All empires eventually decline. For decades, Delaware has held the crown as the premier state of incorporation for domestic companies (and many foreign companies seeking a foothold in the United States capital markets). But today, the barbarians are at the gates. Will state corporate law power fracture into an Eastern empire in Wilmington and a Western empire in Austin or Sin City?

Maybe. But it won’t be easy for the Western hordes. Delaware has strong fortifications and a wide moat. Almost 70% of Fortune 500 companies and almost 80% of 2023 IPOs are Delaware business entities. The fundamental underpinnings of United States corporate law mostly come from Delaware courts.

When studying an empire, a good scholar makes sure to closely examine its foundational myths. Here is the story that Delaware tells about itself:

The question is often asked—why Delaware? Why does this small state (the second smallest in the United States) occupy such a large place in the world of business entities?

. . . .

Delaware is neither “management-friendly” nor “stockholder-friendly”; its aim is to provide both managers and investors with laws optimal for engaging in ethical and profitable business, by balancing the need for managerial flexibility with strong tools to hold managers accountable for using that flexibility to advance the best interest of investors. Delaware’s judges are impartial and not beholden to special-interest donors or shifting political winds.

As myths go, the tale that Delaware tells is credible and largely accurate. Delaware business judges patiently oversee a well-developed legal system that seeks to balance strong protections for officers and directors with meaningful relief for shareholders when significant corporate disputes occur. While it is tough to prevail as a minority shareholder in Delaware disputes, there are real avenues to recover from officers, directors, and controlling shareholders in exceptional cases.

Some managers would prefer to operate in a jurisdiction where these shareholder protections don’t exist. For many years, Nevada has positioned itself as a “liability-free jurisdiction.” Nevada’s efforts have been met with some success, but certainly nothing to meaningfully shake Delaware’s tree. And, in the last year, Texas has also emerged as a competitor, and may attempt to cast itself as more credible than Nevada’s Wild West yet more management-friendly than Delaware.

Are recent prominent examples of corporate flights—Tesla, SpaceX, and TripAdvisor—evidence of an impending exodus from Delaware? Or are these one-offs?

For many public companies, it will be tricky to achieve reincorporation in a new state given that a shareholder vote is usually required. This makes the endeavor both expensive and somewhat fraught if the reason to reincorporate really is, “we prefer that our shareholders have fewer protections than what they currently have as a Delaware corporation.”

New entities, however, face a wider landscape of choice. Will founders increasingly advocate for incorporation in more permissive regimes? How will legal advisors and seed investors react? What impact might incorporation outside of Delaware have on a company’s ability to attract the types of future investors that it needs to scale and to ultimately enter the public markets?

It is too soon to tell. To inform the discussion, we’ll review some of the key differences between the legal frameworks governing securities disputes in Delaware, Nevada, and Texas. We’ll also discuss the potential impact on D&O insurance.

Business Courts

Delaware

The 1980s produced a “thicket” of acquisition-related litigation against Delaware corporations. Since then, the Delaware Court of Chancery—and, in many vital cases, the Delaware Supreme Court— has defined the rules for how directors and officers must manage and oversee their organizations.

1. Judges: Delaware Chancellors and Vice-Chancellors live, laugh, love, eat, sleep, dream, and die with corporate law principles on their lips. There are currently seven judges on the Court of Chancery. The judges are all creatures of Delaware corporate law. Before joining the bench, they generally spent their careers in law firms focused on corporate litigation in the Court of Chancery.
2. Specialization: In practice, the Court of Chancery’s docket is almost entirely composed of corporate and commercial litigation.
3. Precedent: Delaware has a deep pool of judge-made corporate law, filled over decades, of rules and guidelines for managers, directors, and corporations. While litigation is always unpredictable, skilled litigators in Delaware business disputes can draw on decades of detailed precedent to make compelling arguments. The strength of this precedent also means that disputes may be avoided in the first place because corporate lawyers can provide clear advice to their clients. Strong legal rules can also make it easier for both sides to settle nasty cases. In an unexplored legal borderland, it’s hard to figure out if a plaintiff has an unrealistic view of their likelihood of success, or if a defendant is being unnecessarily recalcitrant.

Nevada

In the early 2000s, Nevada established two semi-dedicated business courts, one in Las Vegas and one in Reno.

1. Judges: Most of the incumbent judges appear to hail from general prosecutorial and/or general litigation backgrounds.
2. Specialization: The judges on these courts hear a mix of business, general civil, and (in some cases) criminal disputes. While there has been discussion of establishing fully dedicated specialist business courts, Nevada has not taken this step to date.
3. Precedent: Nevada’s business courts do not issue published opinions. This means that judge-made business common law is scant in Nevada. This, in turn, means that it is very difficult to predict how a court will react to a novel fact pattern or a dispute that tests the margins of the law. Given the breadth of Nevada’s protections for officers and directors, however (see below), it may be that this consideration is less meaningful than it would be in a state with more opportunities for shareholders to sue directors.

