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Delaware, The Courts, and The Race to the Bottom

We have been writing about the predilection of judges in Delaware to use the speaker circuit to expound upon issues relating to the corporate governance process. As the article by VC Strine illustrates, the judges go beyond narrow legal issues and speak on broad issues that include critiques of the players involved in the movement, creating the appearance of judicial bias. Rather than try to reign in this behavior, the Chief Justice has encouraged it.

We have taken the position that the practice, in the end, damages the credibility of the Delaware courts. Rather than seen as neutral decision makers (albeit with a pro-management bias), they are players in the corporate governance debate, crossing the line from judicial to political. These actions in the end make it easer for other regulators, whether Congress (see Say on Pay) or the SEC (note the recent debate on access) to intrude into areas historically left to the states.

With that in mind, we read with interest the article from Delaware Online about the impact of Delaware were the state to lose the revenue that comes from the ability to attract public companies to the state. (The Delaware Corporate and Commercial Litigation Blog has a short post on this subject).  As the article noted:

  • "It would bankrupt us," he [Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware] said. "Overnight we would go broke."
  • "Delawareans most likely would face higher taxes with the loss of state revenue. Law firms would flee Wilmington. Legal support businesses would be left scrambling. The housing market would suffer, as would hotels, restaurants and caterers."
  • "The bar would disintegrate," said Chief Justice Steele. "You'd have 25 percent of the lawyers unemployed."

In other words, Delaware is not motivated in the formulation of corporate law by efficiency or by the goal of the most appropriate law. It is motivated by policies that maximize tax revenue, the franchise and other taxes paid by public companies having become an addiction. The most significant threat to this line of revenue? According to the article, federal incorporation. And why the threat? Because the standards in Delaware for managerial behavior are so low that they have spurred a shareholder activist movement and growing interests in the halls of Congress, something that might spread to the Whitehouse (both Clinton and Obama favor Say on Pay).

The intrusion won't come from a wholesale preemption of state law (determining the record date will always be left to state law), although federal incorporation as an alternative might occur. The reforms will take the shape of a series of changes that over time leave the law of Delaware mostly irrelevant. But the judges of the Delaware courts have not recognized the threat. The article contained a quote from VC Strine who noted that: "There's a lot of things that keep me up at night related to my work, but the possibility of [a federal corporate law] isn't one of them." Their "extrajudicial activities" will only increase the likelihood of greater federal intrusion.

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