Source: https://witnesseth.typepad.com/blog/state-of-incorporation/
Timestamp: 2019-04-20 22:38:16+00:00

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Professor Bainbridge has produced a map of corporation laws in the United States showing which states have adopted the Model Business Corporation Act (MBCA). This is a nice resource for students to get their bearings reading cases in corporations or business associations. The cases themselves often don't mention whether their statute is based on the MBCA, but that information can be important to help students organize the cases in thinking about corporation laws. Of particular note for students, Delaware, California, Texas, and New York do not follow the MBCA, and they are some of the most significant states for incorporation. Kind of makes you wonder what the "majority rule" is, doesn't it?
Where do most companies incorporate? Like most things in law school, "that depends." For more information about where privately held companies tend to incorporate and where they tend to be physically located, see my analysis of private company incorporation decisions here. For similar data on publicly traded companies, see Bebchuk and Cohen's analysis of public company incorporation here.
Keith Bishop at the California Corporate & Securities Law blog has put together a post profiling recent scholarship on Nevada corporate law. The articles and essays linked there show a variety of opinions about Nevada's recent rise to more prominence in corporate law.
The rise has been dramatic, especially for SEC reporting companies. Several months ago I used computer analysis of the SEC's EDGAR database to document the recent meteoric increase in the number of Nevada reporting ompanies. The post showed that Nevada has greatly outstripped Delaware in new SEC reporting companies in the last five years.
The news from Nevada is actually somewhat unsettling when one digs deeper into the data, as the majority of these Nevada public companies have at least one investor red flag. It turns out that most of these companies are (at least) one of the following: shell companies, blank check companies, reverse merger companies, development stage companies, or penny stocks--not exactly traits that exude legitimacy.
Indeed, one might wonder whether Nevada is a sort of "attractive nuisance" for investors. Of course, there are legitimate public companies incorporated in Nevada, but the data on the these "sideshow" companies is compelling. Why are so many of these "unconventional" companies incorporating in Nevada?
Delaware dominates the corporate charter business. About 60% of Fortune 500 firms incorporate in Delaware as has been well documented. And Delaware’s dominance is not limited to large, blue-chip companies; most entrepreneurial ventures that secure professional outside financing are incorporated in Delaware as well. Over the years, Delaware’s incorporation monopoly has been challenged by several other states, but they have had only modest success.
The newest entrant in the “race” among the states is North Dakota, which enacted its Publicly Traded Corporations Act in 2007 in an attempt to offer a “shareholder-friendly” alternative to Delaware. The Act received a fair amount of attention from noted scholars and stimulated a flurry of shareholder proposals to reincorporate there in the 2009 proxy season. But as Stephen Bainbridge predicted and then reiterated, the initiative failed to attract a significant number of companies from Delaware. Even the shareholder proposals seem to have dried up, with no proposals in the 2011 proxy season.
Why did the North Dakota experiment fail? Bainbridge predicted companies would not reincorporate in North Dakota for three primary reasons (loosely paraphrased): (1) Delaware’s case law and courts allow “legal questions to be answered with confidence,” something that would take North Dakota years to achieve, (2) management has no reason to reincorporate there if the race is to the bottom, and (3) nobody has in incentive to reincorporate there if the race is to the top.
I agree with Bainbridge’s basic reasons for why North Dakota’s law failed but disagree about the inevitability of Delaware’s dominance. North Dakota failed because its approach failed to offer a Pareto superior alternative to the Delaware status quo. The problem with a state merely offering a “shareholder friendly” alternative is that shareholders do not have the power to initiate a reincorporation. This means, as Lucian Bebchuk has pointed out (p. 862), it is very difficult to change when managers favor the status quo—Delaware. If a state is to seriously challenge Delaware (absent federal intervention), it will need to offer an advantage that appeals to management as well as shareholders—in other words, a Pareto superior alternative to Delaware.
Do officers have the same fiduciary duties as directors? Gantler v. Stephens (2009).