Texas

Starting in September 2024, high-dollar shareholder derivative suits and securities litigation will be heard by brand spanking new Texas business courts, including both trial courts and a dedicated court of appeals. Let’s take a look at the key substantive features of Texas’s newborn business courts.

1. Judges: The judges for the Texas business courts are hand-picked by the state governor. In June 2024, the Governor Greg Abbott appointed his first slate of business judges. The first batch of appointees are sitting Texas judges and business lawyers. The statute requires that appointees have at least 10 years of experience with business law or as a civil judge.
2. Specialization: Texas is following the Delaware model: its business courts will be dedicated to deciding significant corporate disputes. Proponents of the legislation creating the new courts argued that the business courts would relieve the caseload faced by other state courts and foster predictable outcomes from expert judgments. The Chamber of Commerce and other corporate interest groups supported the legislation, suggesting the view that a business court in Texas will almost certainly be—on balance—business-friendly.
3. Precedent: Under preliminary rules for the new business court, written opinions will apparently be the norm. This means more work for judges, but presumably more precedential opinions that will form the basis of principled and somewhat predictable litigation outcomes for Texas corporations.

Fiduciary Duties, Exculpation, and Business Judgment Rule

Delaware

Under Delaware law, officers and directors have little risk of personal liability for managing and overseeing a corporation—but there are some meaningful exceptions that provide avenues of recovery for plaintiffs.

1. The Delaware General Corporations Law allows companies to exculpate officers and directors unless they breach their duty of loyalty, obtain improper personal benefits, or engage in bad faith or intentional misconduct or knowing violations of the law.
2. Shareholder derivative litigation often takes one of two general forms: (1) challenging a business transaction as benefitting insiders and/or control persons at the expense of minority shareholders; or (2) in the wake of a dramatic corporate loss or scandal, alleging that directors and officers breached their duty to the company by failing to prevent the issue.
3. In connection with corporate transactions, the business judgment rule insulates most behavior from liability under Delaware law. However, if a majority of directors who approve the transaction are conflicted, a heightened entire fairness review may apply. This means that the Delaware courts will scrutinize both the process and the substance of the transaction to see if it was reasonable, or whether it improperly advantaged controlling or insider interests at the expense of common shareholders.
4. With Caremark (i.e., duty of oversight) claims—one of the most common theories advanced by shareholders—plaintiffs must show that officers and directors failed to implement a system of corporate controls and/or consciously failed to respond to red flags in bad faith.
5. Plaintiffs face long odds in succeeding on either type of claim. However, when they do succeed, settlements can be eye-popping. Recent examples include Boeing (Caremark,$287 million) and Dell (transaction, $1 billion).

Nevada

As we have seen, under Delaware law, directors are broadly exculpated for most—but not all —breaches of fiduciary duty. In Nevada, the wild west of corporate law, these protections go even deeper.

1. In Nevada, the business judgment rule has been codified by the legislature, and it can only be rebutted with a specific showing (see below). Under Nevada statute, “Directors and officers, in deciding upon matters of business, are presumed to act in good faith, on an informed basis and with a view to the interests of the corporation.”

2. In Delaware and other jurisdictions, corporations are prohibited from indemnifying directors for breaches of the duty of loyalty. Nevada, in contrast, provides for universal blanket indemnification unless:

   a. The business judgment rule has been rebutted; and

   b. The director or officer has engaged in a breach of fiduciary duty that involves “intentional misconduct, fraud, or knowing violation of the law.”

3. In a 2020 case, the Nevada Supreme Court held that to establish a “knowing violation of the law,” a director or officer must have had “knowledge that the alleged conduct was wrongful.” Gross negligence is not enough. As any litigator will tell you, this is a difficult test to meet, and certainly broader than the standard applicable to fiduciary duty claims in Delaware Chancery Court.
4. Unlike Delaware, Nevada does not have an entire fairness standard of review for conflicted transactions.

