The HBS Blog

The HBS Blog offers insight on Delaware corporations and LLCs as well as information about entrepreneurship, start-ups and general business topics.

The Delaware Court of Chancery has a long history deciding on equity and fairness between parties.

The tiny coastal state of Delaware is widely recognized as the best state in which to form a company, not only in the United States but throughout the world. One of the key reasons for this is the Delaware Court of Chancery.

More than half of the companies listed on the New York Stock Exchange and NASDAQ call Delaware home, as do 65% of the Fortune 500 companies.

The Delaware Court of Chancery is a major feature of the “Delaware Advantage,” and certainly a significant part of why so many companies choose to incorporate in Delaware. The Delaware Court of Chancery is widely recognized as the preeminent forum in which to settle disputes that involve fairness decisions involving Delaware corporations, LLCs and other business entities.

The Delaware Court of Chancery is a non-jury trial court that serves as Delaware's court of original and exclusive equity jurisdiction, and adjudicates a wide variety of cases involving trusts, real property, guardianships, civil rights and commercial litigation.

The court was first established in 1792 and is based on the English model of a Chancery Court. In old English law the King was the final maker of laws, but the Chancellor would hear and decide cases where there were no laws, or remedy at law.

A noteworthy aspect of a Court of Chancery is the equitable expertise that is implemented by judges rather than a jury. One Chancellor will hear your case and make the rulings, unlike the U.S. Supreme Court where the case is heard by all nine (currently eight) Justices and a decision is voted upon.

This is a significant aspect, because the Chancellors are skilled and experienced in corporate law; thus there is no need to educate an uninformed jury on the intricacies of Delaware corporate law, which saves time and thus legal fees.

Litigants can therefore rely on fair and unbiased decisions based on the law rather than public opinion. Chancellors rely on more than two hundred years of case law (history) in making their rulings. This tends to make the decisions of the Chancellors more predictable than decisions made by juries, and makes businesses more confident of a decision based on law and precedent rather than emotions and prejudices.

Corporations of all sizes are formed in Delaware because business owners understand that the Chancellors on the Court of Chancery are using the business judgement rule.

The Delaware Business judgment rule directs the Court to respect the good-faith decisions of the company’s Directors, even when the outcome of their decision may not have been the best in hindsight. Directors are charged with making informed, independent decisions with care and loyalty and the absence of self-dealing.

Sometimes those decisions are questioned by shareholders. When shareholders sue the Board of Directors the case is called a “derivative suit” which makes up the majority of the high-profile cases brought to the Court of Chancery.

The Delaware Court of Chancery consists of five justices; the head of the Court of Chancery is known as the Chancellor while the other four are called Vice Chancellors. The Chancellors must be extremely learned in the law, although there is no requirement to have practiced as a lawyer. They must be residents of the state of Delaware.

All Chancellors are nominated by the Governor of Delaware and confirmed by the Delaware Senate. They serve 12-year terms. In addition to the Chancellors, there are two Masters in Chancery that are chosen by the Chancellor. All Chancellors and Masters must be members of the Delaware Bar Association in good standing.

The current Delaware Court of Chancery is comprised of:

• Chancellor Andre G Bouchard
• Vice Chancellors J. Travis Laster
• Vice Chancellor Sam Glasscock III
• Vice Chancellor Tamika Montgomery-Reeves
• Vice Chancellor Joseph R. Sights III
• Master in Chancery Kim E. Ayvazian
• Master in Chancery Morgan Zurn

Sources:

https://www.scu.edu/ethics/focus-areas/business-ethics/resources/history-and-role-of-the-delaware-court-of-chancery/

http://www.courts.delaware.gov/chancery/history.aspx

http://www.courts.delaware.gov/chancery/judges.aspx

Entrepreneurs are primarily concerned with running a successful company-- on a daily basis, they make myriad decisions and face constant pressure related to the operation of the company.

Often, particularly early on in a company’s existence, taking formal steps to document and track corporate actions and decisions is an afterthought, given the pace at which decisions are made and actions are taken.

