So on Monday I threw up a rather inflammatory post about SB 21, which would dramatically rewrite Delaware law.  (Here’s a post by Eric Talley, Sarath Sanga and Gabriel V. Rauterberg, which takes a more measured tone).

As I’ve talked to people about the law, the first question I get asked is, “Is this a good thing or a bad thing?”  And that’s a really difficult question to answer, because “good” can have many meanings in this context.

Is this good for shareholders?

Well, I find it very difficult to take seriously the notion that the procedures written into the law will have any protective effect for shareholders.  The independence standards of the exchanges are notoriously weak; that’s why ISS and Glass Lewis frequently adopt their own definitions of independence, so much so that the Business Roundtable accused them of proxy fraud. The cleansing standards would insulate transactions by a board that is entirely captured by a counterparty, so long as a single member of that board is independent and votes with the others (a standard that one can easily see being transferred to the demand excusal context).  The definition of controlling shareholder would exclude people with contractual control over virtually all board functioning as long as they didn’t actually have power to vote for nominees, and so forth.

So, whether it’s good for shareholders depends on how valuable you believe more rigorous procedures – and the litigation that enforces them – to be.  Some believe procedural guardrails to be necessary to protect against agency costs, and shareholder litigation to be a necessary corrective to managerial excess; others believe shareholder litigation is a mere nuisance that has little substantive effect on corporate behavior. 

Separately, the bill would drastically limit shareholders’ ability to access internal corporate records.  These matter for more than just litigation – they’re used by shareholders to protect their rights and to facilitate activist intervention. More generally, books and records access, and the prospect that boardroom misconduct will be exposed, can act as a kind of soft discipline that curtails agency costs all by itself.

That said, in recent years, some Delaware decisions have suggested that, in an age of powerful, informed, institutional shareholders, these kinds of legal protections are less necessary.  Markets, including the market for corporate control, work; maybe in that world we don’t need as much litigation or even as much informational access.

At the same time, though, the SEC is starting on a project to limit investor power. The reforms to 13D have the potential to take the largest asset managers out of the oversight business; and we haven’t yet begun to see whatever’s going to happen with proxy advisor regulation. 

What does SB 21 look like in a world where institutional shareholders are suddenly defanged?

Is this good for Delaware?

Delaware, of course, relies on incorporations.  My little joke is that Delaware has exactly one industry – the production and export of corporate law – which is entirely controlled by the government, so functionally the beating heart of American capitalism is a socialist state.

Which means, if there is a real threat that corporations will exit en masse, Delaware must change its law, no question.

But there are other truths here as well.  Part of Delaware’s power also comes from an ecosystem, which Brian Quinn described in this blog post after the Great Battle of SB 313. Law professors study and write about Delaware law, they communicate their respect for it to their students, who go on to recommend Delaware to clients.  Federal regulators avoid treading too far on Delaware’s turf; other states stay pending corporate cases in favor of Delaware adjudication, look to Delaware precedent when interpreting their own law, and respect the internal affairs doctrine.  Delaware judges get invited to international conferences to offer up comparative assessments.  And that ecosystem rests, in part, on a belief that Delaware has a technocratic and balanced approach to lawmaking that is relatively insulated from political or industry capture.

That reputation is at risk if Delaware outsources its corporate governance standards to the exchanges, and is perceived as rewriting its corporate code every time a powerful litigant loses a case, particularly so if ordinary procedures are bypassed to do it.  And that’s especially true if the law gets rewritten in a manner that retroactively restores one particular litigant’s pay package and insulates a pending merger from shareholder challenge to boot.  That’s not even a story of reform; that’s a story of political pay-to-play.  To put it more bluntly, if that’s how Delaware is perceived, these articles don’t get written. Instead, articles get written about the need for a different system, one that is less politically vulnerable.

More generally, Delaware needs cases, not just incorporations alone.  Not simply for the actual business they provide (hotels! Meals! Employment for Delaware litigators!), but because the judicial opinions also contribute to an understanding of the law, which provides the foundation for the respect accorded to Delaware from other actors.  And that means plaintiffs have to be able to win, occasionally, and get their wins affirmed on appeal without legislative interference, and get paid fees that justify the risks involved. 

And then there’s the point that part of Delaware law’s mystique – and what makes it difficult for other states to copy – has been the fact that it’s largely based in caselaw.  If the DGCL just becomes a poor man’s MBCA, it’s, you know, portable. 

Last year, I warned that SB 313 could cause a loss of cases to other venues.  Now, the new SB 21 threatens to limit the ability of shareholder plaintiffs to litigate altogether.  I mean, the Delaware Court of Chancery can always become a court that exclusively hears earnout disputes, but that doesn’t get you a pride of place in the Business Organizations casebook. (And even the earnout disputes aren’t safe; disappointed litigants are now warning of a corporate exodus if those come out the wrong way, too.)

Which means, the question whether SB 21 is good for Delaware is complicated – there’s the short term and there’s the long term, and then there’s the question whether the full package of proposals appropriately balances the two.

Edit: I had further thoughts, here.

Is this good for society?

That’s also complicated, and that’s what I’m trying to work out in my Legitimation of Shareholder Primacy paper. On the one hand, it has often seemed like the guardrails imposed by Delaware law have been the only real constraints on the exercise of an enormous amount of power by a very small number of people.

On the other hand, those guardrails exist, ostensibly, to protect capital, and certainly there is an argument that greater protections for capital come at the expense of other constituencies. 

On the third hand, even before SB 21, those guardrails were pretty thin, and to the extent they fooled everyone, including corporate law professors, into believing they were stronger than they actually were, maybe it’s better that their fragility be revealed.