Delaware is the second smallest state in the U.S. and has the sixth smallest population. Accordingly, it does not have a strong presence in TV or movies, nor does it cross the minds of many ordinary non-Delaware residing Americans in their day-to-day life, provided that those Americans are not corporate lawyers or commercial litigators. In spite of its size, Delaware has wielded an outsized influence in the country’s business community. In 2022, 68.2% of Fortune 500 companies were incorporated in Delaware and almost 2 million entities were in existence under its laws, including Amazon, Google, American Express, Walmart, and Disney. Approximately 79% of the U.S.-based initial public offerings in 2022 were from Delaware corporations registered in Delaware.
What Is a Delaware corporation?
Unlike many other countries, corporate entities in the U.S. are not formed under the laws of the federal or centralized government; rather, they are formed under the auspices of the individual states and territories. This means that a corporation formed in California is subject to different rules and regulations than a Delaware corporation. Since the American legal system is originally an offshoot of English common law that carried over from the colonial era, there are common threads that run through each state’s corporate statute.
Why do companies incorporate in Delaware?
So why does such a small state attract so many businesses? One huge draw to the state is its lax approach to corporate taxes. If a corporation does not operate in Delaware, it does not owe Delaware income taxes, unlike the case in many other states. Further, Delaware law provides greater flexibility to corporate governance and efficiency for business filings. The Delaware Secretary of State allows corporations to expedite their filing turnaround time to just 1-2 hours for an additional fee. In major corporate transactions, such as mergers and acquisitions, having a certificate filing held up by the state can cost millions of dollars.
Delaware also has a unique legal system, which includes the Court of Chancery, made up of one Chancellor and six Vice-Chancellors. The Delaware Court of Chancery is a court in equity and does not use juries. Each case is decided by one Chancellor who has deep knowledge and experience in business disputes; therefore, suits are handled expediently in the court with greater predictability of the outcome.
Finally, another major benefit of Delaware corporate law is its limited disclosure thresholds. The names and contact information for a Delaware corporation’s directors or officers are not public knowledge. In contrast, California requires corporations to file a statement of information that lists the officers and directors of the company. This can be accessed by anyone at any time from the secretary of state’s website for no fee.
Delaware corporate law provides greater anonymity for the principals of a corporation. It is worth noting that as of January 1, 2024, the US government has enacted the Corporate Transparency Act (“CTA”), which applies to all U.S. companies, regardless of the state in which they were formed. Under the CTA, companies are required to disclose the information of its beneficial owners and those who exert substantial control over the company. This information is not available to the public, but Delaware corporations will still need to report this information. If you have any questions regarding your company’s CTA compliance, contact us here).
Since corporations are formed under the authority of a particular state, the question naturally arises regarding which body of law governs the actions of a corporation which is present in one state but is incorporated in another. Under the Internal Affairs Doctrine, only the state in which a company is formed has the authority to govern such company’s internal affairs. Internal affairs encompass matters that relate to the relationship among a corporation’s stockholders, directors and officers.
For example, if a technology start-up based in California is incorporated in Delaware, then it will need to abide by Delaware law regarding its internal corporate governance. Recently, the Delaware Court of Chancery held in JUUL Labs, Inc. v. Grove, that a stockholder could not demand the right to inspect the books and records of the Delaware corporation under the inspection rights given to stockholders pursuant to Section 1601 of the California Corporations Code.
The internal affairs doctrine is critical for corporate governance, and, without it, a corporation’s compliance regime would be a nightmare of competing and contradictory regulations from different states. In the JUUL Labs case, if the company needed to abide by both California and Delaware law, then its compliance costs would increase. It would need to engage more lawyers to ascertain what it needed to do to avoid violating two, possibly conflicting, bodies of corporate law. Further, as the company grew and created satellite presences in other states, it would add to the number of jurisdictions it needed to comply with for its own internal affairs. This would stymie competition and dissuade corporations from expanding.
It is important to emphasize that the Internal Affairs Doctrine only applies to internal corporate governance matters. Google still needs to abide by California employment law regarding its employees located in California and Amazon must do the same in Washington for its employees located in Seattle. An incorporating company has the power to choose which state’s law it wants to follow to manage itself, but not what employment law it wants to comply with.
Corporate Purpose and History
Delaware corporate law has come to dominate the legal landscape, but it was a winding road to get there. At its core, the purpose of a corporation is to pool the resources of individuals in pursuit of a commercial objective to produce profits for those individuals. Further, these individuals are able to undertake a greater business endeavor than they could manage on their own and their risk is limited to the amount of money and resources they have invested into the venture. This is the origin of limited liability. An individual investor or stockholder is not on the hook for the entity’s losses overall, which could be ruinous for all but the wealthiest individuals.
While corporations as we know them today are a relatively modern development, associations of individuals working toward a common purpose trace their origins to antiquity. Ancient Rome had its collegia, which were formed under the authority of the Roman senate or the emperor. A collegium was formed for a civil or religious purpose and had its own distinct legal identity. A collegium generally could enter into contracts, own property, sue, and be sued. Whereas a citizen’s ability to contract, take legal action, or do a number of other acts exists from such person’s natural existence, collegia and, their successors, corporations, existed solely by the authority of the government.
