Real Estate / 5 min read
"This decision dares to 'boldly go where no man has gone before,' or at least where no Delaware court has tread." Such words by Judge Kathaleen McCormick in her opinion in Tornetta v. Musk, 250 A.3d 793 (Del. Ch. 2019) have been interpreted by some as indicating that Delaware may no longer be the corporate safe haven it has been for over a century.
Approximately 70% of all Fortune 500 companies are incorporated in Delaware. Due to certain tax benefits, an efficient legal structure, and well-developed corporate governance laws, the state has gained a reputation as the best state in which a company can incorporate. However, recent rulings by the Delaware Court of Chancery, most notably in Tornetta v. Musk, but also in West Palm Beach Firefighters' Pension Fund v. Moelis & Co., 310 A.3d 985 (Del. Ch. 2024) have cast doubt on whether Delaware's long-standing advantages remain as appealing as they once were or whether the Court of Chancery is becoming an unpredictable liability driven by activist judges.
Given the recent reappraisals of the desirability of incorporating in Delaware, some companies have started to turn to Texas, where the creation of the Texas Business Court and the proposed Texas Stock Exchange have positioned Texas as an attractive alternative to what many feel is court overreach in Delaware.
Delaware Court of Chancery’s Recent Controversies
In Tornetta v. Musk, the Delaware Court of Chancery invoked the "entire fairness" standard, the highest of Delaware's three levels of scrutiny that applies to claims involving transactions in which a "controlling" stockholder of the company is alleged to have engaged in self-dealing and received a "non-ratable benefit." This type of benefit is defined as a transaction that reduces or eliminates a controller's or fiduciary's risk of liability. The high-profile case concerned Elon Musk's 2018 compensation plan, which could have earned him stock options worth up to $55.8 billion if Tesla, Inc., met specific stock value benchmarks. The Court ruled that although Musk only possessed a 21.9% equity stake in Tesla, having less than a majority of the corporation's voting power, he nonetheless wielded considerable influence over Tesla's board of directors and thus essentially "controlled" the corporation, subjecting the compensation plan to the rigorous entire fairness standard as opposed to the more deferential business judgment rule.
The Court found, in assessing whether Tesla's compensation committee was "independent" and whether there was a fully informed stockholder vote, that disclosures made to stockholders prior to and during the vote on the compensation plan were misleading, and it ultimately ruled that Musk's compensation package amounted to a breach of fiduciary duty by Tesla's board of directors. This led to the Court voiding the entire compensation plan—a dramatic move, especially considering that Tesla's stock skyrocketed after the compensation package was approved. While the case is likely to be appealed, the decision has left many questioning whether the Court is overstepping its bounds by overturning a plan that stockholders and directors had already approved. Walter Isaacson, biographer of Elon Musk and himself a former CEO, recently said that the ruling is "going to hurt Delaware…People will say, 'Wait, wait, you mean five years after something happens, eight years after something happens, you'll [Delaware Court of Chancery] undo it?" As a result of this ruling, Tesla moved its incorporation from Delaware to Texas.
Such sentiments are shared by more than a few businessmen, and this trend suggests a shift in corporate America's preferences: states like Texas and Nevada are now being seen as viable alternatives to Delaware's increasingly unpredictable legal climate. Part of the appeal of the Chancery Court is that it operates without a jury with cases being decided by a single judge, a formula that has long been seen as a strength due to its efficiency and specific expertise in corporate governance matters. However, Judge McCormick's ruling in Tornetta v. Musk has sparked concerns and drawn criticism, with some questioning whether the ruling reflects impartiality or a personal bias, and whether it's indicative of a sea change in how the Court analyzes the validity of internal corporate actions.
Attempting to assuage growing concerns about undue judicial interference in corporate decision-making processes, the Delaware legislature passed an amendment to the Delaware General Corporation Law (DGCL) codifying the notion that the affairs of a Delaware corporation be managed by its board of directors "except as may be otherwise provided in the DGCL or in its certificate of incorporation." The major impetus for the amendment stemmed from another controversial Court of Chancery decision in West Palm Beach Firefighters' Pension Fund v. Moelis & Co. In this case, the court invalidated a stockholder agreement between the corporation and its controlling stockholder – who was also its founder and CEO – because the stockholder agreement restricted the corporation's board of director's management authority insofar as it required the board to obtain prior written consent from the controlling stockholder before the board could undertake certain corporate actions. The Court invalidated such an agreement because, according to the logic of the opinion, the controlling stockholder's pre-approval mechanism effectively amounted to a veto right, thus running afoul of the intent to protect a board of directors' decision-making autonomy. The Chancery Court's decision stunned many from the corporate bar by what was perceived as an unprecedented intrusion into the corporate decision-making process. The DGCL amendment served to nullify, with certain caveats, the holding in Moelis & Co. by authorizing these types of delegations of corporate decision-making without having to adhere to often rigid stockholder pre-approval procedures.
A Growing Exodus: Texas as an Alternative
Given these recent controversies surrounding the Delaware Court of Chancery, Texas appears to many companies as a desired state in which to register or reincorporate. Texas has introduced its own specialized business court and is actively positioning itself as a more stable regulatory environment for businesses than Delaware. Further, TXSE Group, Inc., has raised $120 million in capital for a new national securities exchange in Dallas called the Texas Stock Exchange. TXSE Group, Inc., is backed by BlackRock and Citadel Securities, and intends on filing registration documents with the Securities and Exchange Commission later this year. Such a move is the logical consequence of Texas being home to the most Fortune 500 companies in the entire country, and of Texas experiencing significant population relocations and economic growth that has generated an infrastructure conducive to profitable business activity.
Incorporation in Delaware is no longer the no-brainer it once was. Businesses will need to weigh the State's established advantages against its evolving legal environment, which is increasingly defined by aggressive litigation and by what many perceive to be insufficient judicial deference to internal corporate decision-making. The practical ramifications of Texas' new Business Court remains to be seen, but with 10% of Fortune 500 companies already in Texas, and with Texas' intention of making the State more attractive to companies with the creation of the TXSE, it's not unreasonable to speculate that Texas may become the next Delaware in the decades to come.