15 March 2011

Square State Corporate Law

If I were advising a company about to go public on whether it should choose Colorado's corporate law, rather than say, Delaware's corporate law, would I do so?

Probably not. Why?

It isn't because Delaware corporate law is motivated by director primacy. My reasoning would be more mundane.

One of the biggest concerns for counsel seeking to incorporate outside Delaware or New York is that there simply isn't much modern corporate law precedent in any given non-Delaware, non-New York State jurisdiction on a great many issue of concern to publicly held corporation lawyers. Few states besides these states have any significant trial court reporting of corporate law rulings.

By my count, for example, which almost certainly double or triple counts a few cases, Colorado has fewer than 57 cases (state appellate and federal trial court and appellate) decided in 1980 or later (the last thirty-one years) interpreting its corporate code, some of which have been superceded by subsequent legislation (e.g. a line of cases concerning the duties of directors of insolvent corporations to creditors), and others of which deal with issues that only come up for "amateurs" and closely held corporations (e.g. the effect of failing to file a certificate of incorporation and the state's alter ego cases), rather than the kinds of issues (e.g. director obligations in regard to poison pills) that matter to large publicly held corporations with reasonably competent counsel. In state court, a significant share of those cases would also be federal court cases that are only persuasive authority (and a fair number of the Colorado precedents in the state reverse prior federal court holdings on corporate law issues in the state), and on any given issue, only a handful would be relevant.

For example, there are just three reported cases in the history of the state on indemnification of officers and directors, and just two on director conflicts of interest. Just one case in the history of the state addresses the business judgment rule or a director's duty of loyalty. There are two reported cases in the history of the state on derivative actions. The last time there was a reported decision on a proxy fight in Colorado was in 1956.

Delaware law and New York law, because each has quite different statutory language, often does not offer very persuasive precedent on Colorado corporate law issues.

Colorado's corporation code is well written and regularly updated to address the concerns raised by the bar. But, frequently, a lawyer forced to take a position on the meaning of the law when a corporate law issue presents itself must rely on the text of the statute, a decade old bar journal article, and equally thin precedents from other states with similar statutes, which makes for very thin (or very fat and not very definitive) legal briefs and memorandums of law. This is quite an uncomfortable position for a lawyer in a case where hundreds of millions of dollars may be at stake.

Again, to be clear, there is very little, if anything, wrong with the substance of Colorado's corporate law statutes. Indeed, on the merits, I probably would usually find Colorado's rule to be superior to that of Delaware when there is a clear difference, such as the arguably excessive ability of Delaware directors and officers to reduce their legal liabilities to shareholders relative to officers and directors in Colorado corporations. But, in a great many situations there is considerable ambiguity concerning what the statute requires when it comes to making a nitty-gritty line drawing legal judgment about what Colorado corporate law requires, since courts have particularly great latitude to decide cases of first impression.

The heavily litigated points of corporate law in Delaware are far less useful to closely held firms, and Colorado has more depth in its case law on issues of special relevance to closely held firms. Also, Colorado law, because it is not embellished with many layers of case law doctrine, provides few instances of laws that don't mean what they appear to mean for corporate officers and directors who, despite my best efforts, are determined to try to figure out the law for themselves, rather than consulting a lawyer.

Delaware's edge is also far narrower in the case of "uncorporations," such as limited liability companies, where no state has a long tradition of case law and individually drafted operating agreements matter more than express statutory rules.

As unfair as it is that the elected representatives of the state of Delaware should get to decide how corporate law is made for the vast majority of large publicly held corporations in the United States, for the foreseeable future, deficiencies in Delaware's corporate laws are more effectively addressed through federal law than through efforts to get corporations to incorporate in the states where they actually have their headquarters.

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