Jumping forward a millennium, we can find more familiar predecessors to Apple and Amazon. The East India Trading Company was a joint-stock company that existed by virtue of the British Crown. The Company was granted a monopoly over the trade in India and the Indian ocean and grew so powerful that it became a quasi-government over portions of the Indian subcontinent with its own standing army. Most joint-stock companies under monarchies at this time were granted monopolies over the trade of the territories of the world, antithetical to modern focuses on competition and robust antitrust legislation.
The Virginia Company was another monopolistic company established by the British Crown, which was established to colonize the Eastern coast of North America. After the American Revolutionary War, the American legal system was still nascent and relied heavily on British common law. The Delaware Constitution of 1776 made no references to corporations but did state that the common and statutory law of England was widely adopted and remained in force. In fact, one relevant aspect of British law was the Bubble Act of 1720 (foreshadowing the Securities Act of 1933 and the Securities Exchange Act of 1934) which made illegal “presuming to act as a corporate body” and the issuance of transferable shares except by authority of an Act of Parliament or royal charter. Therefore, in order to establish an early Delaware corporation, an individual would need to seek a special charter to do so from the Delaware legislature.
The first special charter was granted to the Colonial Bank of America in 1786. In the following century only a handful of special incorporations were submitted each year. The process was expensive, cumbersome, and time consuming. Enterprising agents set themselves up as lobbyists for their clients to lobby the Delaware legislature and secure the votes to establish a special charter for them.
Charters were reserved for large-scale enterprises that would affect the state as a whole, such as banks. Businesses existed in every town but were what we now call sole proprietorships. There was no limited liability and there was no Walmart selling goods to the town. It was just Joe, the blacksmith who set up shop next to Bill, the baker.
In 1875, the constitution of Delaware was amended to grant the legislature the power to “enact a general incorporation act” which it did and then repealed and replaced it in 1883. In 1899, to attract more business to the state, the act was once again rewritten and modeled largely after New Jersey’s general corporate law, which was considered one of the most popular and business-friendly at the time. The 1899 act removed the concept of incorporation by special act, ending the cumbersome, political process to form a corporation and allowing everyday businesspeople to apply for a certificate of incorporation along with the payment of a fee.
Over the next half century, the general corporate law of Delaware was subject to many amendments and adjustments as the legal landscape changed for business. The Progressive Era brought in many regulations on workplace safety and anti-trust regulation. The so-called “Switch in Time that Saved the Nine,” overthrew the former Lochner era, where the Supreme Court would generally strike down any regulations that encumbered businesses allowing FDR’s New Deal legislation to prevail.
The Securities Act of 1933 and the subsequent Securities Exchange Act of 1934 became the law of the land to reign in wild speculation in stock markets that brought about the crash of 1929 and heralded the Great Depression. Business communities and state legislatures were constantly making adjustments to the ever-shifting legal landscape. In 1963, after the federal legal landscape had stabilized and the effects of the New Deal were fully realized, the Delaware legislature commissioned a review of its general corporation law and passed a revised General Corporation Law on July 3, 1967, which is largely still in effect today.
The Delaware General Corporation Law
Delaware’s general corporate law is contained in Title 8 of the Delaware Code and is known as the Delaware General Corporation Law, often referred to as the “DGCL.” The DGCL can be found online here. The DGCL governs all aspects of a company’s corporate existence, from formation; to the duties of directors and officers; to the rights of stockholders; to winding up and dissolving the company. Some of the most commonly cited provisions of the DGCL are as follows:
Section 141 of the Delaware general corporation law sets forth the rules related to the board of directors such as how many directors a corporation is required to have, what their powers are, how the board can take corporate action, and how directors can be removed. DGCL section 141(f) is frequently cited in corporate records since it authorizes the board to take action via unanimous written consent instead of needing a formal meeting.
One notable difference between Delaware corporate law and California’s is its flexible board structure. A Delaware corporation can have a single director regardless of how many stockholders it has. A California corporation on the other hand, can only have one director if it only has one stockholder. Further it must have two or more directors if the corporation has two stockholders and it must have at least three directors if it has three or more stockholders.
Section 144 of Delaware general corporate law allows a board to approve a corporate transaction that one or more directors/officers may have an interest in. A contract or transaction isn’t void or voidable solely because a director or officer has an interest in it, provided that (i) the material facts of the interest are known or disclosed to the other directors and its approved by a majority of the disinterested directors in good faith, (ii) the material facts of the interest are known or disclosed to the stockholders and its approved by the stockholders in good faith, and (iii) the contract or transaction is fair to the corporation at the time it is approved by the board.
The Delaware General Corporation Law also sets out the rights of stockholders. For example, DGCL Section 222 lays out how much notice a stockholder is entitled to for a validly called stockholder meeting. By default, a stockholder must be provided no less than ten and no more than sixty days’ notice of a meeting. DGCL Section 228 allows the stockholders to take action by written consent in lieu of a meeting. DGCL Section 231 provides the voting procedures for electing directors and requires inspectors of the election. Delaware does not require cumulative voting to elect directors whereas other jurisdiction, such as California, do require cumulative voting.
