Courts Out of Money & Delaware Law Challenged

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2:20Eric Talley:Delaware's Supreme Court is going to address the fallout from a trial judge's rejection of Elon Musk's blockbuster pay package, a corporate law overhaul in the state that took effect in March that narrowed the definition of controlling stockholder, making it easier to avoid scrutiny of potentially conflicted transactions. The high court will decide the constitutionality of that law as Musk, Meta CEO Mark Zuckerberg, and other corporate leaders publicly discussed moving their companies from Delaware to Texas and Nevada. My guest is business law professor Eric Talley of Columbia Law School. So Eric, Delaware Supreme Court is going to decide the constitutionality of SB 21.

3:08Eric Talley:What is SB 21? So SB 21 was a legislative reform that by historical standards rocketed through the Delaware General Assembly back in February and March of this year. And substantively, what it did was it basically intervened to push back and on some level to overturn some of the decisions that had been made by Delaware's Chancery Court, its much vaunted corporate law court, that deal with how do you sort of judge actions that are taken by someone who is a controller of a company and might be actions that are kind of self-serving or have a conflict of interest. So probably the most famous of these was Elon Musk's first compensation package, which was famously overturned by Delaware Chancery Court Judge Kathleen McCormick in early of 2024.

4:05There were some other cases that also involved controllers that were basically litigating a transaction that had a conflict of interest that lost. And that's what this set of reforms did. And it did it in two ways. The first is it basically said it's much harder for stockholders to challenge various types of conflicts involving that controller and the traditional protections that had been put up that would allow stockholders an easier route into court. Those were going to get sort of heightened a little bit and the wall was going to be higher to surmount to get into court. And another related reform was that the typical way that some of these stockholders would bring a case against any corporate fiduciary is to use historical rights that they have to get the books and records of the corporation.

4:54And that's kind of how they figure out what's going to go into their complaint. And this is a longstanding stockholder right. There was a statute that allowed pretty easy access to those things. And that statute itself got amped up to make it harder to get access. So both of these big reforms were large reforms that were pretty much in a pro-controller, pro-defendant direction. And probably as controversially, they not only were so-called prospective in nature, but they also applied to any historical cases that involved some conflict of interest a year ago, for example, in which the case hadn't been brought in court yet.

5:36So it had this retroactive application as well.

5:40Eric Talley:Plaintiffs are challenging the law on two constitutional grounds. Explain those challenges. The first is that it was an overreach by the Delaware General Assembly to have a retroactive application of law. The idea is, hey, listen, everyone knew what the rules of the road were when they were acting back in, you know, the pre SB 21 days. And they either complied or they didn't. But to suddenly say the rules of the road have now changed and we're going to use the new rules to assess prior conduct seemed a little bit off the rails, at least according to the plaintiffs that are challenging this case.

6:20And then the second, which in some ways is much more historical, has to do with the fact that what the Delaware Assembly basically did in overturning these chancery court opinions, if you read the text of the statute, it basically says that under certain circumstances, we're not even going to allow the Delaware Court of Chancery to exercise its legal or equitable powers over certain of these cases. And that is an interesting wording because there's some old cases in Delaware that says if the Delaware General Assembly tries to limit the equitable jurisdiction of the Court of Chancery. It is a court of equity, after all.

7:01That's unconstitutional under the Delaware Constitution, at least if it's trying to do things that caused the Court of Chancery to have fewer powers than it had in, and get this June, back in 1792, back when the original Constitution was drafted. So those are effectively the two constitutional challenges, that the retroactive effect was unconstitutional and that the handcuffing of the Delaware Chancery Court and the walling off of its ability to exercise equitable powers was also unconstitutional under the Delaware Constitution.

7:35Eric Talley:Did the Delaware Supreme Court fast track this case? Well, everything about SB 21 has been fast tracked. So one of the things that's interesting about the legislation itself is that, you know, corporate law is a pretty technocratic enterprise. And a lot of times, in fact, during the last quarter century, every time that the law has been amended, it's gone through this, what's known as the Delaware Council. And it's part of the State Bar Association. And it's got a bunch of defendant side attorneys and plaintiff side attorneys and transactional attorneys and former judges. And they debate these things.

8:12This particular set of provisions bypassed that counsel went straight into the assembly and within a month pretty much had been passed by both houses of the assembly and signed in to law by the governor. So it was already being fast-tracked on the legislative basis. The plaintiff in this case, a company called Clearway, well, the shareholders of that company, filed suit shortly thereafter complaining of conduct that predated all these statutes. And so the plaintiff attorney said, hey, these things are unconstitutional. shouldn't apply to us, and we want to challenge the constitutionality of the amendments.

8:49That is above the pay grade of any of the judges in the Delaware Chancery Court. And the chancellor basically said, I'm going to just certify this question to the Delaware Supreme Court. It had made so much news, it really would have been shocking to me, June, had the Delaware Supreme Court decided they were going to sit on it for, you know, 10 months or a year. They pretty much had to say, okay, we're going to take briefing on this reform, and we're going to hear argument before years end so that we can add some clarity to exactly what is Delaware law going forward.