Texas

1. As in Delaware, a corporate director’s fiduciary duty in Texas is mostly a creature of judge-made common law. Texas law recognizes that directors owe a corporation the duties of obedience, care, and loyalty.
2. In Texas, "the business judgment rule protects corporate officers and directors from being held liable to the corporation for alleged breach of duties based on actions that are negligent, unwise, inexpedient, or imprudent if the actions were ‘within the exercise of their discretion and judgment in the development or prosecution of the enterprise in which their interests are involved."
3. To rebut the business judgment rule, the Texas Supreme Court has indicated that a plaintiff must identify “ultra vires, fraudulent, and injurious practices, abuse of power, and oppression on the part of the company or its controlling agency clearly subversive of the rights of the minority, or of a shareholder, and which, without such interference, would leave the latter remediless.” Consistent with this language, recent state appellate court rulings suggest that gross negligence is not enough to rebut the business judgment rule.
4. Texas law follows a similar structure to Delaware law regarding conflicted transactions and fairness review, but the caselaw in this area does not appear to be well-developed.
5. In the past, Texas courts handling business disputes have often looked to Delaware cases for guidance. As a result, Texas corporate law looks quite similar to Delaware corporate law on its face. Going forward, the specialized Texas business courts will presumably continue to look to Delaware caselaw for inspiration – but they may also look for openings to show that Texas is friendlier to managers and controlling shareholders.

Other Considerations

Other factors to consider include:

• Interests that Directors May Consider: In Delaware, directors must be laser-focused on maximizing shareholder value. In Nevada (and, apparently, Texas), directors are allowed to consider a broader range of considerations, which theoretically might make it more difficult for plaintiffs to allege that they have breached their duties.
• Attorneys’ Fees: Texas caps attorneys’ fees in class actions at 4 times the time actually billed by the plaintiffs’ attorneys on the case. Delaware has no such cap, which can lead to outsized fees for plaintiffs.
• Taxes and Fees: Unlike Delaware and Texas, Nevada does not impose a franchise tax on corporations.

D&O Insurance Considerations

Turning to D&O insurance, recall that the price of insurance is related to the risk being transferred to the insurance carriers. As we have seen, Nevada officers and directors face an apparently lower risk of liability in shareholder litigation than in Delaware. Presumably, this will also be true—perhaps to a lesser extent—in the new Texas business courts. If the chance of winning is lower, presumably plaintiffs will also bring fewer cases against companies incorporated in Nevada (and presumably Texas). Thus, some would argue, companies incorporated in Nevada or Texas should pay less for their D&O insurance than companies incorporated in Delaware.

Maybe. We simply don’t have enough evidence to know if this argument holds water.

Historically, D&O insurance has not been measurably impacted by a company’s state of incorporation. If a body of evidence accumulates over time, this could change. For any differences in pricing or terms to be meaningful, insurance carriers would need to see different loss curves materialize based on state of incorporation—and this kind of data takes time to develop. Moreover, plaintiffs’ lawyers are very resourceful so, if a flight from Delaware really begins to take shape, we can expect them to aggressively and creatively look to create avenues for recovery in the other jurisdictions.

There is a nuance that may come into play sooner than later, however. As our readers know,Side A D&O insurance is designed to protect individual directors and officers from having to pay personally for non-indemnifiable costs. A major non-indemnifiable risk for directors and officers of Delaware corporations is the settlement of derivative suit claims.

Delaware prohibits indemnification of directors and officers for amounts paid to settle shareholder derivative suits because “the corporation would simply be paying itself for injury caused to it by the very directors being indemnified by the corporation.” If Nevada and/or Texas prove to be more permissive on this point, we should expect that the cost of Side A D&O insurance for Nevada and/or Texas corporations will decline compared to the cost of Side A D&O insurance for corporations incorporated in states—such as Delaware—where indemnification of derivative suit settlements is not permitted.

To Delaware Or Not To Delaware? Piercing the Veil of Ignorance

If you are an investor, you may have different roles in different companies. In one, you may be the lead outside investor, with a control position and a majority of board seats. In another, you may be a minority shareholder with a sizeable investment but without a management or board seat and with limited influence over the company’s decisions.

As an investor behind a Rawlsian veil of ignorance, imagine that you don’t know which of these positions you will occupy in any given company. If you have board seats, you will want robust protections to make sure that you are not faced with liability. You will also want well-qualified judges with expertise in complex business transactions. If you have minority common stock, you will want robust protections to make sure that—if the board or management team loot the company, engage in criminal misconduct, waste corporate assets, or engage in a fire sale to benefit their own interests at the expense of shareholders—you will have meaningful remedies in court. You will also want well-qualified judges with expertise in complex business transactions.

Since you don’t know whether you will be a board member or a minority shareholder, you need to find a jurisdiction that balances both considerations, offering you a reasonable place where your rights will be fairly vindicated in almost all relevant scenarios. Following this thought experiment today leads you straight down I-95 to Delaware.

That said, many young companies may—not unreasonably—begin to seek greener corporate pastures out West. The extent of this trend, its consequences, and Delaware’s response (if any) will be revealed in time.