as comprehensiveness and determinacy. Accordingly, predictions that other controllers will follow Musk out of Delaware likely are overstated.

By the way, look for future blog posts responding to some points Keith Paul Bishop has made on this issue.

A Division in the Corporate Bar

Anthony's analysis of fissures within the Delaware bar due to controller-skeptical rulings is insightful. I agree that these decisions may strain traditional “Delaware Way” norms. However, I view Course Correction as an opportunity to realign those norms with the expectations of modern market participants. Addressing the discontent of transactional lawyers who counsel founders on the stability of Delaware law is, in part, the impetus for this work. By promoting a more predictable standard, my proposal aims to restore trust in Delaware as the optimal forum for controlled companies.

Anthony's request for a deeper dive into the political economy of Delaware’s corporate bar, akin to my earlier work in Fee Shifting: Delaware's Self-Inflicted Wound, is flattering and well-noted. While Course Correction concentrates on doctrinal refinement, I see fertile ground for exploring the broader implications of Delaware’s legal-political landscape in future scholarship. His observations about plaintiff-side adaptability and the jurisdictional stickiness of defense lawyers present valuable avenues for further exploration.

Practitioner Anonymity and the Broader Debate

Finally, I appreciate Anthony's reflections on the use of anonymized practitioner insights. Suffice it to say that the lawyers I quoted are known figures for whose views I have great respect. Their anonymity reflects not just a practical concern but also the delicate balance practitioners must strike in a contentious field. While it limits the color of the narrative, it ensures that the conversation remains substantive and inclusive.

A Retrospective on Gary Gensler’s Tenure as SEC Chairman

SEC Chair Gary Gensler recently announced that he will be resigning before President Trump takes office in January. Gensler thus continued the tradition of the SEC Chair resigning when a new POTUS takes office so that the new President can put his stamp on the agency. Commendable.

Gary Gensler’s tenure as Chairman of the Securities and Exchange Commission (SEC) was nothing if not ambitious. During his time in office, he pursued an aggressive regulatory agenda, focusing on everything from cryptocurrency oversight to environmental, social, and governance (ESG) disclosures. While Gensler’s supporters viewed this as a much-needed modernization of financial markets, a closer examination reveals that his approach often prioritized politics over practical, evidence-based policymaking.

Overreach in ESG Disclosure Mandates

One of Gensler’s hallmark initiatives was the push for expanded ESG disclosures, including requirements for companies to report on workplace diversity and environmental impacts. Gensler framed these measures as a response to "investor demand." But where was the evidence?

As I have previously noted, the best indicator of investor preferences isn’t surveys or anecdotal commentary—it’s voting behavior. When given the opportunity to vote on shareholder proposals related to ESG issues, investors largely demonstrated apathy. In 2020, for example, only a handful of workplace diversity-related proposals garnered majority support, with an average approval rate of just 32%.

Ehether you think workplace diversity or environmental stewardship have merit, the SEC’s claim that these proposals aligned with widespread investor demand was dubious at best. If investors had truly prioritized these issues, we would have seen far greater support for ESG proposals in shareholder meetings. Instead, Gensler advanced what often seemed like a political agenda under the guise of responding to investor interest.

Uncertainty in Cryptocurrency Regulation

Another area where Gensler’s tenure was marked by controversy was cryptocurrency regulation. Gensler publicly stated his intent to bring cryptocurrencies under greater regulatory control, labeling many tokens as securities and pursuing enforcement actions against major players in the industry.

Rather than working with Congress to establish clear legislative guidance on cryptocurrency, the SEC under Gensler relied heavily on enforcement to set de facto policy. This led to accusations of regulatory overreach and unpredictability, creating an environment where companies were unsure of the rules and increasingly wary of innovation in the United States.

Critics of Gensler’s approach argued that this strategy stifled the burgeoning crypto sector, pushing innovation offshore while failing to provide the regulatory clarity that investors and companies needed. Instead of fostering growth and accountability, the SEC operated through ambiguity, leaving both markets and consumers worse off.

