DelawareEC

8/14/2019 DelawareEC

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DoverA look at why so many companies choose to incorporate inDelaware


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Marissa Cerami

Dr. Read

AC312

April 3, 2008

Introduction

Despite the fact that it is the second smallest state in the nation, more than half of allpublicly traded companies in the United States are incorporated in Delaware. Most businessesare attracted to the state because of its flexible corporate laws, ample tax benefits, and access toits practiced Chancery Court, one of the only state courts in America exclusively devoted tohearing business cases. The state also makes it easy for companies to file for incorporation byproviding all resources online, and even offering services such as 1-hour, 2-hour, and same

day registration. In some neighboring states, the incorporation process can take more than twoweeks. Delaware has perfected the art of attracting businesses to incorporate in the state and as aresult has been able to generate more than 25% of its annual revenue from its state corporatefranchise tax. Ultimately, Delawares approach to providing something for everyonemay be thestates greatest tool for drawing companies away from other states.

Location FreedomDelawares corporate laws do not restrict businesses based on physical location. A

Delaware corporation need not even maintain an office or an address inside the state. In fact,companies registered in Delaware may have their headquarters in another state or countryand donot even need to conduct any form of business within the state. However, companies registered

in another state must register with up to six additional Delaware departments in order to conductbusiness within the state borders.

The Court SystemMany businesses are attracted to the First State for its court system. The Delaware Court

of Chancery has been in existence for over two centuries and has influenced most of the currentU.S. corporation case laws. Many businesses feel safer filing in Delaware because the extensivehistory of its court system and experience dealing solely with business cases makes it easy toknow how shareholders will be treated and how courts will define fiduciary duties for a boardand other corporate governing issues (Enterprise). Since management is able to look at pasthistory of the court and its rulings, the outcome of a corporate case is more predictable.

Takeover DefensesAnother significant reason that many corporations choose Delaware as their home state,

on paper, involves the business laws regarding takeover defenses. A takeover is an attempt by abidding company to gain controlover a target company. Bidder companies can do so in a numberof ways, such as by acquiring enough shares to control the target companys management. In1985 two pivotal cases were decided by the Delaware courts involving takeover defense. InUnocal vs. Mesa Petroleum, the Delaware courts upheld a discriminatory stock repurchase byUnocal which was done to avoid a hostile takeover situation by Mesa. In the second case,


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Moran vs. Household International, the court ruled that Morans use of the poison pill defensewas an acceptable business tactic to avoid a hostile takeover (Heron). Following the ruling ofMoran in November, 1895, corporations already registered in Delaware quickly amended theircorporate bylaws to include poison pills and companies who were not incorporated inDelaware flocked tostate to sign up. The Delaware court systems ruling inParamountCommunications, Inc. v. Time, Inc,upheld the right of directors to refuse a fair offer by a bidderto buy the company. This power of directors to just say no is yet another potent takeoverdefense made available to Delaware corporations during the 1980s.Director Liability

Companies registered in Delaware are allowed to include a provision in their originalcertificate of incorporation which limits or altogether eliminates an executives personal liabilityto a corporation for breach of his fiduciary duty of care as director in certain circumstances(Beirut). In other words, the Business Judgment Rule protects board members from beingresponsible for decisions made with respect to advancing shareholder interests and loyalty. Theaim of this clause is to attract and retain high quality persons to serve as directors for Delawarecorporations by reducing pressure on managements decisions to stockholders. Many believethis is a dangerous clause because it allows management to be careless in the interest of its

shareholders. Managers are shielded from having to deal with petty lawsuits from variousshareholders for not acting in the best interest of equity financers, making Delaware a veryattractive option to businesses, especially since management makes the decision of where toincorporate the company.

