delaware court of chanceryWhat’s the big deal with the state of Delaware?

It’s the smallest state in the union, and it’s ranked #45 in population with under a million residents. But it’s oversize in importance to American businesses.

Delaware has the highest number of incorporated businesses in the country, the result of fee structure, tax regulations and their unique business court establishment.

There are over 1 million active business entities incorporated in Delaware. In 2013, these businesses contributed $883.4 million in associated tax and fee revenue to the state’s coffers. According to the Delaware Division of Corporations, over 50% of all U.S. publicly-traded companies are incorporated in Delaware. Even more impressively, 63% of the Fortune 500 companies are incorporated in Delaware.

Delaware’s pro-business environment has a long history and resulted in the establishment of the Court of Chancery, a specialized business court which is dedicated exclusively to corporate litigation matters. The Court of Chancery has a reputation for being accessible and smooth-functioning. Because so many companies are incorporated in Delaware, its Court of Chancery ends up being the court of record for a great deal of this country’s corporate litigation.

In essence, what happens in Delaware does not stay in Delaware.

One of the most significant issues that is being determined now in the Court of Chancery is the issue of “loser pays bylaws”.

Companies incorporated in Delaware are now considering including clauses in their bylaws regarding shareholder lawsuits. These clauses state that a shareholder who loses a lawsuit against a company must pay the winner’s legal expenses, that is the litigation fees of the company whom they are suing. This setup is atypical; in most states, each side in a corporate litigation matter is responsible for their own legal fees. The desired effect of these “loser pays bylaws” would be tamping down on the number of shareholder lawsuits against companies.

Shareholder lawsuits are typically filed for the purpose of seeking more information from the corporation and with an implied allegation that the company is not acting in the shareholders’ best interests. There has been a sharp increase in shareholder lawsuits from investors, particularly when a merger has been at issue. This statistic from 2013 is illustrative of the issue: among corporate mergers valued at over $100 million, 94% faced a challenging shareholder lawsuit.

The fee-shifting bylaws could prevent the weakest cases from going forward, but could also prevent action from non majority shareholders, who truly have an issue with a company’s behavior or planned financial decisions. Shareholder attorneys worry that the loser pays bylaws could ultimately encourage corporate misconduct by making the price too high to sue.

The fight is on in Delaware regarding fee-shifting bylaws, pitting the strong counsel representation corporations and the equally strong trial lawyers who represent shareholders, who are allied with Delaware state Democratic lawmakers who proposed a bill outlawing the loser pays bylaws.