Introduction to the Delaware Corporations Law

Although every state has its own corporate law, we will focus on the Delaware General Corporation Law. We do this for one very important reason: two-thirds of all publicly-traded U.S. companies, including more than 60% of the Fortune 500, and a significant number of private corporations are incorporated in Delaware. A study by by Robert Daines found that when private companies are incorporated that there are only two incorporation choices. First, they tend to incorporate in the state in which they are headquartered and in which they do their business. Second, they incorporate in Delaware.

You might well ask how is it possible that a corporation that is headquartered in Massachusetts and does business in Massachusetts should be governed by Delaware law? This seemingly odd result is a function of a variety of factors, including historical developments as well as our federal system.

In the earliest days of our Republic, the power to incorporate corporations was reserved to the states. Prior to the adoption of general incorporation statutes, the incorporation of a corporation required state legislatures to adopt a law incorporating the entity. These incorporation statutes laid out the powers and responsibilities of the corporation, including the rights of corporate stockholdhers with respect to the entity formed by the state legislature. It was not uncommon at the time for the state grants of corporate charters to reserve some monopoly power within the state to the corporation - typically to facilitate the development of some critical infrastructure like a canal, roadway, or railroad. Over time, the process of incorporation was simplified as states adopted general incorporation statutes, which took legislatures out of the business of incorporating individual businesses. General incorporation statutes laid out default powers and responsibilties of the corporation as well as describing the default powers and rights of the corporation's stockholders vis a vis the corporation. 

When one combines the power of states to incorporate busineses with constitutional prohibitions against states impeding interstate commerce and Article IV's full faith and credit clause (requiring each state to provide full faith and credit to public acts of every other state) with a state's power to incorporate, then one makes it possible for a corporation to be incorporated in one state and then do business in another. 

Of course, a corporation's outward acts - acts other than those related to their relationships with their stockholders, for example with respect to employment law or the environment - are subject to the jurisdiction of the law in which the acts occur. However, the internal affairs of the corporation (relations among the stockholders, and managers with the corporation itself) are the stuff of the law of the state of incorporation. In a 1982 case, Edgar v Mite Corp. (457 US 624 (1982)) the US Supreme Court recognized the "internal affairs doctrine" as well settled law in the US: 

The internal affairs doctrine is a conflict of laws principle which recognizes that only one State should have the authority to regulate a corporation's internal affairs — matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders — because otherwise a corporation could be faced with conflicting demands. See Restatement (Second) of Conflict of Laws § 302, Comment b, pp. 307-308 (1971). 

But Edgar is not a unique application of the internal affairs doctrine by the US Supreme Court. In an earlier case, Cort v. Ash (422 US 66, 1975), the court described the doctrine and the primacy of state law in the following way:

Corporations are creatures of state law, and investors commit their funds to corporate directors on the understanding that, except where federal law expressly requires certain responsibilities of directors with respect to stockholders, state law will govern the internal affairs of the corporation. If, for example, state law permits corporations to use corporate funds as contributions in state elections, see Miller, supra, at 763 n. 4, shareholders are on notice that their funds may be so used and have no recourse under any federal statute. 

The ability of entrepreneurs to elect to incorporate their businesses in one of any number of states gave way to something of a competition among states in the early 20th century for the revenue associated with incorporation of businesses. In corporate governance circles, this competitive environment was criticized as a "race to the bottom" with states competing with each other to reduce management accountability to its lowest possible level in order to attract incorporations. While this race to the bottom logic is by now slightly overblown, at one point in the past states aggressively competed for incorporations.  Although some states occassionally attempt to revive their incorporation business, the age of active competition for incorporations is long since over with Delaware decisively winning. As Daines noted, the incorporation decision these days is more likely to be binary - incorporate where you do business or in Delaware.

Rather than see itself in competition against other state jurisdictions, Delaware sees itself in tension with the SEC and federal regulators for dominance in corporate governance. Delaware is protective of its position as a leader in the law of corporations. To the extent the SEC and federal regulators adopt, or threaten to adopt, rules that affect corporate governance, Delaware reacts.  Over the course of this semester we will see various examples of federal movement in the corporate governance area along with reactions by the state of Delaware as it reacts to protect its position. 

For now, though, we will focus on the basics of the Delaware corporate law, starting with formation.