Landmark Delaware corporate law changes aim to stem exits

Two weeks ago, Gov. Matt Meyer told the business world that Delaware’s substantial corporate law needed some changes to allow the state to remain the pre-eminent legal domicile for millions of U.S. companies.

On Monday, he and lawmakers jointly introduced those changes in Senate Bill 21, a surprise piece of legislation that may shift the balance of power between big stockholders within companies and mom-and-pop investors.  

On Tuesday, CNBC published a bombshell report claiming that attorneys for the world’s richest man, Elon Musk, helped to draft the bill. 

The story also stated that a key provision within the bill – which would restructure how powerful individuals can make deals within their own companies – could “pave the way” for Musk to regain a massive $55.8 billion pay package from his company, Tesla.

Last year, a Delaware judge struck down that pay package for a second time on the grounds that it was unfair to the company and its shareholders.

Musk serves as Tesla’s CEO and is the company’s largest shareholder. 

In the wake of the report, the sponsor of SB 21, Senate Majority Leader Bryan Townsend, said his legislation had nothing to do with Musk, and that he has “no reason to believe it has any impact” on his billion-dollar pay package dispute.

“This legislation applies equally to every Delaware corporation, and it’s not retroactive, so it’s not about affecting any kind of pending litigation,” Townsend said in a reference to Musk’s pay dispute, which is currently pending before the Delaware Supreme Court.  

What’s in the bill?

SB 21 includes several significant changes, but it particularly defines “controlling shareholders” as individuals who own at least half of a company’s shares or a third of shares plus a managerial role.

That would have excluded Musk in his watershed compensation case, as he only owns 21% of Tesla stock.

The amendments also lower the threshold for corporate action by controlling shareholders, requiring them to receive approval from shareholders or independent board members – but not both in most cases. That had been the current procedure, and was again applicable to Musk’s case.

Also restricted by SB 21 are “books and records” requests, which pertain to how plaintiffs suing companies for unscrupulous actions can obtain documents, files, meeting minutes and communications to help build their case. Delaware’s Court of Chancery has long been deferential to minority shareholders and has increasingly allowed deeper requests for records, including emails and text messages.

The proposed changes would strip the ability for plaintiff lawyers to obtain those communications in most cases, and also limit record requests to a three-year window while increasing the procedural hurdles to gain access to documents.

Meanwhile, legislative leaders have also filed Senate Concurrent Resolution 17, which asks the  influential Corporate Law Council of the Delaware State Bar Association to review and make recommendations for legal fee caps by March 31. Any prospective change may be amended into SB 21 or introduced as its own bill.

Notably, Musk’s compensation case saw the awarding of $345 million in legal fees, which was one of the largest judgments ever awarded in a securities case. Lawyers in that case had sought shares of Tesla stock that would have been worth $7.7 billion.

Who drafted the bill?

After several companies, including DropBox and Meta, announced Jan. 31 that they were considering moving their incorporation out of Delaware, Meyer and legislative leaders began meetings with corporate leaders, lawyers and law professors.

Present at some of the earliest conversations were Srinivas Raju and James Honaker, the chair and vice chair of the Corporate Law Council, according to Townsend.

The Law Council typically authors highly technical changes to the state’s corporate law, but for Towsend’s bill, that wasn’t the case. 

Instead, Delaware leaders turned toward a scholarly paper written by former Chancellor Leo Strine Jr., Vice Chancellor Jack Jacobs and Delaware Law School professor Lawrence Hamermesh that largely laid out many of the proposed changes that ultimately ended up in Townsend’s bill. Strine, Hamermesh and former Chancellor William Chandler III also took part in discussions about the bill earlier this month, according to Townsend.

“This is not meant as an end run around the Council. We’re very much looking for Council’s feedback, but in terms of how to try to meet the moment, the idea was that drafting this very quickly was important,” Townsend said.

Strine and Chandler emailed Spotlight Delaware a joint statement in which they said the bill “reflects long-standing principles of Delaware corporate law that provide high levels of protection to stockholders, but in a balanced way that provides corporations with a reliable road map to efficiently conducting business.”

They also acknowledged in their statement that they had provided input in the crafting of the bill, after their guidance had been sought by Meyer and lawmakers.

“Companies in many industries and many regions are considering relocation, and the elected leaders asked for help in assuring Delaware companies and their stockholders that our state remains the national leader,” the judges stated.