A Pattern of Questionable Justifications

What tied these issues together was a troubling pattern: Gensler’s SEC often relied on questionable justifications for its actions. In the case of ESG disclosures, the purported investor demand didn’t hold up to scrutiny. In the case of crypto enforcement, the SEC claimed to be protecting investors, yet its actions left retail participants with little guidance and fewer options.

This approach was emblematic of a broader problem with Gensler’s leadership style—an overemphasis on expanding regulatory power without sufficient regard for its practical implications. Regulation for its own sake is not regulation that works.

A Call for Evidence-Based Policy

The SEC plays a critical role in protecting investors, maintaining fair markets, and fostering capital formation. But to be effective, its policies must be rooted in evidence and aligned with the needs of market participants. Gensler’s tenure too often prioritized headlines over results, politics over substance.

A better path forward would focus on pragmatic reforms that respond to demonstrable investor needs, not political trends. It would involve working with Congress to modernize outdated regulatory frameworks rather than relying on enforcement to legislate from the executive branch. And it would require the SEC to acknowledge the limits of its mandate, rather than overstepping in ways that risked damaging the very markets it sought to protect.

As Gensler departs the SEC, it is worth reflecting on whether the agency’s priorities during his leadership truly aligned with those of the investors and companies it served. In many cases, the answer appears to have been: no.

A Critical Summary of Project 2025's Blueprint for Trump's SEC and CFTC with Suggestions

John Jenkins reports that:

With the election in the rear-view mirror, many people are speculating about the potential implications of Trump 2.0 for the SEC and securities regulation in general.  Some of these are pretty obvious – Donald Trump promised that Gary Gensler would be a goner “on day one,” and he seems likely to depart even before Trump takes office. The SEC’s climate disclosure rules also are almost certainly on the chopping block, and its long-delayed proposals on human capital management and corporate board diversity disclosures will probably never see the light of day.

Those political footballs may garner most of the headlines during the next few months, but what about the Trump Administration’s approach to more “meat & potatoes” securities law issues?  Even though Donald Trump claims to know nothing about Project 2025, plenty of others in his orbit do, and it seems likely that many of the policy objectives laid out in that document will be on the agenda when it comes to securities regulation. 

Herewith a critical summary of the Project's proposals, focusing on those in my wheelhouse:

One central focus is reform of the Securities and Exchange Commission (SEC) and related bodies, which the Project's authors argue have evolved into overly complex, costly structures that inhibit economic growth. (There's certainly some truth to that.) It argues that the SEC’s regulatory mandates, developed over decades, have become a burden for companies, with recent rules such as the climate change disclosure mandate purportedly adding prohibitive costs to being a public company. To rectify this, the authors propose reorienting the SEC’s mission to reduce barriers to capital formation, favor transparency, and prioritize traditional financial metrics over politically driven criteria like environmental, social, and governance (ESG) standards.

The blueprint advocates for a simplified securities disclosure system that organizes firms into private, intermediate, and public categories, each with scaled reporting requirements. It's not entirely clear what the authors have in mind here. But two possibilities come to mind. First, by referencing an intermediate category, they may have in mind additional regulatory relief for smaller public issuers. If so, a number of ideas spring to mind:

• Quarterly Reporting Adjustments: Allow small public companies the option to provide biannual or simplified quarterly reports, which reduces reporting frequency and helps alleviate compliance costs without compromising transparency for investors.
• Shortened MD&A Requirements: Limit the Management’s Discussion and Analysis (MD&A) requirements for small companies to emphasize only significant developments and omit extensive discussions of historical financial results and off-balance-sheet arrangements that may be less relevant.
• Broaden Regulation A+ Eligibility: Permit smaller, seasoned public companies to conduct public offerings under Regulation A+, which would allow them to raise capital with less regulatory burden compared to traditional public offerings.
• Increased Offering Caps: Raise the maximum offering limit for Regulation A+ from $75 million to a higher threshold for small public companies, facilitating larger capital raises under more simplified procedures.
• Streamlined Proxy Requirements: Implement reduced requirements for proxy statement disclosures, allowing small public companies to focus on material issues and minimize lengthy governance disclosures.
• Exemptions from Say-on-Pay Rules: Exempt small public companies from say-on-pay and related executive compensation voting requirements, alleviating the burden of preparing detailed compensation reports and disclosures. On say-on-pay, see my article Remarks on Say on Pay: An Unjustified Incursion on Director Authority: https://ssrn.com/abstract=1101688 
• Exempt Small Public Companies from ESG Reporting Mandates: As ESG disclosure requirements continue to evolve, exempt small public companies from detailed ESG and climate-related disclosures, reducing complexity and compliance costs for companies with limited resources to manage these disclosures. For a critique of ESG in general, see my book The Profit Motive.

