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As business entity formation experts, we are often asked to explain the advantages of incorporating a start-up in Delaware.
Our answer typically entails the fact that Delaware's corporate law structure and legal environment are advantageous to corporations and LLCs.
In fact, the tiny state of Delaware is famous as the home of more than 65 percent of Fortune 500 companies.
A significant reason for this fact is the phenomenon known as the corporate veil.
The corporate veil is not unique to Delaware. The corporate veil is a legal concept “that separates the personality of a corporation from the personalities of its shareholders, and protects them from being held personally liable for the company's debts and other obligations.”
The corporate veil is essentially the concept that maintains corporate law throughout the world. Without the ability to act as its own entity, how else could companies transact business? The idea of a corporation or LLC acting as a separate entity and limiting the liability of the shareholders is what allows the business world to function.
The importance of the corporate veil in Delaware cannot be understated. Delaware possesses stacks of legal doctrine stipulating the separation of a corporation from its shareholders. This distance between investors and the corporations in which they have invested is what permits investors—aka shareholders—to feel comfortable in investing.
Delaware courts have been very reluctant to allow the piercing of the corporate veil. If a corporation is sued, its shareholders typically will not be held liable.
Piercing the corporate veil is defined as a situation in which a court decision puts aside limited liability and hold a corporation's shareholders or Board of Directors personally liable for the corporation's actions or debts.
Any Delaware corporation that is qualified to do business in another jurisdiction (through Foreign Qualification) can fall back on Delaware law structure; that is, a Delaware company can rely on the world-famous case law of the Delaware Court of Chancery in the case of any litigation.
Foreign qualification can play an important role in piercing the corporate veil, as a court in a state with less stringent corporate case law may rule differently when it comes to piercing the corporate veil.
In 2014, Cornell Glasgow, LLC vs Nichols demonstrated the Delaware Court of Chancery’s position where the Court recognized that closely held entities, such as the defendant's Delaware LLC, are under the complete control of their owners, and emphasized "that's why people form closely held entities, to cabin their exposure under contracts."
If contracting parties do not avail themselves of the frequently-used contractual protections — personal guarantees, security agreements and the escrowing of assets — then they cannot expect the Court of Chancery to hold owners personally liable by seeking to pierce the corporate veil.
The concept of the corporate veil is quite significant in any jurisdiction, but Delaware remains the destination for start-up corporations and LLCs in the United States due to the Court of Chancery’s extensive case law on the subject.
*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.