Townsend said that the final draft of the bill was written by John Mark Zeberkiewicz, a corporate lawyer at Wilmington’s largest law firm Richards, Layton & Finger, which has represented Tesla in Delaware lawsuits. Zeberkiewicz is a member of the Council who has previously drafted changes to the state corporate law.

Richards, Layton & Finger confirmed their involvement in the drafting of SB 21 on Tuesday, but spokeswoman Laura Rossi said “the process was not on behalf of or otherwise influenced by any firm client.”

Townsend also said that none of Delaware’s legislative leaders have been in contact with Chancellor Kathaleen McCormick or the Court of Chancery regarding the proposed changes.

On Tuesday, a spokesman for the court said the judges declined to comment on the proposal.

Law professors weigh impact

The Monday announcement set off a flurry of academic analysis around the country, with many indicating that the amendments are a once-in-a-generation shift in Delaware corporate law.

Ann Lipton, a Tulane University law professor who has long studied the Chancery Court, wrote that the changes effectively eliminate the potential for shareholder litigation and “represent a wholesale repudiation of Delaware’s common law approach to lawmaking.”

“The changes, if adopted, mean it will be laughably easy, with a few incantations of magic words, to create the appearance of procedural regularity, while shareholder plaintiffs will be denied access to the information necessary to establish any procedural irregularity,” she said, adding that the “law itself isn’t doing any work except to launder managerial power.”

Adding to the criticisms were law professors Eric Talley, Sarath Sanga and Gabriel Rauterberg who wrote that the “amendments are poised to reshape the very equilibrium that has made Delaware the unrivaled home for U.S. incorporations.”

“Let’s be clear: These amendments amount to a direct rebuke of the Delaware judiciary. They impose a legislative clampdown on the very judicial discretion that, for decades, has defined Delaware’s distinctive brand of corporate governance,” they said.

However, UCLA Law School Professor Stephen Bainbridge, whose writings also played a part in the drafting of SB 21, said he supported the proposal, arguing that “Delaware courts need a course correction.”

“They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas,” he wrote.

Plaintiff work could be hurt

It’s no secret how important the legal incorporation business is to Delaware, with taxes and fees related to the industry bringing in more than $2.2 billion last fiscal year, or about a third of the state’s budget.

Leaders have long argued that revenue allows Delaware to continue avoiding a statewide sales tax and helps to subsidize state services while allowing a favorable tax climate for residents. And as Meyer eyes significant new investments into public education, health care and more over his four-year term that began last month, he can ill afford to lose a key revenue driver.

But the decision to reset the state’s legal balance away from small shareholders could also impact the number of plaintiff lawsuits filed in the state. Many company leaders would welcome that result, but it could also impact the amount of lawyers who work in Delaware. .

Wilmington’s largest law firms, such as Richards, Layton & Finger; Morris James, Young Conaway, Potter Anderson specialize in defending corporate boards. Meanwhile, several of the largest plaintiff-focused firms – which file more than 1,000 cases in Chancery Court annually – are largely based out of state.

A tenured plaintiff attorney who frequently files cases in Chancery Court — he asked for anonymity considering the fraught nature of the debate — told Spotlight Delaware that passage of SB 21 would effectively end his desire to bring cases to the First State. He particularly pointed to the provision limiting shareholders’ ability to gain access to companies’ records as the reason, and said he would likely look to file cases in other states like California or New York.

A reduction in such case filings and preliminary hearings could be a welcome change of pace for Chancery Court, which shoulders an enormous burden of hundreds of cases per each judge each year, but could also have a trickle-down impact on the city’s legal scene.

Will opposition materialize again?

Townsend said that he expects a robust debate to ensue when SB 21 is first heard at a Senate Judiciary Committee hearing on March 12.

If that hearing is anything like the debates over comparatively more modest changes to corporate law from last year, then lawyers, law professors and retired judges may be headed back to Dover to testify.

Among the critics last year was retired Delaware corporate law professor Charles Elson, who said Tuesday that Townsend’s latest bill was “much worse than last year,” because it did not originate with the Corporate Law Council.

“You just end-run that process, and what resulted is a very one-sided approach that, frankly, I think, destroys our brand of neutrality,” said Elson, who is the founding director emeritus of the Weinberg Center on Corporate Governance at the University of Delaware.

Elson said he will testify against the bill in front of lawmakers if he is asked.

Because SB 21 would change the Delaware General Corporate Law, it requires two-thirds of both legislative chambers to approve it – or 28 in the House and 14 in the Senate. Townsend’s bill was co-sponsored by both the Democratic and Republican leaders in the House and Senate in a rare showing of bipartisan support, putting its chances of approval very high.