Second, the authors may be referring current SEC Chairman Gary Gensler's  proposals for expanding the SEC's oversight of private companies. If so, I urge that the line between which companies are subject to the SEC's regulatory jurisdiction and which are not remain as clear as possible. Requiring disclosures from non-reporting (private) corporations because it could impose excessive compliance costs on businesses that are not publicly traded, potentially stifling innovation, growth, and flexibility that these firms rely on. Public disclosure rules are designed to protect public shareholders; however, private companies raise capital primarily from sophisticated investors who typically require and negotiate access to necessary information independently. Imposing public-company-style disclosures on private firms may not provide meaningful investor protection benefits while undermining their ability to operate efficiently and meet capital needs effectively within the private market’s distinct regulatory environment.

Project 2025 argues for the elimination of the Public Company Accounting Oversight Board (PCAOB) and Financial Industry Regulatory Authority (FINRA), recommending instead that their functions be integrated into the SEC to reduce bureaucracy and enhance effectiveness. As for the PCAOB, I agree. The PCAOB adds excessive costs to public companies through its audit standards and inspections, which disproportionately impact smaller firms. In addition, much of what the PCAOB does duplicates existing SEC oversight functions, creating redundancy without clear benefits in fraud prevention or investor protection.

As for FINRA, however, I disagree. FINRA provides valuable industry-specific insights, quicker responses to industry issues, and a structure that allows for the adaptation of regulatory practices. Its ability to oversee a vast network of broker-dealers through industry-led governance can enhance market expertise that may be diluted if its functions were moved entirely under the SEC.

Entrepreneurial growth is another critical area of Project 2025's focus, with proposals to ease the regulations surrounding entrepreneurial capital formation. Suggested reforms include streamlining exemptions for small offerings and crowdfunding under Regulation A and Regulation CF, removing the accredited investor restriction, and allowing more flexible access to private capital markets. These adjustments are intended to foster broader market participation and empower smaller entrepreneurs to compete in capital markets, enhancing economic dynamism. As discussed above, I favor these proposals. I elaborated on the importance of capital market competitiveness and capital formation in my book chapter Corporate Governance and U.S. Capital Market Competitiveness: https://ssrn.com/abstract=1696303

The blueprint envisions significant changes to the oversight of securities markets to strengthen their functionality and accessibility. It proposes preempting state-level securities registration requirements for securities traded on national exchanges and dismantling regulatory barriers that limit market liquidity. Congress should repeal disclosure requirements viewed as tangential to financial returns, such as those in the Dodd-Frank Act related to CEO pay ratios and mine safety. Additionally, the authors argue for terminating programs like the Consolidated Audit Trail (CAT), which they suggest have become financially burdensome without adding equivalent value. I would gladly see most of the corporate governance provisions of Dodd-Frank and Sarbanes-Oxley repealed. See my book Corporate Governance After the Financial Crisis.

Digital asset regulation is an area of particular interest, with a call for coordinated oversight between the SEC and the Commodity Futures Trading Commission (CFTC). Instead of relying on enforcement actions that have sown confusion and hindered innovation, both agencies should establish clear, unified rules to define the regulatory status of digital assets. The proposed framework differentiates securities from commodities, recommending that only digital assets offering revenue shares or liquidation rights be considered securities. In the absence of regulatory coordination, the authors recommend that Congress enact legislation to clarify digital asset classifications, empowering the CFTC to regulate digital assets not meeting the criteria of investment contracts, which sounds reasonable. 