Other Types of Incorporated Entities
The most recognizable and universal corporate entity is the corporation itself. Echoing the structures of the British East India Trading Company and the Virigina Company, corporations with their boards of directors and stockholders are well known. Delaware, along with the other states also allow for other types of incorporated entities under the DGCL. The most popular alternative to a corporation is a limited liability company. In fact, in 2022, three LLCs were formed for each Delaware corporation. An LLC provides much of the same limited liability protection as a corporation but allows for the owners to take corporate action in a simpler matter. Further, Delaware LLCs are often taxed as a partnership or a disregarded entity (for single-member LLC). This avoids the double taxation that corporations are subject to at the federal level. A corporation is first taxed on its income at the entity level, then the stockholders are taxed on the proceeds they receive from the corporation as dividends or from selling their stock. In contrast, profits and distributions are taxed only at the member level for LLCs.
Corporations will typically be designated as a C corporation or an S corporation. The C or S status of a corporation is not a state-level designation, but rather a federal tax status. C corporations are taxed under the standard double taxation of corporations. S corporations meet strict criteria and are not taxed at the entity level, but rather are taxed as a partnership. At a high level, an S corporation cannot have more than 100 stockholders, cannot have non-US stockholders, and can’t have certain entities as stockholders. An S corporation is used often used for family, closely-held corporations and provides a blend of the benefits of a corporation and an LLC.
Corporate Governance
The Delaware General Corporation Law provides the default governance rules of an entity; however, an entity is largely free to establish its own governance rules, provided that such modifications are not unlawful. An entity’s governance rules will be found, for a corporation, in its bylaws; for a limited liability company, in its operating agreement; and, for partnership, in its partnership agreement.
A Delaware corporation is created upon the filing of a certificate of incorporation with the Delaware Secretary of State. The certificate of incorporation contains the most fundamental aspects of a corporation’s governance, such as the authorized number of shares it may issue and a statement of the corporation’s purpose. A corporation’s rules of governance are found in its bylaws. The bylaws are usually drafted by a lawyer and must abide by the limitations established by Delaware General Corporate Law.
Most lawyers draft their bylaws to be as permissive as the DGCL allows them to be; however, there are circumstances where an entrepreneur needs more restrictive governance rules on their company. For example, a founder may want certain actions by the corporation to be made by a supermajority of the board of directors or the stockholders or change certain notice requirements regarding board and stockholder meetings. If the bylaws are silent as to a certain aspect of corporate governance, then the DGCL and the case law of Delaware will fill its place.
The advisability of changing these default rules depends on the unique circumstances of the Delaware corporation and the founders. It is important to discuss with your lawyer all of your goals and concerns for your business, that way a skilled lawyer can guide you to find the right balance to protect your interests and allow your company to function effectively.
Litigation and the Delaware Court of Chancery
As previously mentioned, one unique aspect of the Delaware legal system is the Court of Chancery. The Delaware Court of Chancery is a special circuit of state courts that specifically handles business disputes. Since the court only handles business disputes, the judges on the court are well-versed in corporate matters. In most other states, the state courts will handle a broad range of legal disputes; therefore, judges who typically handle personal injury matters may be presiding over a business dispute. This means that parties may spend more time getting the court up to speed on the current state of corporate case law. In the Court of Chancery parties are able to breeze through the preliminary matters quickly and get to the meat of the matter faster.
The Delaware Court of Chancery also allows for parties to go into litigation with more certainty of the outcome. A dedicated corporate judiciary settling a broad range disputes involving the most sophisticated corporate companies means that there is a robust body of case law for lawyers to rely on. The plethora of opinions available means lawyers are more able to find cases with similar facts, so they can better advise their clients on the outcome of their dispute.
Delaware Company Formation
Initial costs for forming a Delaware corporation are among the lowest in the country. Delaware also provides an efficient process for forming a corporation, since business filings can be expedited and approved within 1-2 hours. Venture capitalists prefer to invest in Delaware corporations due to the expediency of dealing with the Delaware Secretary of State and the ability to take advantage of the Delaware Court of Chancery. In fact, if a corporation is not formed in Delaware, they often request that the company convert to a Delaware corporation before they invest.
A Delaware corporation begins its existence by filing a certificate of incorporation with the Delaware Secretary of State. Then your corporate attorney will put together all the initial documentation you need to get set up. This includes (i) bylaws, (ii) a resignation of the sole incorporator, (iii) application for an EIN, (iv) issuance of stock and stock certificates, (v) establishing the board of directors and officers of the company, (vi) filing any required “blue sky” filings, and (vii) filing an “S Corp” election.
Beyond the basic aspects of corporate formation your attorney will advise on other aspects of setting up the business as your circumstances require. For example, you may need to set up a stock option plan or put together offer letters and NDAs for your employees and consultants. Each business is unique, and a knowledgeable business attorney is a crucial part of any team. If you would like to speak to one of our business attorneys about your corporate needs contact us here.