Does the Delaware statute of frauds apply to LLC operating agreements? Olson v. Halvorsen (2009).
Can preferred stock be created with no right to receive dividends? Shintom v. Audiovox (2005).
What happens when a fiduciary fails to observe its duty of full disclosure? Berger v. Pubco (2009).
What is a promoter's liability in connection with a preincorporation agreement? Re: GS Petroleum, Inc. v. R and S Fuel (2009).
Are employment contracts containing restrictive covenants are assignable in a sale of the business? Great American Opportunities v. Cherrydale Fundraising (2010).
These are not obscure interstitial details or rapidly-evolving, cutting edge issues. These are basic questions in stable, even hoary areas of law that should have been resolved clearly and definitively decades ago. I do not mean to suggest that other states do a better job that Delaware at clarifying corporate law rules; they don’t. Other states have all of these types of enduring and perplexing uncertainties, and more. The point is that the law is unclear everywhere because of the maddeningly inefficient tradition of making corporate law decisions through judge-made law. But is that inevitable?
The answer is “no,” because there is an obvious alternative no state has tried. A state like North Dakota could provide more certainty than Delaware simply by taking the monopoly on answers away from the litigators and opening it up to planners. A rival state should create a system for providing reliable answers in advance of litigation—indeed, in advance of corporate action—by allowing its companies to simply ask for authoritative answers to basic questions such as whether preferred stock must pay dividends, by asking in advance of taking action, rather than by litigating after taking action. This is the type of guidance that is common in tax, bank regulation, securities regulation, and other areas that require advance planning, but is strangely absent in corporate law. Whether the ex ante guidance took the form of advisory opinions from a court or interpretive guidance from an administrative agency, the state that established such a mechanism to provide managers with authoritative answers ahead of time about uncertain questions of law would lure managers away from Delaware, shareholder friendly or not.
In this approach, a state would set up an authoritative body, which could consist of a business court or an administrative agency, that would receive and act upon confidential requests for interpretive guidance. Instead of paying Delaware counsel hundreds of thousands of dollars for uncertain predictions about the inclination of their friends on the Court of Chancery, a North Dakota agency could answer the question definitively, with certainty, and most importantly, before a decision had to be made. Other states would have to yield to North Dakota’s interpretation of its own corporate law under the Supreme Court’s interpretation of the internal affairs doctrine, which means that companies would be completely protected by such an interpretation. Thus, managers could proceed with routine transactions without the nagging uncertainty of litigation, and shareholders would be immunized from the destructive activity of nuisance plaintiffs.
Suppose a state implemented this suggestion and was successful in attracting companies away from Delaware. Why wouldn’t Delaware just adopt the innovation and outcompete the upstart state? That is the essence of Bainbridge’s final argument, “if investors valued the provisions of the North Dakota Act, Delaware would have gotten there first.” Yet Delaware could not follow where North Dakota could lead, and this is the key to the understanding why this proposal would work.
Delaware has no incentive to provide ex ante answers to legal problems, either as a first-mover or in response to another state. Why? Because Delaware’s advantage in the corporate charter business is also its vulnerability. The Delaware bar’s entrenched interest depends on the ex post revelation of corporate law answers through constant litigation and adjudication. The demand for members of the Delaware bar is driven by the uncertainty, ambiguity, and confusion created by the reliance on judge-made law. Only Delaware lawyers are able to provide companies the best advice based on off-the record conversations with their friends on the bench. Delaware’s wealth is in its human capital: its bench and its bar. But these informal networks of influence and social advantages are no longer valuable when authoritative answers can be had in advance from another state.
In future posts, I plan to build out this proposal for how a small state could make a big impact on corporate law in the United States. In the mean time, I'll wait for a call from North Dakota.
Are Nevada Public Companies for Real?
The last post showed that among public companies that seek external financing under Regulation D, Nevada appears to have overtaken Delaware as the top state of incorporation. This statistic is a little bit misleading, however, as we see in this post.