9:19Eric Talley:So was this rush to pass the law and then, you know, to litigate it, is it because Delaware fears losing corporations to Texas or Nevada? It certainly had an anxiety vibe. So after, you know, right after the original opinion on Elon Musk's compensation package came out, he took to Twitter, which, of course, is his right since he owns the company, and said, never incorporate your company in the state of Delaware. And he followed up with several other, you know, sort of Delaware-hating, Delaware-rage type of tweets. And, you know, Mr. Musk is a pretty influential person, knows a lot of people. And so all of his friends and associates and prospective associates started saying, wow, I wonder whether he's on to something, started asking their own corporate counsel, should we reincorporate outside of Delaware?

10:13And my sense is that those questions, at least, started to really pick up velocity after he started to tweet rage a little bit against the state of Delaware. It never really picked up a huge sense of momentum in terms of actual reincorporations. It was more like a handful of companies decided to reincorporate, and some transactional lawyers reported, I would assume truthfully, that, oh, they were being inundated with questions about it. But when the rubber hit the road, there wasn't an awful lot of empirical support for a rush out of Delaware, though that clearly was the vibe that was animating both the governor and the General Assembly.

10:56And in their view, they just needed to do something and something quickly to preempt what they had at least become convinced was going to be a mass exodus out of Delaware. Since the statute was passed, you know, it's been constitutionally challenged. So its official status, I guess, is still being kicked around a little bit. There really hasn't been that big of an upswelling of companies that have left Delaware to incorporate in Nevada or Texas, which are the two biggest states. You can definitely see a handful of companies that have done so, but it's not been like a gigantic rush. It may actually have picked up even a little bit compared to where it was before the reform.

11:38Interestingly enough, a couple of the companies that have reincorporated out of Delaware since the reform said that they were doing so because these new reforms had so many words in them and they were so complicated. They just wanted to sit that dance out. They didn't want to have to bear the risk of figuring out how this new statute was going to get interpreted over the years. So it's been a really interesting debate amongst people who are corporate law nerds, and I unfortunately include myself in that club, June, and maybe you as well. But it really has been kind of an interesting thing to see how this plays out.

12:11I think a lot of people, you know, if you asked them two years ago, would have told you, oh, you know, this race, this dance-off between different states to attracting corporations, it's not a real thing. Delaware won it 75 years ago, and it's not going to let go of its winning margins. I think that a lot of people, including myself, think, well, you know what? At least the discussion about, you know, effective competition amongst other types of states or other jurisdictions has now become a real thing. You hear it on a regular basis. So it probably is the case that Delaware is more vulnerable than it was two years ago.

12:49Where people might differ is whether the vulnerability is due to the cases like the Musk compensation case, or is it due to the fact that the Assembly was putting together a slapdash set of statutes that no one knows exactly they're going to work, right? And it might be a combination of both things.

13:06Eric Talley:Was there another law that had an overhaul because of an unpopular Chancery Court ruling? There is. Interestingly enough, about six months before this SB 21 reform, there was another reform in around August of 2024. Now, that was a case that itself was responding to a different case, a case involving the Mollis Corporation, and some side contracts that its founder, Ken Mollis, had reached with the company that protected him against a whole bunch of different fiduciary duty allegations. The judge in that case basically said, you know, you might be able to do these things, but you can't do it in a side contract.

13:48You got to do it in the corporate charter or the bylaws and basically invalidated those side contracts. And so the 2024 reforms were another, you know, essentially a legislative overturning of a different case. This Mollis case came about around the same time as the Musk case came out. And, you know, at the time it was quite controversial, but it did go through the council and it had the sort of the ordinary schedule in being passed. It didn't sort of have this kind of fire alarm exit rush that SB 21 had. And while people were, you know, I guess busy clutching their pearls over this 2024 reform, which is called SB 313, if you're interested in the alphabet soup, suddenly this SB 21 thing comes along and steals everyone's attention from it.

14:37But you are correct that that 2024 reform is still in the mix, and it has some interesting interaction effects with SB 21 because it basically says, look, regardless of what Delaware is doing in its corporate code, it is now possible to enter into a side contract that might allow you to get around most of the Delaware corporate code. In fact, I've just written an academic paper with my colleague Dorothy Lund that based You know what? Delaware may actually prevail in its first place position in this race because it is basically empowered a bunch of corporations, if they don't like what was happening to Delaware, just to go private and just privatize their entire governance structure.

15:24Eric Talley:Coming up next. But is it a bad look for Delaware? You're listening to Bloomberg. The thing about AI for business, it may not automatically fit the way your business works. At IBM, we've seen this firsthand. But by embedding AI across HR, IT, and procurement processes, we've reduced costs by millions, slash repetitive tasks, and freed thousands of hours for strategic work. Now we're helping companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business, IBM. Support for this show comes from public.com. If you're actively involved in your portfolio, you probably catch yourself repeating the same actions.

