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State Law and Corporate Governance

24. What is the role of state law in corporate governance?

State corporate law is the primary law governing corporate governance and operations. Each state passes its own statutory corporate laws and develops its own common law surrounding those statutes. Shareholders seeking to bring actions to enforce their rights must generally do so under state law. Many state legislatures, rather than independently drafting corporate statutes, adopt the Model Business Corporations Act (MBCA) as the default corporate law in that state. The MBCA is a model set of laws prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association. Twenty-four states have chosen the wholesale adoption of the MBCA. This practice has added a degree of uniformity to state statutory law across state borders.

A corporation may incorporate in any state, whether or not the corporation carries on business in that state. This is a common practice when a corporation wishes to take advantage of a state’s favorable legal environment for businesses operations. The most common state for incorporation by businesses that operate primarily outside of that state is Delaware. That is, many corporations (particularly public corporations) incorporate in Delaware but establish their headquarters in other locations. Delaware does not follow the MBCA, and corporations organizing in Delaware do so with the purpose of availing themselves with Delaware’s corporate governance provisions and court system. Delaware allows for several legal benefits that make it a popular choice for companies headquartered in other states, including:

•    Developed Corporate Law – Delaware has an extensive body of corporate law (statutory and common law) that is generally considered to be more thoroughly developed than other states. While the point is debatable, many argue that the Delaware body of corporate law is more favorable to managers (officers and directors) than shareholders.

•    Legislative Responsiveness – The Delaware legislature prioritizes corporate law by reacting quickly to propose legislation dealing with important issues. This is important when gaps in statutory law could lead to uncertainty in corporate governance or procedure.

•    Chancery Court – Delaware has a dedicated chancery court to hear corporate law matters. This is an executive court controlled by chancellors (judges) who are experts in corporate law. The chancery court does not allow for jury trials, so the chancellor serves as fact finder in legal disputes before the court.
All of the factors provide greater degrees of certainty and comfort to corporate managers and directors.

•    Discussion: Why do you think corporations prefer to have a well-developed body of corporate law? Why do you think corporations prefer to adjudicate legal disputes involving corporate law before a chancellor rather than a jury? Why do you think that the legislature is so responsive in acting upon corporate law issues? (Hint: Think about the nature of statutory law versus common law.)

•    Practice Questions: Why do many corporations organize in Delaware as apposed to their primary states of operation?

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