The definition of a "public" company for securities purposes is often tied to whether the company is required to file reports under Section 12 of the Securities Exchange Act of 1934. By this definiton, Nevada is clearly an important player in the incorporation market, with about the same share as Delaware in recent years. But many of the “public” corporations that one finds in Nevada are not what one might expect—companies with substantial assets and traded on a major exchange and therefore required to be report under Section 12. In fact, it appears that many of them in fact have no significant operations at all, and their primary purpose for existing is to file reports under Section 12.
To examine this seemingly odd claim, I collected data on whether companies in the data set fall into several categories that are subject to special treatment by the SEC. Specifically, I searched the 10-K (or 10-Q if no 10-K was filed) of each company for the following terms: (1) “reverse merger”, (2) “penny stock company”, (3) “shell company”, (4) “development-stage company”, and (5) “blank-check company.” Each of these terms is used by SEC regulations to denote a set of companies that are singled out for special scrutiny because of the potential for abuse. Note that none of these categories indicates that a company is violating the law, merely that the company has limited operations and assets and is susceptible to being a vehicle for securities fraud.
The Table below sets forth the percentages for various states of each category for Nevada and Delaware. More data is available in the paper that accompanies this analysis.
The table shows that Nevada has about twice as many companies in each of these categories, except “blank-check companies” where it is second to Delaware. Indeed, most of Nevada’s public reporting companies (64%) are penny stock companies, which generally refers to companies not traded on an exchange with a share price of less than $5. These statistics would not be encouraging for a substantial operating company considering reincorporating in Nevada.
Because many of the categories above are overlapping, perhaps more telling is the percentage of “normal” public companies in each state. By “normal” companies, I mean those that are not in any of the five categories above. Turning the analysis above areound, the next table gives the percentage of normal public companies together with the percentage of public companies in the top 10,000 public companies according to the SEC.
The information in the table is striking. Only about 14% of Nevada's public corporations are normal public corporations, where in Delaware the majority are. It is also clear that normal public companies are in the top 10,000, and being a non-normal companies are not in the top 10,000.
Why are these companies public reporting companies when they are so insignificant? In many cases the whole purpose of the companies is merely to be public so that they can serve as a "back door" IPO vehicle for another company. The real question is why has Nevada attracted so many companies in these categories? I will leave this to future posts and the comments.
An earlier post showed that Delaware is dominant state of incorporation for private companies that raise external financing. California was second with about 7% and Nevada was third with about 4%. A follow-up post showed that virtually all corporations incorporate in either their home state or Delaware. In fact, Delaware had about 91% of the corporations incorporated out of state. But Nevada had a respectable second place finish with about 5% of out-of-state incorporations. That is an especially impressive figure when one considers that the remaining 4% is spread among the other 48 states.
Overall, Delaware had about 62.5% of the private companies, as shown in the prior post "Where Do Privately Held Corporations Incorporate?" But how would Delaware fare among public companies reporting to the Securities and Exchange Commission? For many years, Delaware has been thought uniquely adapted to the needs of public companies, so we might expect it to have an even greater share there. We use the same data derived from Form D filings to find information on public companies. I determine whether a company is a reporting company by whether it has filed a 10-K or 10-Q on EDGAR.
Somewhat surprisingly the data show that among public companies filing reports with the Securities and Exchange Commission, Delaware actually has a substantially lower share than it had among private companies. Only 48% of the public reporting companies were incorporated in Delaware. Nevada was again second, but among the public companies its share was far higher, with about 27% (compared to 4% for private companies).
Indeed, not only does Nevada have a huge chunk of the reporting companies, it has had a rise in its share over the last several years. Among corporations incorporated prior to 2007, Nevada had a 20% share compared to Delaware’s 52%. Among those incorporated in 2007 or later, Nevada had a stunning 47% compared to Delaware’s 35%.
Is Delaware losing its grip on public companies to Nevada’s competition? The story is more complex, as we will see in the next post.

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