Nimble Dividends

In some states in the U.S. corporations are required to satisfy prior earnings deficits withcurrent earnings before using them to pay out current dividends. However, in Delaware, acorporation is allowed to pay dividends out of current earnings despite the deficit position of thecompany. This is known as a nimble dividend and allows companies to make payments toshareholders even in times of an earnings deficit. Nimble Dividends allow management to keepshareholders happy even in times when earnings revenue is at a deficit, reducing some of thepressure on executives to alter the bottom line to impress stockholders. If the shareholders canbe satisfied with a dividend in a given year, they may be less concerned about the bottom line ofthe corporation as long as they have cash coming in.

Tax and Fee Advantages

Many businesses may also be attracted to the state for the tax benefits it provides tobusinesses. For starters, Delaware does not impose a sales tax on goods sold to consumerswithin the state which can make products appear cheaper to customers. The state does impose asmall tax on the gross receipts of most businesses which can range from 0.077% to 2.125%depending on the type of company. Because of the vast number of corporations registered inDelaware, the state can afford to keep fees per company relatively low and still manage to bring

in more than $300 million per year in business taxes and fees revenue. Delaware also does notcharge any state corporate tax on interest of investment income, on business transactions, orwhen a value-added situation occurs. The First State also does not impose a tax on stocktransfers.

ConclusionDelaware has been the number one state of incorporation in the nation for more than a

century now because of the various benefits it can offer to companies, their management teams,


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Works Cited

Brooks, Nelson B and Stephen Jackson. Keeping Up with a New Act. CAMagazine Apr. 2003.

2 Apr. 2008 .

Corporations Still Flocking to Delaware. New York Times27 Dec. 1997: D14. Lexis Nexis.Bentley College Library, Waltham, MA. 30 Mar. 2008 .

Crystal, Gary. What is a Delaware Corporation. WiseGeek. 2003. 2 Apr. 2008.

Delaware Corporations Choice for More than Fifty Percent of US Corporations. Beirut Times20 Jan. 2000. LexisNexis. Bentley College Library, Waltham, MA. 30 Mar. 2008.

Delaware Incorporation Benefits Local Firm. Enterprise Vol. 27, Issue 43, 20 Apr.1998. Regional Business News. EBSCOHost. Bentley College Library, Waltham, MA. 30Mar. 2008. .

File Certificates of Business Formation. 24 Mar. 2008. State of New Jersey Department of theTreasury Division of Revenue. 30 Mar. 2008..

Heron, Randall A. and Wilbur G. Lewellen. An Empirical Analysis of the ReincorporationDecision. Journal of Financial and Quantitative Analysis. Vol. 33No. 4 Dec. 1998.JSTOR. Bentley College Library, Waltham, MA. 30 Mar. 2008

.

Johnson, Carrie. Incorporation Rules Enable Fraud, Officials Warn Panel. Washington Post 15Nov. 2006: D02. 30 Mar. 2008 .

Kihlstrom. Richard E. and Michjael L. Wachter. Corporation Policy and the Coherence ofDelaware Takeover Law. University of Pennsylvania Law Review EBSCOHost.Bentley College Library, Waltham, MA. 30 Mar. 2008. .

McCormick, Eleanor. "Nimble Dividends: Some States Do Permit Dividends Despite Deficit inAccumulated Earnings. " Journal of Accountancy (pre-1986)

88.000003 (1949): 196. ABI/INFORM Global. ProQuest. Bentley College Library,Waltham, MA. 30 Mar. 2008 .

Paredes, Troy A. The Firm and the Nature of Control: Toward a Theory of Takeover LawJournal of Corporation Law Vol. 29, p 103. 30 Mar. 2008.
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Shaw, Bill. Statutory Limits on Director Liability - Protection for Corporate Officers.Business Horozons July-August, 1989. BNET. 1 Apr. 2008.

State of Delaware: The Official Website of the First St a te . 16 Jul. 2007. 30 Mar. 2008.

Triumph of the Pygmy State. The Economist 25 Oct. 2003. US Ed. Lexis Nexis. BentleyCollege Library, Waltham, MA. 30 Mar. 2008 .
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