Finally, the blueprint emphasizes a restrained approach to federal influence over business operations, particularly opposing mandates that require businesses to engage in socially-driven disclosures. It criticizes federal initiatives aimed at redefining the purpose of businesses to address societal goals and argues for returning to a model where corporations focus on shareholder value rather than broader social or political objectives. This is accompanied by calls for the elimination of disclosures deemed extraneous to financial performance. All of which is consistent with the arguments made in my book The Profit Motive.

In sum, while I recognize that much of Project 2025 is highly controversial, many of the proposals for SEC reform are good ideas that I and other conservative/libertarian corporate law commentators have long supported.

Delaware Corporate Law is the Foundation of Our Economy: So Elon Musk and Donald Trump Need to Leave Delaware Alone

Ann Lipton spotted an Elon Musk tweet that threatens "to threaten to preempt Delaware law with federal corporate governance standards, if the Delaware Supreme Court does not restore his Tesla pay package":

Delaware corporate law is not perfect. It's not even close to perfect. Nothing created by humans ever is. But the corporation is the foundation of our economy and Delaware corporate law is the engine that makes it run. I firmly believe that federal preemption of corporate law is a terrible idea.

For over 200 years, corporate governance has been a matter for state law. Even the vast expansion of the federal role begun by the New Deal securities regulation laws left the internal affairs and governance of corporations to the states. The state-based system of regulating corporate governance is one of the main strengths of the U.S. capital markets. Indeed, as Professor Roberta Romano famously claimed, state regulation and the resulting regulatory competition between jurisdictions it is the “genius of American corporate law.”

No one seriously doubts that Congress has the power under the Commerce Clause, especially as it is interpreted these days, to create a federal law of corporations if it chooses. The question of who gets to regulate public corporations thus is not one of constitutional law but rather of prudence and federalism.

Until the New Deal, corporate law was exclusively a matter for the states. Around the beginning of the last century, however, economic progressives began arguing for federal preemption—frequently in response to various corporate scandals of the day. After the Great Crash of 1929, serious consideration in fact was given to creating a federal law of corporations. Throughout the 1930s there were repeated proposals to federalize corporate law. All failed.

Legislative inaction is inherently ambiguous. All that can be said with certainty is that Congress chose not to act. Yet, the Supreme Court nevertheless has routinely rejected regulatory efforts to preempt state law and create a de facto federal law of corporations. Because it believes that “state regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law,” CTS Corp. v. Dynamics Corp., 481 U.S. 69, 89 (1987), the court has consistently reaffirmed that: “It ... is an accepted part of the business landscape in this country for states to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.”  Id. at 91. Indeed, the Supreme Court opines that “[n]o principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations.” Id. at 89.

It is state law, for example, that determines the rights of shareholders, “including ... the voting rights of shareholders.” Id. State law thus determines such questions as which matters may be authorized by the board of directors acting alone and which must be authorized by the shareholders. State law typically requires, for example, that certain control transactions, such as mergers or sales of substantially all corporate assets, be approved in advance by the shareholders and establishes the vote required (often a supermajority) for shareholder approval of such matters. State law likewise regulates the conduct of shareholder meetings, specifies who may call such meetings and prescribes whether, and the procedures by which, actions may be taken without a shareholder meeting.

The Supreme Court also has consistently recognized that state law governs the rights and duties of corporate directors: “As we have said in the past, the first place one must look to determine the powers of corporate directors is in the relevant State’s corporation law. ‘Corporations are creatures of state law’ and it is state law which is the font of corporate directors’ powers.” Burks v. Lasker, 441 U.S. 471, 478 (1979) (citations omitted). State law defines the directors’ powers over the corporation, for example. State law establishes the vote required to elect directors. State law determines whether shareholders have the right to cumulative voting in the election of directors, whether the corporation’s directors may have staggered terms of office, and whether shareholders have the right to remove directors prior to the expiration of their term of office.

Does the Supreme Court’s defense of what might be called “corporate federalism” make policy sense?

