Delaware, Inc agonises about Musk backlash as its lawyers seek changes
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The drop just before the long Easter holiday weekend did not seem like a coincidence. On Thursday, March 28, a group of powerful Delaware lawyers put in motion a plan to make a series of changes to the state’s eminent corporate code, known as the Delaware General Corporation Law.
The lawyers are members of the Delaware state bar association that customarily makes such proposals to update the state’s corporate law. But this set of revisions had come hastily and was, according to the plan, to be quickly approved by the Delaware legislature in order to take effect by August 1.
It has not been an ordinary year in the First State. About two-thirds of American companies are incorporated in Delaware, attracted to the small, mid-Atlantic state by its sophisticated legal system. But a series of highly technical rulings in recent months have seemingly overturned long-standing legal provisions in both merger and stockholder agreements, leaving them open to challenges in the courts.
That has unnerved the lawyers who believe the state’s reputation for predictability is eroding, potentially risking its status as the premier place for US businesses to incorporate. Concerns voiced both privately and publicly were serious enough for the state bar to spring into action, proposing changes aimed at restoring that predictability.
Still, all of this would probably still be “inside baseball”, confined to law conventions and journal articles, if not for one man: Elon Musk. The Tesla co-founder’s frustration with Delaware law has brought unprecedented attention to the state this year.
Musk has been railing against the state since late January when a Court of Chancery judge nullified a $56bn stock pay package he had been awarded in 2018. And just last week, Tesla said it would ask its independent shareholders to vote in June to move its domicile to Texas — writing in its proxy statement that Delaware corporate law “may be less predictable for an innovative company like Tesla”.
The elegance of Delaware law is that it has, for decades, struck a fair balance between corporate and shareholder interests. Both sides can then benefit if investors put a premium on companies incorporated there. But the recent moves by the state bar association to change the DGCL, which have been criticised by legal scholars as rushed, arguably reflect signs of panic and insecurity.
Musk’s problem with Delaware stems from the state’s strictness towards potentially self-interested deals for companies with dominant shareholders. In overturning his pay package, the court said Musk, who owns more than a fifth of the company, was too cosy with Tesla’s board and the value of the package was unfair to other shareholders.
The three newly proposed changes to the DGCL have little to do with the doctrines that aggrieved Musk but highlight the agonising of lawyers about their state’s future when it comes to business. Of the three, the most controversial change seeks to allow boards to more easily strike direct agreements with a specific shareholder, a common practice to head off proxy fights. The Delaware court this year invalidated such a practice at the investment bank Moelis & Co, which had given its founder veto power over nearly all of the standard work conducted by a board of directors.
Several law professors have pointed out that boards are supposed to exercise judgment consistent with their duties to all shareholders. They cannot simply make decisions to placate a specific shareholder. The professors’ argument is not that the DGCL should not be amended. Rather, it is that the proposed changes tackle a fundamental issue at the heart of what a corporation is — whether directors should use their judgment in making decisions or simply be told what to do through a contract. As such, rushing to make changes to the corporate code is imprudent.
And for all of the histrionics of Musk, there is not even a hint that other big public companies are set to abscond to Texas, Nevada or any other state. The vast majority of them will never have a contract or fiduciary duty dispute of any significance, and irritating shareholders with a forum-shopping gambit is almost certainly not worth it.
Still, Delaware, Inc is going to have to decide whether its brand should be based on being an even-handed, dispassionate system or something more corporate-friendly, designed to keep up in a regulatory race to the bottom. Tesla argued in its proxy filing last week that the state of incorporation was irrelevant to shareholder value. We are about to find out.