Drafting corporate resolutions, recording meeting minutes and tracking stock available for issuance is sometimes seen as a distraction from the company’s primary focus of pursuing its business plan and achieving its goals.

Such a mindset, however, can ultimately prove damaging to a business’s growth and future.  Mistakes or failures to monitor corporate actions can come back to haunt a company at the most inopportune times, such as when it is looking to bring aboard investors.

Take for example, a company that has issued stock to its founders and employees without documenting these grants through corporate resolutions, only to find that it has issued more shares than permitted under the company’s Certificate of Incorporation.

Such an issue is a red flag for both investors and lenders, both of whom view adherence to formalities as a sign of a company’s overall commitment to detail.

All is not lost, however, because under Section 204 of the Delaware General Corporation Law  a company can retroactively ratify mistakes through action that, prior to the adoption of Section 204 of the Delaware General Corporate Law in 2013, would have been deemed invalid as well as a financial and logistical mess to correct.

Elaborating on our example, assume that a company is authorized to issue 2 million shares of stock under its Certificate of Incorporation but has inadvertently issued 2.1 million shares.

What would Section 204 require as a corrective action for the issuance of these 100,000 shares of unauthorized stock that was issued to the shareholders?

1. Board Resolution:  The Board of Directors must adopt a resolution providing details about the invalid shares, and then ratify and approve the shares.

2. Potential Vote:  If the invalid shares would have required a shareholder vote (which, in our example, would be the case, as a stock amendment of the Certificate of Incorporation would be required), then the company traditionally would submit the ratifying corporate resolution to a vote of the current shareholders as well as the shareholders at the time of the defective action.

3. Potential Notice:  If the invalid shares would not have required a shareholder vote, then notice of the ratifying resolution is typically sent to all current shareholders as well as those persons who were shareholders at the time of the defective action.

4. Corrective Filing:  If the invalid shares would have required a filing to be made (which would be the case in our example (an amended Certificate of Incorporation)), the company would traditionally file a certificate of validation with the state of Delaware describing the defective action and making the required filing after the fact.

If the above actions are done in compliance with Section 204, the defective action is approved by the state of Delaware and, in our example, the 100,000 formerly invalid shares would be deemed valid stock and the amended Certificate of Incorporation would govern.

Section 204 is not the only means by which a Delaware company can give authorization to correct prior mistakes, but it is a formal means with which to deal with serious problems, such as the breach of a company’s Certificate of Incorporation, per our example.  

This is unique to the state of Delaware and yet another example of how Delaware keeps the Delaware corporate law structure on the cutting edge.  

A company reviewing its past or current compliance with corporate formalities should seek the assistance of counsel to ensure that any corporate clean-up is documented appropriately.

How to Close a Delaware Company

When a Delaware company is no longer viable, there are two options available to the company owner in order to complete a business dissolution.

One approach is to file the proper cancellation (for an LLC) or dissolution (for a corporation) documents with the state of Delaware to formally close the company.

Just as formation documents are filed with the Secretary of State’s office to create a Delaware company, official documents must also be filed to legally close the company.

An alternative route is to have the acting Registered Agent resign upon the entity. While this course of action is not the same as filing a formal certificate, it will put the company into a forfeit status. An entity in a forfeit status is considered an inactive company by the state of Delaware.

However, the resignation process actually takes a couple of months to complete; it does not occur right away like a cancellation/dissolution.  These steps must be taken before the Registered Agent is formally resigned from the company:

• First, the current Registered Agent must provide the entity with a notice of its intent to resign. This notification informs the entity the Registered Agent is pursuing the resignation, which will put the company into a forfeit status.

• The Registered Agent must wait 30 days after this notice has been sent to the company before taking any action. This time period basically gives the company the option to request that the Registered Agent not proceed with the resignation filing. 

• If there is no action from the entity, the Registered Agent can then submit the resignation filing to the state of Delaware.

At this point, the state of Delaware gives the entity another 30 days to rename the former Registered Agent as its current Registered Agent for the entity or to find a new Registered Agent to act on its behalf. 