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18:16Eric Talley:In response to a trial judge's rejection of Elon Musk's blockbuster pay package, Delaware's legislature passed a corporate law overhaul. SB 21 narrowed the definition of controlling stockholder, making it easier to avoid scrutiny of potentially conflicted transactions. Now Delaware's highest court will decide the constitutionality of that law. I've been talking to Eric Talley, an expert in business law and a professor at Columbia Law School. Eric, is it a bad look that the legislature changes the law to make it friendlier to corporations so those corporations don't leave the state? It seems like a bad look to me.

19:02Well, there are aspects of it that are a bad look. I do want to defend the enterprise of Delaware in trying to keep the franchise alive, right? The secret sauce of Delaware for a long time was, hey, look, we're a small state. We don't have a lot of like operating industries in our state that are going to capture our general assembly. So we can basically focus on, you know, trying to formulate the best possible operating, you know, corporate law that is possible. And in fact, Delaware benefits quite a bit from that because it's a small state. Incorporation fees alone, you know, probably pave half the roads in Delaware.

19:36So they really do benefit from the revenues that are raised. On the other hand, in this particular instance, the fact that it was so procedurally irregular, the fact that it really seemed, even though the governor and the state legislators deny this, it seems pretty obvious that the pressure initially was coming from Elon Musk himself and attempting to change law by himself. And the fact that it It rocketed through the Delaware legislature incredibly fast with very few opportunities for critics to raise their concerns or to voice their concerns. One of my colleagues testified in front of the General Assembly and was literally shouted down and was told to leave the lectern.

20:19So it really is kind of an interesting moment for Delaware. I don't think the look has been particularly good with Delaware. And that's in some ways one of the dangers is that you can fail to compensate for things that may be emerging problems in the state, but you can also overcompensate. And, you know, to add even another complicating factor, the two big cases that were being, you know, sort of responded to with these reforms, the Mollis case and the Elon Musk case, they still had not at that point gotten to even an appeal before the Delaware Supreme Court. they were still active live cases, and the Delaware Assembly was effectively responding to a trial court opinion.

21:00If there's a chance a trial court opinion makes a mistake, and sometimes they do, the usual route is, okay, appeal it and see what the Delaware Supreme Court does with it, and only then would you want to step in and say, okay, we still don't like what the Delaware Supreme Court's going to do, and so we're going to change the law. And so there really was a bit of a rushed kind of atmosphere to this entire ordeal. And I think on some level, that probably caused the urgency to escalate as opposed to the signal that I suspect the governor was trying to send, which is, no, we're going to move really, really quickly to, you know, to put this fire out.

21:34And putting the fire out, they may have like started inadvertently three or four other fires.

21:39Eric Talley:I mean, it's expensive to incorporate in a different state, isn't it, to move states? It can be. In a lot of these states, in Nevada and Texas, the expense is actually lower than in Delaware. And Delaware doesn't charge a ton. The most that you're going to pay in an annual franchise tax is like$250 ,000, which is peanuts. And it's smaller if you're not a big company. So it really is a scale business. It's not a, you know, Delaware does not make all its money from three or four companies. It makes it from the millions of companies that are incorporated there and pay annual franchise taxes. And that's been their entire design.

22:22One thing that's kind of interesting about this new competition from Texas and kind of a pre-existing but newly invigorated competition from Nevada is that it's not really clear that they are in this game to make money. It seems like they're more in this game almost to rejoin where are you incorporated and where are you doing business. The folks at Texas say, oh, yeah, we want people to incorporate in Texas because we want their factories to be in Texas. And that's kind of a quaint approach, at least by historical standards, because the big innovation that Delaware introduced to the world is you don't have to do any business in Delaware to be incorporated there.

23:01And what they specialize in is in corporate law. So some of the most recent competition, I think, has been hard for Delaware to match up to because it seems to be not about making money. And a lot of these states seem to be interested in kind of keeping the cost down of incorporating. Now, if you're going to reincorporate and you're a public company, that's a very costly process. You've got to put it out in front of the stockholders. You've got to solicit their votes. You have to have long disclosures. And there's a fair amount of rigmarole that goes into trying to figure out how am I going to reincorporate in a different state.

23:36Eric Talley:So now, as far as SB 21, do you think it's unlikely that the Delaware court will find it unconstitutional? This is a really interesting issue. So the case from which a lot of this comes is a case from the 1950s, actually. And that case itself was a controversial case when it first came down. It hasn't really been tested very much. And so I think probably, you know, if I were placing odds, I'd say the chances are probably that the Delaware Supreme Court is going to find a way to either uphold the statute or say, OK, look, technically the statute is not constitutional. But if you put in a small fix to it, like make it an opt in statute or something like that, it would be constitutional.

24:24We'll see what happens. But it's interesting that it's had the kind of legs that it has. And in some ways, not surprising because really the whole sort of last seven or eight months in corporate law has kind of forced us back into this kind of existential moment of trying to figure out, you know, what is valuable in corporate law and what is it?