The basic case for federalizing corporate law rests on the so-called “race to the bottom” hypothesis. States compete in granting corporate charters. After all, the more charters the state grants, the more franchise and other taxes it collects. According to the race to the bottom theory, because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders. As the clear winner in this state competition, Delaware is usually the poster-child for bad corporate governance.

Basic economic common sense tells us that investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not lend to such firms without compensation for the risks posed by management’s lack of accountability. As a result, those firms’ cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from adopting excessively pro management statutes.

Even if that were not the case, one should still be reluctant to embrace federal preemption. Those who favor preemption betray a complete lack of sympathy for—and perhaps even awareness of—the vital relationship between federalism and liberty. In other words, even if one could prove that state competition is a race to the bottom, basic federalism principles would still counsel against federal preemption of corporate law. The corporation is a creature of the state, “whose very existence and attributes are a product of state law.” States have an interest in overseeing the firms they create. States also have an interest in protecting the shareholders of their corporations. Finally, a state has a legitimate “interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” CTS Corp. v. Dynamics Corp., 481 U.S. 69, 91 (1987). In other words, state regulation not only protects shareholders, but also protects investor and entrepreneurial confidence in the fairness and effectiveness of the state corporation law.

According to the Supreme Court’s CTS decision, the country as a whole benefits from state regulation in this area, as well. As Justice Powell explained in that case, the markets that facilitate national and international participation in ownership of corporations are essential for providing capital not only for new enterprises but also for established companies that need to expand their businesses. This beneficial free market system depends at its core upon the fact that corporations generally are organized under, and governed by, the law of the state of their incorporation. This is so in large part because ousting the states from their traditional role as the primary regulators of corporate governance would eliminate a valuable opportunity for experimentation with alternative solutions to the many difficult regulatory problems that arise in corporate law. As Justice Brandeis pointed out many years ago, “It is one of the happy incidents of the federal system that a single courageous State may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of country.” New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting). So long as state legislation is limited to regulation of firms incorporated within the state, as it generally is, there is no risk of conflicting rules applying to the same corporation. Experimentation thus does not result in confusion, but instead may lead to more efficient corporate law rules.

In contrast, the uniformity that would result from federal preemption would preclude experimentation with differing modes of regulation. As such, there will be no opportunity for new and better regulatory ideas to be developed—no “laboratory” of federalism. Instead, we will be stuck with rules that may well be wrong from the outset and, in any case, may quickly become obsolete.

The point is not merely to restate the race to the top argument. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. if one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, such that exit by the regulated is no longer an option, an essential check on excessive regulation is lost.

In other words, by promoting the economic freedom to pursue wealth, competitive federalism does more than just expand the economic pie. A legal system that pursues wealth maximization necessarily must allow individuals freedom to pursue the accumulation of wealth. Economic liberty, in turn, is a necessary concomitant of personal liberty—the two have almost always marched hand in hand. The pursuit of wealth has been a major factor in destroying arbitrary class distinctions, moreover, by enhancing personal and social mobility. At the same time, the manifest failure of socialist systems to deliver reasonable standards of living has undermined their viability as an alternative to democratic capitalist societies in which wealth maximization is a paramount societal goal. Accordingly, it seems fair to argue that the economic liberty to pursue wealth is an effective means for achieving a variety of moral ends.

In turn, the modern public corporation has turned out to be a powerful engine for focusing the efforts of individuals to maintain the requisite sphere of economic liberty. Those whose livelihood depends on corporate enterprise cannot be neutral about political systems. Only democratic capitalist societies permit voluntary formation of private corporations and allot them a sphere of economic liberty within which to function, which gives those who value such enterprises a powerful incentive to resist both statism and socialism. As Michael Novak observes, private property and freedom of contract were “indispensable if private business corporations were to come into existence.” Michael Novak, Toward a Theology of the Corporation 45 (2d ed. 1990). In turn, the corporation gives “liberty economic substance over and against the state.” Id.

In sum, Donald Trump should not start his presidency by blowing up the bedrock of our corporate economy just because Elon Musk is throwing a hissy fit.