Again, if no action is taken, then the entity will become officially forfeit and will lose its good standing status.

During the approximate 60-day waiting period, the entity can potentially still receive notices for payments due, such as the annual Franchise Tax Fee. Until the entity is actually resigned upon and in a forfeit status, the Franchise Tax notices will continue to be generated by the state of Delaware.

People often assume—incorrectly—that if their company is in the resignation phase they will not have to pay that company’s Franchise Tax Fee. The Franchise Tax Fee is automatically imposed on the entity by the state of Delaware at the beginning of each new year. 

Regardless of whether the entity has conducted any business, it will generate a Franchise Tax Fee. If the entity is resigned upon and the Franchise Tax Fees are not paid, the assessment stays with the entity.

Therefore, if the entity is restored at a later date, the outstanding Franchise Tax Fees must be paid at the time of a renewal filing. However, no new Franchise Tax fees are imposed on an entity that is in a forfeit status.

All possible options and subsequent consequences should be reviewed by the company’s responsible parties to determine the best course of action for the entity.

Most people that form a Delaware LLC do not actually operate their company in Delaware. They simply form the business in Delaware in order to take advantage of the state's strong corporate law structure.

There are many advantages to forming a company in Delaware, even if you operate it in another state, such as Maryland. 

Maryland, like many other states, has an application process and a state fee for Delaware companies that operate there. The process in which a Delaware LLC registers in Maryland is called Foreign Qualification.

If you want to your Delaware LLC to do business in Maryland, your LLC will be domestic to Delaware and foreign to Maryland, so Foreign Qualification is the process by which Maryland grants your company permission to operate in that state with a Delaware LLC.

In addition to the Maryland Foreign Limited Liability Company Registration form, Maryland also requires you to provide it with a Certificate of Good Standing from Delaware. The agency that accepts this registration is the Maryland State Department of Assessments and Taxation.

A Registered Agent is required to be listed on the registration form. Maryland will send all legal documents and correspondence to your Registered Agent. If you have a physical address in Maryland, you are welcome to act as your own Registered Agent, though you can also retain one in Maryland.

The state of Maryland does not have a requirement to publish your application unless it is specifically required by the county in which your Registered Agent resides.

Normal processing for a Maryland Foreign Qualification application can take eight weeks, plus time for mailing; many people choose to expedite the processing time for an additional fee so they have all the paperwork in hand as soon as possible.

Once your LLC is registered as a foreign entity in Maryland, the state of Maryland will require an annual report. This report is due April 15 of each year, along with a $300 fee, and it must be mailed to the state--it cannot be emailed. The annual report is similar to a tax return and many clients seek the help of a tax professional for assistance.

At your request, we can prepare the registration form for you, obtain the Certificate of Good Standing from Delaware, file everything with Maryland in a timely fashion and pay the state fee for you.

If you take advantage of our service, you will likely receive your approved documents in about 10 business days.

For more information or to get started, please visit our Foreign Qualification page. We're also available to help with the Maryland Foreign Qualification process over the phone at 800-345-2677.

We offer the least expensive Delaware Registered Agent service AND we are the only company to guarantee your annual Registered Agent Fee will never increase.

Other companies tempt you with a low Registered Agent Fee and then increase it year after year.

The infographic below illustrates why our Delaware Registered Agent service is the best, and shows how much money you can save with Harvard.

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<p><strong>Please include attribution to delawareinc.com with this graphic.</strong><br /><br /><a data-cke-saved-href='https://www.delawareinc.com/blog/comparing-delaware-registered-agent-fees' href='https://www.delawareinc.com/blog/comparing-delaware-registered-agent-fees'><img data-cke-saved-src='https://www.delawareinc.com/blog/images/img/RA_Infographic_1.2.png' src='https://www.delawareinc.com/blog/images/img/RA_Infographic_1.2.png' alt='Comparing Delaware Registered Agents Infographic' width='625' border='0' /></a></p>

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