Why Delaware Corporate Law Matters So Much

How has Delaware corporate law changed the business world?

The reasons to incorporate in Delaware are numerous and oft-repeated. To review:

• 65% of Fortune 500 companies and over half of all U.S. publicly traded companies are incorporated in Delaware.

• Delaware has been ranked the most corporate-friendly state in America many times.

• Venture capitalists and angel investors typically prefer investing in Delaware companies than companies incorporated in other states.

• Startup costs for Delaware corporations and LLCs are among the lowest in the world.

• Delaware’s Court of Chancery possesses the most current corporate case law in the country.

• Owners of Delaware LLCs and corporations retain tremendous flexibility when it comes to structuring and running their companies.

These are irrefutable facts, but how and why did these facts come to be? In other words, if Delaware corporate law is so great, has it changed the business world? The answer is yes, and if you keep reading, we’ll explain how the tiny First State has brought about tremendous changes to the business world.

One of the most significant decisions of the Delaware Court of Chancery was handed down in 1986 in a case called Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc. Every CEO of a corporation should be familiar with this landmark case, which involved a hostile takeover.

In short, Ronald Perelman, CEO of Pantry Pride, was attempting to buy the Revlon corporation (with junk bonds, but that’s a whole different story), whose Board of Directors did not want Perelman as their new owner. The board rejected Perelman’s initial fair offer of $42 to $45 per share. Perelman and Pantry Pride then put forth a hostile cash offer for any or all of Revlon’s shares at $47.50.

The Board of Directors of Revlon advised its shareholders not to take Pantry Pride’s offer, nor to take any of its subsequent offers over the next few weeks, the last of which increased the offer price to $53 per share. In fact, the Revlon board looked elsewhere to sell, and began discussing a leveraged buyout with a private equity firm for $56 per share. 

Pantry Pride immediately raised its offer price to $56.25 per share; in addition, it publicly announced its intention to beat any further bids by the equity firm. Within days, Revlon agreed to a deal in which the equity firm would pay $57.25 per share (and receive some options, provisions and waivers).

In response, Pantry Pride not only increased its offer to $58 per share but it also filed a claim in the Court of Chancery, arguing that Revlon’s Board of Directors had breached its fiduciary duty by pushing its stockholders away from the Pantry Pride sale and toward the less financially-rewarding sale to the equity firm.

The Court of Chancery's decision was that in particular circumstances, i.e. if the sale or dissolution of a company is all but inevitable, the Board of Directors must have one specific fiduciary obligation, and that is to sell the company stock at as high a price as possible so the stockholders may receive as much money as possible for their stock.

Although this is a simplified summary of Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc., the results of this case answer our initial question as to how Delaware corporate law has changed the business world. After this landmark case, the term “in Revlon mode” became widely known within the corporate world as a company for sale that will be auctioning or selling its stock to the highest bidder.

Furthermore, the major results of this case are:

• There are three levels of judicial review amid an allegation of breach of fiduciary duties—the business judgment rule, the scrutiny standard and the standard of fairness. The business judgment rule has defined Delaware corporate law since the Revlon case, in that it demands that every Board of Directors acts on an informed basis—they must proceed in good faith and with the genuine belief that all actions that have been taken have been in the best interest of the corporation. This business judgment rule also allows boards to manage their companies with a solid amount of leeway and flexibility, as long as the board consistently acts in the best interests of the corporation’s shareholders.

• When a change in control is pending, an overall reasonableness standard must be adhered to by the Board of Directors. This means that the board must be completely independent and pay careful attention to the array of information it must integrate; the board must also commit to good faith negotiations as well as a concentration on the results that will yield the biggest value for the board’s shareholders.

It is important to remember that Revlon, Inc. v. MacAndrews and Forbes Holdings, Inc. was decided by the Delaware Court of Chancery, a court in which rulings are decided by judges rather than juries. Many people wrongly assume that so many companies from around the world incorporate in Delaware in order to avoid taxes or hide their owners behind the corporate veil.

In fact, the five judges and lack of juries in the Court of Chancery are the more reasonable and compelling reasons. These five judges are experienced, professional judges who hear primarily only corporate cases and base their rational decisions on decades of legal precedents in Delaware.

Thus corporate lawyers and CEOs prefer to have their corporate disputes and lawsuits heard in Delaware’s Court of Chancery, because they are confident the 200-plus years of case law and subsequent legal precedents to their cases are fair decisions made by a capable Court of Chancery judge who respects the good faith decisions of a Board of Directors.

Furthermore, the Court of Chancery acts and resolves cases quickly; even appeals to the Delaware Supreme Court can be expedited, thus saving everyone involved both time and money.

Delaware’s corporate law is so strong that many other states have begun copying it and becoming low on regulations and high on flexibility, thereby appealing to corporations in their home states.

In 2009, concerned about the increasing corporate litigation competition, Delaware passed a law which allows those litigants with more than four million dollars at stake——to try their cases in closed arbitration meetings with the Court of Chancery rather than public courtrooms. This way the cases—and the results—would remain private and never appear on the public record.

However, the Delaware Coalition for Open Government sued the judges of the Chancery Court, saying these private meetings were unconstitutional. The district court agreed—it found the closed door meetings violated the public’s First Amendment right of access to judicial proceedings. The Court of Chancery judges appealed, arguing there was no reason the public should have access to all hearings.

In 2013, the Third Circuit court affirmed the district court’s decision. Since the Supreme Court of Delaware declined to hear the case, the lower courts’ rulings remain in place, thus creating yet another legal precedent for lawyers to reference, if they wish to do so.

Most lawyers—once they have passed their state bar exam—are familiar with Delaware corporate law because it has become the standard in American law schools. That is, law school professors teach Delaware corporate law, whether they are citing one case to make a point or teaching an entire semester of corporate law.

Delaware’s corporate law structure—a derivative of its corporate law—allows entrepreneurs to form different types of business entities. Therefore a Delaware startup can decide to form an LLC, a Limited Partnership, a Limited Liability Partnership, a series LLC, a benefit corporation or a non-profit corporation.  These alternate entities offer business owners a level of flexibility typically not found in other states.

The tractability of Delaware corporate law statutes also offers founders, CEOs, managers and Boards of Directors flexibility in how they organize their Delaware business entities, especially corporations and LLCs.

Delaware corporate law has had and will continue to have a significant impact on the business world due to the fact that over 65% of Fortune 500 companies are incorporated in Delaware and are thus affected by the decisions of the Delaware Court of Chancery.

The Court of Chancery utilizes the most groundbreaking, established and current case law to determine the outcome of the cases it hears, and both the case law and the decisions in turn affect both domestic and global businesses.