Delaware’s New Competition

William J. Moon is Assistant Professor of Law at the University of Maryland. This post is based on his recent article, forthcoming in the Northwestern University Law Review. Related research from the Program on Corporate Governance includes The Market for Corporate Law by Oren Bar-Gill, Michal Barzuza, and Lucian Bebchuk; Federal Corporate Law: Lessons from History by Lucian Bebchuk and Assaf Hamdani; Delaware Law as Lingua Franca: Evidence from VC-Backed Startups by Brian Broughman, Darian Ibrahim, and Jesse Fried, and (discussed on the Forum here); and Delaware’s Competition by Mark J. Roe.

American corporate law is built on a metaphor of a race: states compete to supply corporate law. For nearly half a century, corporate law scholarship has revolved around endemic questions about whether other states put competitive pressure on Delaware, and whether this competition is normatively desirable.

There is a missing piece to this important body of scholarship. In my article, Delaware’s New Competition (forthcoming in the Northwestern University Law Review and available on SSRN), I introduce foreign nations as emerging lawmakers that compete with American states in the increasingly globalizing market for corporate law. In recent decades, entrepreneurial foreign nations in offshore islands—principally the Cayman Islands, the British Virgin Islands, and Bermuda—have attracted publicly traded American corporations by offering permissive corporate governance rules and specialized business courts.

Aided in part by an elite cadre of private sector lawyers who draft legislation for these lawmakers, these jurisdictions have built sophisticated legal infrastructures that enable them to compete with Delaware. These lawmakers, for one, rely heavily on incorporation fees for government revenues, allowing them to credibly commit to retaining laws that are attractive to the private sector. Because the population of offshore incorporation havens tends to be a fraction of even sparsely populated states in the United States (for instance, as of 2019, the population of the Cayman Islands is 59,613 compared to 961,939 in Delaware and 2,998,039 in Nevada), these jurisdictions can enact legislation swiftly in response to private sector demand. Indeed, far from offering archaic corporate governance rules, offshore jurisdictions frequently update their corporate law statutes. For instance, since its original enactment in 1981, Bermuda has amended or updated its corporate law at least forty-five times. Official government publications do not shy away from pronouncing the purpose of these legislative amendments. The Cayman Islands government, for example, describes the purpose of legal updates as improving “the competitiveness and attractiveness of companies incorporated in the jurisdiction[.]”

Skeptical readers may point to the “unique” legal system in Delaware that is said to make it near impossible for any other jurisdiction to mount a serious challenge to Wilmington’s corporate law empire. Indeed, many foreign jurisdictions do not offer a Delaware-style legal system famous for producing an abundance of well-reasoned and fact-specific case law appearing on Westlaw and Lexis. Instead, many legal proceedings offshore take place in secret, and full-length opinions are frequently unpublished or available only to insiders. These jurisdictions compete not by carbon copying Delaware’s judiciary, but rather by offering dispute resolution fora functionally similar to modern commercial arbitration. Like arbitration, courts in offshore incorporation havens swiftly resolve disputes without juries. Judges serving in these courts, like arbitrators, are credentialed business law jurists including partners at major international law firms who fly in from overseas to preside over cases ad hoc.

This account complicates some of the fundamental theoretical building blocks underlying the study of American corporate law. Whereas several prominent academics have assessed that other states do not vigorously compete to give a run for Delaware’s money, thus dubbing the inter-state competition story a “myth,” my article suggests that a handful of foreign nation states are actively vying to gain a share of the American corporate law market. Thus, even if state-to-state competition is or will remain weak, state-to-nation state competition may be alive and kicking, albeit not with the same set of consequences that the standard inter-state framework would have us believe.

Normatively, the emergence of an international market for corporate law may improve the robustness of competition between jurisdictions to supply corporate law. The fact that lawmakers in small foreign nations are easily “captured” by the private sector, in certain respects, merely indicates lowered transactional cost of producing “off-the-rack” templates of corporate law. Indeed, one benevolent explanation for the emergence of offshore corporate law is that they cater to corporations that want to hedge against frivolous lawsuits. It does not seem like shareholders are actively hostile to lax rules offered in foreign nations, either. In 2011, for instance, New York fashion house Michael Kors went public on the New York Stock Exchange choosing British Virgin Islands corporate law and raised nearly $4 billion.

But there are several reasons why we cannot take an expanded selection of corporate law as necessarily promising socially desirable outcomes. First is the ubiquity of tax. While incorporation decisions cannot purely be explained as a problem of tax arbitrage, current tax laws do allow corporations to reduce federal tax liability by incorporating outside of the United States. To the extent that firms can continue to alter their effective tax liability by incorporating in foreign jurisdictions, U.S. taxpayers are the big third parties negatively affected by incorporation decisions of private corporations. Second, foreign jurisdictions may enable domestic corporations to opt out of “desirable” mandatory rules. While Delaware corporate law is predominantly made up of “enabling” default rules that leave significant discretion to private choice, it includes a number of “mandatory” rules that even the most sophisticated corporations cannot waive compliance through contract. A survey of key corporate governance rules offered by leading foreign jurisdictions reveals distinctive templates of corporate codes. This includes (1) virtual prohibition on shareholder derivative lawsuits; (2) restrictions on shareholders inspecting books and records; and (3) lax fiduciary duty rules. Viewed in this light, foreign jurisdictions enable corporations (for better or worse) to opt out of certain mandatory rules that may not be possible in a pure inter-state market.

The foregoing analysis yields several new insights that make the topic ripe for future research. While legal regime shopping enabled by entrepreneurial foreign nations can strip away parochial restraints on private contracting, they can also undermine mandatory domestic rules designed to effectuate important social policy.

The complete article is available for download here.

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One Comment

  1. John C Coates
    Posted Wednesday, June 19, 2019 at 9:33 am | Permalink

    Arbitration of major commercial disputes is often far from swift.