Delaware Aptly Balances Certainty and Scrutiny in Corporate Law

Delaware’s leadership in corporate chartering has been headline news lately, amplified by criticisms from Elon Musk after he suffered court losses in the state. Those and other court rulings have made it harder for companies to defend certain transactions, especially those involving controlling stockholders such as Musk, unless they are approved by both disinterested directors and minority stockholders. Other rulings have made it easier for plaintiffs to get information about potential claims from defendants, including email and text messages.

Critics said the rulings unduly favored the plaintiffs’ side. Some companies and their advisers began to reconsider whether Delaware remains the best place to incorporate a business, with many preparing to act on this question during the upcoming annual meeting season. Musk has already exited from Delaware.

The state’s leadership is responding with a sense of urgency. Earlier this month, Gov. Matt Meyer (D) appeared on national television to acknowledge the criticism and promise a prompt resolution. Within two weeks of the governor’s appearance, a bipartisan group of Delaware’s legislative leaders introduced a bill, almost certain to pass in some form, that would overrule some of the cases. In doing so, the state follows a long tradition of balancing its rich reservoir of judicial opinions with legislative intervention—a process that’s simultaneously productive and fractious.

After all, legislative line-drawing in corporate law is always contested. Critics debate who should set the rules—a famous tension between bench and bar—and how to balance legitimate stockholder concerns over managerial misconduct with managerial concerns about judicial second guessing of business decisions.

The bill raises many issues illustrating the difficulty of striking a balance, including the scope of information plaintiffs can seek before stating a claim, how to determine a “controlling” stockholder, and how to define a “disinterested” director.

First, the Delaware statute has long authorized stockholders to inspect a corporation’s books and records, such as its stockholder list or minutes of board meetings. Plaintiffs have been successful in expanding the ease of access, which they say is essential to root out wrongdoing, while defendants counter that many are fishing expeditions that can be expensive to resolve.

The bill proposes a specific statement of what books and records stockholders can demand for inspection, excluding emails and text messages. Reasonable people can disagree about how to draw that line, although most will agree a line must be drawn.

Second, the proposed amendments aim at case law that has indicated an expansive conception of what counts as a controlling stockholder, subjecting related decisions to court scrutiny. The proposal would define a “controlling stockholder” using two prongs: someone with power “functionally equivalent” to a majority stockholder and holding at least one-third of the voting power.

While the latter simplifies analysis, it risks being too rigid. Delaware law typically resists bright-line tests in favor of contextual analysis, so this definition could exclude de facto controllers who fall below the threshold. The “functional equivalent” language is intended to maintain flexibility, though it may leave some uncertainty.

Third, the courts in recent years have been strict in what is necessary to show that a director is “disinterested.” The amendments introduce a presumption that stock exchange-defined independent directors are “disinterested,” unless that is overcome with “substantial and particularized” evidence. Some adjustments in this area may be warranted, but the stock exchange standards focus on independence from management, not from controlling stockholders.

Another concern about relying on stock exchange standards is that a board’s independence determinations are based on director questionnaires. While generally reliable, these can fail to account for undisclosed conflicts.

Challenging issues such as these are important considerations in evaluating the bill, but they are not fatal flaws. The drafters’ work is a heavy lift, and as with any legislative effort, debates about precision, scope, and speed are inevitable. While these proposals spark disagreement, the interplay between judicial doctrine and legislative action isn’t new. In 1967, law professor Ernest Folk drafted a landmark revision of Delaware’s corporate statute, notably including a provision allowing interested directors to insulate transactions from judicial review by using procedural safeguards.

Likewise, in 1985, following a Delaware Supreme Court ruling that directors could be personally liable for failing to become fully informed, the legislature changed the law to permit corporate charters to exculpate such violations, although not more serious transgressions. This change was very controversial at the time, with vocal opposition from prominent law firm partners.

Just last year, after court rulings found certain market practices unauthorized under Delaware law, the bar and legislature swiftly amended the corporate code to accommodate them. One such practice effectively allowed boards to grant contractual rights over key governance functions to founding stockholders, strengthening their control. This was also controversial, entailing a balance between two contending values—stockholder protection versus freedom of contract.

Perspectives on the current bill vary as well. Some see it as a tailored statutory amendment to judicial doctrine, while others view it as a sweeping overhaul of decades of careful judicial thought. All should be able to agree on a fundamental point, however: Delaware has long channeled business decisions into boardrooms and stockholder meetings rather than courtrooms.

The business judgment rule expresses strong judicial deference to directors’ decisions while statutes and case law map out how approval by disinterested, fully informed directors or stockholders can insulate transactions involving interested parties from judicial second guessing. The proposed amendments follow that tradition, even as intense disagreement boils over.

Yet others criticize the process being followed to produce the bill. In Delaware, amendments to the corporate statute usually originate in a council of Delaware corporate lawyers representing diverse interests, including those who routinely bring lawsuits on behalf of stockholders and those who defend them. After often-lengthy deliberations, an agreed bill is presented to the General Assembly, which takes it through regular legislative processes, such as hearings and ultimately the governor’s signature.

In this case, the process was almost the reverse. Gov. Meyer played a leading role, giving interviews in print and broadcast media acknowledging the challenge and promising that reforms would be forthcoming. Within two weeks of that, the General Assembly released its bill, which had been drafted by a small team of Delaware law luminaries outside of the council. The bill also requests that the council conduct a separate study on a different but related topic: whether the state should enact caps on lawyers’ fees in these cases.

There’s no blueprint for law production in Delaware and no branch or group holds a monopoly on requisite wisdom—Delaware’s leadership in corporate law is due not to one branch or body but to all three branches plus the bar, the corporations services sector, and voters.

Delaware has long been the state of choice to incorporate a business thanks to the contributions of all three branches of government—it offers a flexible corporate statute, it has a specialized business court comprising sophisticated corporate judges who have produced a vast body of precedents, and its executive branch provides efficient administration to make its corporate citizens’ lives easier. Like it or not, so long as that combination stays in place, Delaware will remain the leading place to incorporate a business.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Lawrence A. Cunningham is director of the John L. Weinberg Center for Corporate Governance at the University of Delaware.

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