Over 65% of Fortune 500 companies are incorporated in Delaware. The often-repeated mythology related to the question of “Why?” is two-fold: to pay less in taxes and to file companies without listing an owner’s name.
Both are incorrect. The real reason is the Delaware Court of Chancery, which hears all corporate litigation cases for companies incorporated in the state.
The Court of Chancery possesses, and relies on, many years of judicial precedents; it is these judicial precedents that the founders and CEO’s of some of the world’s biggest and most successful companies are seeking when they incorporate in Delaware.
The Delaware Court of Chancery was borne from the English common law system, which is law that is developed by judges, courts and tribunals which not only decide individual cases but also create law precedents (as opposed to statutes, which are created via legislation).
In the English common law system, separate courts heard law and equity matters. England’s highest court of equity was called the High Court of Chancery.
In 1792, the state of Delaware revised its Constitution and added a special provision for a court of equity, i.e., the Delaware Court of Chancery. Delaware’s Constitution states it “shall have all the jurisdiction and powers vested by the laws in this state in the Court of Chancery.”
The Delaware Court of Chancery’s jurisdiction is meant to be the same as the English High Court of Chancery’s jurisdiction in 1776, and so it hears and determines all equity-related matters.
In this modern era, the Court of Chancery mostly hears corporate litigation cases as well as litigation related to trusts, estates, wills and land purchases. It also hears cases based on real estate title ownership and general contractual issues.
The most noteworthy type of case handled by the Delaware Court of Chancery is called a “Derivative Suit.” This is where the stockholders of a company are suing the Board of Directors of the company over financial matters or control issues.
The interest of the stockholder is the money the company makes. They want it to be distributed to the shareholders as dividends. The Directors, however, hold the power to dictate how the money will be spent, and they will often opt for buying out competitors, creating an expansion program or initiating huge salaries for company officers.
When the two groups clash, the case goes to the Delaware Court of Chancery where one Chancellor (not a jury or a group of judges) decides the case as a matter of fairness.
Over the 200 year history of the Court of Chancery, these cases are usually decided in favor of a Board of Directors, as long as the Directors have acted in good faith in their decision making. The proper way to say this is, “The Delaware Court of Chancery usually respects the good-faith decisions of the Board of Directors above the selfish interests of the shareholders.”
However, when the Directors shirk their duty to be loyal to the best interests of the company, or to take due care in making their decisions, or when they engage in self-dealing and fraudulent actions, the Court of Chancery has the power to punish them by levying personal fines and removing them from office.
The Court also has jurisdiction over several other matters; it has the sole power to appoint guardians of the property and person for mentally and/or physically disabled Delaware residents and can also assign guardians for minors.
The Court of Chancery has earned the respect of both the domestic and international business world, and it is the wisdom and consistency of the Chancellor and Vice Chancellors that continues to motivate new entrepreneurs to incorporate their startup companies in Delaware.
THE AUTHOR OF THIS BLOG ARTICLE IS NOT A LAWYER AND HARVARD BUSINESS SERVICES, INC. IS NOT A LAW FIRM. THE ARTICLE ABOVE IS NOT INTENDED AS LEGAL ADVICE AND SHOULD NOT BE TAKEN AS LEGAL ADVICE. THIS SHORT ARTICLE IS STRICTLY TO MENTION SOME ASPECTS OF DELAWARE’S CORPORATION LAWS AND/OR LAWS RELATING TO OTHER FORMS OF ENTITIES WHICH YOU MAY NOT BE FAMILIAR WITH. WE RECOMMEND THAT YOU CONSULT WITH A LAWYER BEFORE FORMULATING A STRATEGY WHICH WILL BE SUITABLE FOR YOUR SPECIFIC CASE.