What do Walmart, Amazon, CVS health, Berkshire Hathaway, Coca Cola, and Ford Motors, and the other 60 % Fortune 500 companies have in common? State of Incorporation – Delaware, United States of America (“Delaware or the “State”). Half of the publicly traded companies listed on the United States of America (“USA”) stock exchanges are incorporated in Delaware. Delaware is also a leading jurisdiction for out-of-state corporations (where a company is incorporated in one state and headquartered in another state). The reasons for such attraction of incorporators towards Delaware are multifarious – such as the governing Statute, Courts of Delaware, and taxation laws. This article discusses why companies prefer Delaware as their home for incorporation.
The law governing corporations in Delaware is contained in Title 8, Chapter 1, General Corporation Law – Delaware Code (“DGCL or the “Statute”). DGCL is considered one of the most advanced, flexible, and business-friendly laws in the USA.
The Statute is widely accepted and appreciated in the entire country and is a common language to law practitioners in the USA. Most of the law colleges include DGCL in the curriculum and many states have referred to the provisions of the DGCL in drafting corporation law. The Statute deals with some important practical problems. DGCL provides that directors’ liability can be limited by adding a provision in the certificate of incorporation[i] with some exceptions. This was a direct response to the high cost of liability insurance. In the same vein, the Statute also provides provisions for authorizing corporations to indemnify directors, officers, and employees[ii] of the corporation which has been widely copied by other company laws. DGCL is also very relaxing in regulating companies’ day to day affairs, whereas other corporation laws try to regulate nearly every nuance thereof.
Some corporate laws try to regulate too much of the company affairs. In contrast, DGCL only regulates relationships and activities amongst shareholders, directors, and officers and other vital issues. Separate laws are drafted to deal with specific issues. Such laws apply to corporations within the physical borders of the State whereas DGCL applies to corporations incorporated in the State irrespective of the principal place of business. Needless to say, exceptions are there and territorial jurisdiction may be questioned in a court of law and in some cases, even cause of action can be questioned. It is one of the prime reasons why lawyers advise corporations to be incorporated in Delaware.
The people of Delaware also understand that one of the major sources of revenue for Delaware is taxes paid by corporations. Hence, the awareness they possess to make the law by electing representatives whose priority is in the right direction is exceptional. Legislature and Corporation Law Section of the Delaware Bar Association have an unwritten compact. Legislature calls upon the Delaware Bar Association for reviewing, drafting, and recommend almost all amendments to the Statute. The association consists of a wide variety of practitioners such as transactional attorneys, and corporate litigators. Delaware Bar Association takes it as a pride to recommend an amendment in the DGCL. They also understand that all the suggestions should be made keeping their clients’ interest out of the way.
With a long history of company law matters, the Delaware legislature has also developed, over time, an acumen suiting for business laws, resulting in a philosophy which emphasizes on the stability of the Statute. Hosting so many companies also means that no single big player can mould the law in his favor with the use of undue influence over the legislature. This is another point that inflates DGCL’s stability. The Division of Corporations of the Delaware Secretary of State’s Office is also a very active department helping corporations in filing and other compliance-related affairs. The department is open for 15 hours a day, serving businesses with speedy responses.
Judiciary in Delaware
Delaware has a special court which only tries cases related to company law affairs called the “Court of Chancery”. Court of Chancery in Delaware was formed back in 1792 and since then hearing and trying cases related to company affairs. Although the Court of Chancery dates back to the 14th-15th century, it was established in Delaware in 1792. Another prominent feature of the court is that, it has judges and not juries. When the court was established, judges were called upon to try the cases instead of a jury. Judges then used to pronounce the judgment along with the reasoning attached thereto, this impressed and created a positive and just reputation in the eyes of people. Lawyers were impressed with the knowledge these judges possessed and their ability to handle complex matters. Over the years, this has amplified, and today Delaware has a trusted, just and precedent loaded court, specialized in company law matters. Many other states even refer to precedents set by the Delaware court of chancery. Former Chief Justice William Rehnquist of the United States Supreme Court said
“Corporate lawyers across the United States have praised the expertise of the Court of Chancery, noting that since the turn of the century, it has handed down thousands of opinions interpreting virtually every provision of Delaware’s corporate law statute. No other state court can make such a claim. As one scholar has observed, “[t]he economies of scale, created by the high volume of corporate litigation in Delaware, contribute to an efficient and expert court system and bar.”
The ruling of the court of chancery may be directly appealed to the Supreme Court of Delaware. Supreme Court of Delaware judges also hold expertise in business laws. In most of the cases, a 5 judge bench tries the case and in the rest of the cases, a bench of 3 tries a case, which results in considered and well opined judgement. Supreme Court tries to give a written reasoned judgment within 180 days of the appeal. The Delaware judiciary system was also one of the earliest adopters of the e-filing system.
Tax is one of the greatest benefits a corporation gets incorporating in Delaware. Delaware has a unique exemption for corporations that have offices in Delaware but not operating businesses in Delaware. These kinds of corporations are exempted to pay income tax in Delaware[iii]. This gives the flexibility to corporations to incorporate in Delaware but to establish the business in other bigger states as Delaware is a small state with limited resources.
States having registered office in Delaware but conducting business out of the State are only required to pay franchise tax, such tax is imposed on net worth or capital held by the company. Title 8, Chapter 5 gives two options to calculate the franchise tax. First, the authorized share method and second assumed no par value capital method[iv]. The law provides whichever amount is lesser, shall be paid to the secretary of state. Delaware also exempts income from intangible investment,[v] which allegedly corporations in higher tax jurisdictions use to evade by creating a subsidiary for this purpose in Delaware. Like the infamous Toy “R” Us case[vi].
So, why do corporations prefer to be incorporated in Delaware? As discussed above, no single reason constitutes a major benefit to set up your business in a particular state. Yes, good taxation policies and the well-drafted statute is something which a businesses would relish. Some may argue that other states have the same or similar advantages in the USA. However, these points, individually, are not very strong to support the argument to incorporate the corporation in a particular state. The combination of the excellent, efficient, and effective judiciary, tax policies and the well-drafted statute is the reason why one should and why most of the incorporators and lawyers prefer Delaware. These features cannot be replicated. These are the reasons why one of the smallest states of the USA hosts a maximum number of corporations.
[i] § 102 (b), DGCL
[ii] § 145, DGCL
[iii] § 1902 (b) 6, title 30, chapter 19
[iv] § 503, title 8, chapter 5
[v] § 1902 (b) 8, title 30, chapter 19
[vi] 437 s.e.2d 13 (1993)