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Doubtful about Delaware? 3 things to know about place of incorporation

If you are setting up a business, and have decided on a corporate form, one thing you’ll have to decide is where to incorporate.

For decades, Delaware has been the state preferred by a majority of U.S. companies in which to incorporate. Though it’s a small state, it has wielded an outsize influence in corporate law, as many companies with headquarters elsewhere have chosen Delaware as their place of incorporation.

Recently, however, Delaware’s longtime status as the preferred state for incorporation has become under scrutiny from multiple sources. In this post, we will summarize three important things to know about this.

There are conflicting theories on why Delaware has established such prominence as a place of incorporation.

A recent research study took note of opposing views on why companies so often have chosen Delaware as the state in which to incorporate. In recent years, somewhere between half and two-thirds of all public companies in the U.S. have made this choice.

One view is that Delaware has carved out a leading niche as an incorporation location because of its efficient legal rules and the expertise of its courts in applying those rules in ways that give wide flexibility to corporate managers.

An opposing view is that Delaware’s laws and courts tend to give precedence to company insiders in ways that can be harmful to shareholders and the interests of the corporation as a whole.

Research has called attention to a so-called “Delaware trap,” by which companies that incorporate in Delaware can find it difficult to reincorporate in another state.

If you incorporate in Delaware, there is no legal reason why you can’t reincorporate in another state if so choose.

Practically, however, it can be difficult to get the stakeholders – shareholders as well as management – to agree to this. Choosing Delaware as the state in which to incorporate can therefore be something of a trap.

You will want to get sound legal counsel before you commit to a decision that may have far-reaching consequences.

A recent ruling by the Delaware courts has raised the issue of how favorable Delaware courts will continue to be to shareholder interests.

The case is Shawe v. Elting, in which shareholders of a privately-held corporation disagreed about the direction of their business. After the dysfunction led to deadlock, minority shareholders filed suit, seeking the appointment by the court of a custodian to sell the business.

The Chancery Court ruled that the minority shareholders could force a sale of the business. The Delaware Supreme Court affirmed this decision.

The case is not over, however, because it is now in federal court. It is possible that the U.S. Supreme Court will get involved before the matter is resolved.

For now, the bottom line is this: If you are facing decisions about where to incorporate, or have become involved in a shareholder dispute, it’s important to get sound legal counsel.

 

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