‘‘You’ve got a bunch of judges down in Wilmington who are threatening our future, who are depressing the standard of living for the US public.” Those words did not come from Elon Musk, who last week expressed his fury at the Delaware court that nullified his $56bn pay package from Tesla.
Rather the rebuke came in 1989 from Marty Lipton, the godfather of modern M&A law who argued that the Delaware Court of Chancery had become too unkind to his corporate clients in that decade’s takeover wars.
Lipton at the time wondered out loud about blue-chips ditching their Delaware domiciles — where the majority of large, listed American companies choose to incorporate — for the likes of New Jersey and Pennsylvania, in order to find friendlier judges.
But an exodus never materialised. Lipton eventually became a leading evangelist for the “Delaware Way”. His law firm, Wachtell Lipton Rosen & Katz, later dominated the practice of representing corporate boards in Delaware disputes, even hiring multiple Delaware judges after they retired from the bench.
Musk is now reviving the debate about Delaware and the power its courts wield over corporate America. He has pledged to let shareholders vote on whether Tesla should shift its incorporation to Texas, which has touted its courts as a corporate sanctuary.
Musk’s international following has brought unprecedented attention to the once-niche topic of incorporation. Most Delaware watchers are, however, unworried. Of the 470 public companies in the Fortune 500, 328 make their corporate home in the small, mid-Atlantic state best known for President Joe Biden and chemicals group DuPont, drawn in part to its stable and well-understood corporate law regime.
Delaware’s chancery court is structured as a “court of equity”, looking to legal principles to enforce ideals of fairness. Its cases are not heard by juries but rather judges themselves, known as chancellors or vice-chancellors. It traces its origin to 1792, and is modelled on the High Court of Chancery of Great Britain.
The decades of precedents that guide M&A dealmaking and proxy fights that it has produced, as well as the deep-seated Delaware legal community, would be nearly impossible to replicate elsewhere, said Joel Fleming, a longtime plaintiffs’ litigator in Delaware.
A 2001 study found that companies with a Delaware incorporation enjoyed a premium on their valuations. “If we assume founders and managers have an incentive to minimise their cost of capital, they will prefer to incorporate in a state that ensures investor protection,” said Stephen Bainbridge, a corporate law professor at UCLA.
Bainbridge said he believed Delaware’s willingness to harness Musk would buttress the state’s supremacy rather than threaten it.
As a general rule, Delaware prefers not to interfere with corporate decision-making. Its famed “business judgment rule” means independent directors cannot be held liable for the decisions they make on behalf of shareholders, so long as they acted with sufficient care and in good faith.
“After ‘investment banker’, ‘independent director of a Delaware public company’ is the safest job in M&A,” Leo Strine, former chief justice of the Delaware Supreme Court, liked to quip.
Musk benefited from this reluctance to intervene when Delaware courts refused to sanction him over Tesla’s 2016 buyout of SolarCity, after the carmaker’s shareholders accused him using one part of his empire to bail out another.
But the deferential rule does not apply when the court sees enough evidence that directors were too close to the person behind a transaction. Musk found himself on the losing side of that doctrine when Tesla directors and management who brokered the pay agreement were found by Chancellor Kathaleen McCormick to be chummy with the tycoon.
Her detailed legal analysis — as well as an in-depth look at the financial plumbing of Musk’s unprecedented pay deal — is the backbone of the specialised Delaware Court of Chancery.
Still, the court has not been immune from criticism, even before Musk’s blow-up. What has been a largely technocratic court is grappling with the modern culture wars over “stakeholder capitalism” and ESG, already drawing political or social players who want to use a business court to make broader point.
Delaware has cracked open the door for boards to be held accountable by shareholders for failing to prevent scandals. Boeing, for example, settled such charges over 737 Max planes for more than $200mn. Separately, the Court of Chancery last year denied a customary “books and records” request from a shareholder probing how Disney had reacted to Florida’s “Don’t Say Gay” legislation.
Ironically, Texas, the object of Musk’s affection, is embroiled in its own controversies, including an ESG backlash and abortion restrictions that have tarnished its reputation as a low-drama business hub.
For Texas, Musk’s endorsement is coming at an opportune time. It is set to launch its own business court later this year that supporters believe can challenge the Delaware chancery. It is not obvious if its jurisprudence would prove more CEO-friendly. Companies will need shareholders’ approval to relocate, regardless. Tesla has already moved its corporate headquarters from California to Texas.
“Delaware thinks: ‘We’re smarter than you are, and we’re going to have judges up here in Wilmington look at the economics of your transaction,” said Byron Egan, an elder statesman of the Texas corporate law bar, firmly taking a poke at Chancellor McCormick’s conclusion that Musk’s pay was way out of line.
“I would tell Elon what Davy Crockett [the legendary frontiersman] said: ‘Some people were born in Texas, others came as soon as they could.’”