VC Laster Responds to My Blog Post on When Controlling Shareholders Owe Fiduciary Duties to the Minority

On LinkedIn, Delaware Vice Chancellor Travis Laster posted an interesting and detailed response to my blog post Delaware Vice Chancellor Travis Laster on When Controlling Shareholders Owe Fiduciary Duties to the Minority. VC Laster's critique offers a descriptive analysis that challenges the assumption that controllers owe no duties when acting as stockholders or contractual parties. His approach rigorously tests the "common-knowledge" premise against actual case law, finding the premise inconsistent with judicial outcomes. The VC's claim is that either the law as applied defies this common belief or critics must reinterpret these cases or assert judicial error—which strikes me as a thoughtful call for legal empiricism.

I thank VC Laster very much for his comments. At the moment, however, my response is mainly tangential. (Having said that, I confess to having ascribed normative intent to what VC Laster describes as a descriptive analysis. My apologies.)

As regular readers know, my article DExit Drivers: Is Delaware's Dominance Threatened? argues that "Delaware courts have decided a series of recent high profile cases that have raised controller’s liability exposure." I also report that "multiple sources have identified controlling shareholder liability exposure as the key DExit driver." At the moment, it is a trickle but I do think those of us interested in Delaware corporate law need to pay attention to this area and its potential impact on Delaware's status as the premier choice for incorporation.

Towards that end, I am about 2 weeks away from posting an article "A Course Correction for Controlling Shareholder Transactions." With great respect, my paper critically examines the evolving legal standards applied by Delaware courts to controlling shareholder transactions, highlighting the increasing constraints faced by controlling shareholders. It argues that Delaware's judicial expansion of who qualifies as a controller has had significant implications, particularly for defining conflicted transactions that demand rigorous cleansing standards. By analyzing case law trends, including the influential MFW framework and the Sinclair Oil standard, the paper suggests that Delaware courts have moved towards an overly restrictive view of controlling shareholder rights, which may inadvertently discourage beneficial transactions and increase litigation costs. This paper proposes a course correction to streamline cleansing processes, redefine controller qualifications, and limit the entire fairness standard to scenarios where minority shareholders directly incur harm. The suggested reforms aim to balance the interests of controllers and minority shareholders while preserving Delaware’s attractiveness as a jurisdiction for incorporation.

Delaware Vice Chancellor Travis Laster on When Controlling Shareholders Owe Fiduciary Duties to the Minority

Delaware Vice Chancellor Travis Laster argues that Delaware law reflects an action versus no action distinction, under which fiduciary duties do not apply when a controller acts to preserve the status quo, such as by voting against a proposed transaction, but do apply when the controller alters the status quo, as by voting to approve a proposed transaction. Travis Laster, Stockholder Votes, Linkedin.com (Feb. 19, 2024), https://www.linkedin.com/pulse/dispatch-from-tampa-sears-mundane-stockholder-votes-travis-laster-0mcle/. Even if we accept that as an accurate statement of Delaware law, however, Laster rightly acknowledges that it is not a tenable distinction.

Laster offers an example in which a controlling shareholder is committing fraud—ala Bernie Madoff—with the assistance of the firm’s current outside auditor. Id. If the controller votes to retain the auditor, thereby preserving the status quo, under Laster’s interpretation of the law, fiduciary duties would not apply. Id. Accordingly, Laster proposes an alternative regime that “would start by applying the business judgment rule, then assess whether the plaintiff had alleged facts sufficient to rebut one of its presumptions, which the auditor vote might well satisfy.” Id.

I disagree with Laster. Neither the action/no action distinction nor Laster’s proposed replacement get to the heart of the matter. What I propose is (1) we narrow the definition of controller; (2) a controller always owes fiduciary duties to the minority; (3) we narrow the class of cases under which entire fairness is the standard of review.

Laster also suggests that there may be cases in which the appropriate standard of review would be enhanced scrutiny, as where “the controller is acting unilaterally to remove an incumbent director and fill the vacancy with someone else.” Laster, supra. In such a case, the controller is “interven[ing] in the domain generally reserved for board action, warranting enhanced scrutiny.” Id. The proposal strikes me as problematic for two reasons. First, hinging the standard of review on whether the shareholder is using the vote strikes at the heart of the controller’s right of selfish ownership. The right to vote in one’s own self-interest is a core element of ownership. See Gilbert v. Perlman, No. CV 2018-0453-SG, 2020 WL 2062285, at *1 (Del. Ch. Apr. 29, 2020) (“Corporate controllers . . . may vote their stock, and take other actions with respect to the entity, in their own self-interest free of fiduciary strictures, so long as they do not employ the corporate machinery itself.”). Second, Laster’s test introduces considerable uncertainty by conditioning the standard of review on the extent to which the controlling shareholder intrudes on the board’s sphere of action. See Laster, supra (“If the intervention seemed more significant and designed to invade the board’s domain, then I would be inclined to apply enhanced scrutiny.”).

SB 219: California Climate Disclosure Law Fraught with Potential Conflicts and Costs

Wachtell Lipton reports:

Last week, California Governor Gavin Newsom signed into law Senate Bill 219, which applies broadly to public and private companies “doing business” in California.  The law will require companies that have total annual revenues of over $1 billion dollars to disclose and independently assure their scopes 1 and 2 emissions (direct and purchased emissions) beginning in 2026 and to disclose scope 3 emissions (value chain emissions) beginning in 2027.  In addition, companies that have annual revenues of over $500 million dollars will be required to prepare a climate-related financial risk report in accordance with the recommendations of the Task Force on Climate-related Financial Disclosures beginning on or before January 1, 2026. 

The problems with SB 219 are numerous and severe. First, as I have observed previously:

It strikes me that there a couple of problems with requiring Scope 3 disclosures.

First, requiring companies to include Scope 3 emissions in their disclosures would be extremely costly. Companies would have to gather data from companies in their supply chain. For companies with complex multi-national supply chains would incur expenses that would dwarf the controversial conflict mineral disclosure regime. The Harvard Business Review reports that "Scope 2 emissions [were carved] out of Scope 3 because they are easily measured and allocated to specific companies." In contrast, "the difficulty of tracking emissions from multiple suppliers and customers across multitier value chains makes it virtually impossible for a company to reliably estimate its Scope 3 numbers." ... 

Second, wouldn't disclosing Scope 3 emissions result in confusing double (or more) disclosure?. Suppose Apple has to include the carbon emissions of Supplier One Inc.--a company in its supply chain--in its carbon disclosures. Suppose Supplier One is publicly held, so that it must disclose its carbon emissions. Those emissions would be double counted. Meanwhile, Supplier Two Inc. is in Supplier One's supply chain. Supplier Two is also publicly held. So it's carbon emissions would be disclosed in its 10-K, but if Scope 3 emissions must be disclosed, those emissions would also be counted in Supplier One's and Apple's disclosures. A portfolio holding all three stocks would appear to be emitting way more carbon than it actually is.

Second, to the extent these disclosures are intended to provide information to investors, there is no evidence that investors really want and are willing to pay for such disclosures.

Third, by extending the disclosure requirement to privately held companies, SB 219 is inconsistent with the general scheme of financial disclosure, which focuses on public corporations. Unlike publicly traded companies, privately held corporations do not have the same need to disclose financial details to the public. Forcing them to reveal sensitive financial data can place them at a competitive disadvantage. Competitors might exploit this information, which can be detrimental to the company’s market position.

In addition, disclosure requirements can be expensive and time-consuming. Privately held corporations, especially smaller ones, may lack the resources to comply with complex regulatory demands, leading to increased operational costs without corresponding benefits. As a result, financial disclosure could discourage private investment and entrepreneurship. Investors and founders often choose the private structure to avoid public scrutiny, and disclosure requirements could drive businesses away from these structures.

Finally, there is great potential for companies being subjected to inconsistent regulations. Back to Wachtell Lipton:

With the SEC’s climate disclosure rules stayed pending litigation, California’s latest law, along with international regulatory obligations, will require many companies to provide climate-related disclosures.  ... Senate Bill 219 is also a reminder that states are willing to unilaterally address climate-related concerns and that companies should be vigilant of climate-related regulatory efforts at the state and local levels, particularly if federal initiatives are stalled.

Despite the bill's instruction that the regulator attempt to minimize duplication, there is still a serious problem. Global regulators, the SEC (if its acts), and other states will all have a say. Differences could readily emerge on issues such as:

• Which companies have to provide what disclosures. One can readily imagine, for example, that SEC regulation will apply only to reporting companies (not private) and provide lessened obligations for small reporting companies.
• Whether Scope 3 emissions must be disclosed and, if so, how they are to be calculated.
• When disclosures are due.
• What assurances by an independent assessor will be required, if any.
• The amount of information required.

In shoirt, SB 219 is yet another example of why California's business climate stinks and keeps getting worse. It's unilateral action on an issue that should be decided at a national or global level, inattentive to costs, and lacks clear benefits. It's showboating.

SEC Conflict Minerals Disclosures Have Done Nothing to Quell Violence in the DRC

The SEC's much ballyhooed conflict minerals disclosure rules reportedly have done nothing to reduce violence in Congo and in some ways has made it worse:

GAO found no empirical evidence that the rule has decreased the occurrence or level of violence in the eastern DRC, where many mines and armed groups are located. GAO also found the rule was associated with a spread of violence, particularly around informal, small-scale gold mining sites. This may be partly because armed groups have increasingly fought for control of gold mines since gold is more portable and less traceable than the other three minerals. Further, GAO found that the number of violent events in the adjoining countries did not change in response to the SEC rule.

Reliable data on costs is hard to come by, but is surely in the hundreds of millions of dollars over the years.

The Case Against Imposing Fiduciary Duties on Controlling Shareholders

I'm working on a law review article on fiduciary duties of controlling shareholders. In it, I take as given the longstanding proposition that controlling shareholders do owe fiduciary duties to the minority shareholders. But I believe there is a case to be made for the proposition that shareholders—majority or minority; controlling or not—should not be treated as fiduciaries at all. Here it is in a nutshell.

There are certain textbook fiduciary relationships, including those between attorney and client, executor and heir, guardian and ward, principal and agent, trustee and trust beneficiary, and senior corporate official and shareholder.[1] As with other examples of fiduciary relationships, all of these examples involve discretionary authority and dependency.[2] It is not merely that the fiduciary exercises discretionary powers that may impact the beneficiary, but that the beneficiary has justifiably reposed trust and confidence in the fiduciary.[3] Put another way, there must be reliance on the beneficiary’s part and de facto control and dominance on the part of the fiduciary.[4] The former is not merely vulnerable to the latter’s actions, but also relies on the latter to serve the beneficiary’s interests. Hence, as Judge Cardozo famously explained, fiduciaries are held to “the punctilio of an honor the most sensitive.”[5] As such, a fiduciary is obliged to put the interests of their beneficiary ahead of their own.[6]

None of this is true of the controlling shareholder—minority shareholder relationship. Granted, the controller wields discretionary voting power that could be used adversely to the interests of the minority, but the minority does not repose trust and confidence in the controller.[7] The minority does not rely on the controller to put the minority’s interests ahead of the controller’s own interests.[8]

Update: My friend and colleague Andrew Verstein sent along this comment:

I completely agree. 

But, I do tend to think that it would be a better world if minority shareholders can begin to repose trust in majority shareholders - which they can do if the law effectively imposes such duties. 

Of course, that still leaves many questions, such as this one: can the law just stipulate fiduciary relationships wherever they would be helpful, without any preexisting social understanding of trust?  If randomized controlled studies proved conclusively that the economy would function better if everyone were a fiduciary to individuals younger than them, could we just decree such a relationship? Probably not. There seem to be practical and theoretic limits to instrumentally imposed fiduciary duties. And that makes your observation truly central to the debate. 

Harvard Law School Business Associations Exams from 1871

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