Discord tests Delaware’s corporate-friendly image

Delaware’s billion-dollar corporate brand, the state’s bread-and-butter, is facing an unusual amount of pressure.

The state’s unclaimed property law — which requires companies to turn over assets like uncashed checks and dormant stock accounts when there is no clear owner — is facing a constitutional challenge in federal court, and revenue from the program is tanking amid uncertainty.

The U.S. Chamber of Commerce and the Delaware State Bar Association publicly sparred over a new law that bans Delaware corporations from shifting legal costs onto shareholders.

And name-brand corporations, which registered in Delaware for access to business-friendly laws and sophisticated business courts, have not been shy about publicly complaining to policymakers — threatening to pull business out of Delaware if management doesn’t get its way.

In April, Delaware corporation Ancestry.com told members of the General Assembly that the company would consider leaving the First State if lawmakers did not attempt to curtail a surge in shareholder lawsuits.

Delaware law gives executives and directors broad discretion in managing corporate spending, but also affords rights to shareholders who want to challenge the price of mergers and acquisitions.

Now, more than nine in 10 of corporate deals valued over $100 million are challenged, often in Delaware state courts because the companies are legally registered here.

In his letter, William Stern, Ancestry.com’s chief legal officer, said he had long believed that registering the corporation in Delaware was an “unwritten rule” because of the state’s predictable corporate laws. But he questioned whether Delaware’s foundation remained strong.

“Delaware, we were told, had certainty,” Stern wrote. “Delaware, I believed, created stability. Delaware, it was thought, created no unknown liabilities. No more.”

Evidence hardly suggests that Delaware is losing ground as a dominant corporate sanctuary. Sixty-six percent of Fortune 500 companies are registered in Delaware, an all-time high. Google, Walmart, Berkshire Hathaway, AT&T and General Motors are all legal Delaware corporations.

Corporate formations also are surging, with Delaware bringing in more revenue from alternative entities like LLCs and limited partnerships.

But the state’s century-long status as the top U.S. legal home for corporations, long a source of pride and more than $1 billion in annual tax revenue, has been subject to an unusual level of public and political conflict over the past 18 months.

Lawrence Hamermesh, an expert in Delaware corporate law at Widener University, said there’s little evidence of a corporate exodus from Delaware. But he said the disputes have been ratcheted up to a level not seen in recent years.

And the politics could be damaging to Delaware’s corporate dominance.

“I’d love to go back to a state where nobody paid any attention and we all went about our business,” Hammermesh said.

The intense lobbying effort of one company — banana importer Dole Food Co. — has defined much of the debate over the past year.

Last September, Dole’s top lawyer sent an email to Gov. Jack Markell’s chief of staff complaining the state was doing too little to regulate costly shareholder lawsuits in Delaware courts.

The fruit importer is a Delaware-registered corporation, but also has clout among Delaware policymakers as the Port of Wilmington’s largest tenant. So the email from Dole attorney Genevieve Kelly was taken seriously.

Kelly’s note pointed to a recent panel in New York where lawyers explained how investors could use mergers-and-acquisition lawsuits in Delaware against corporations as a way to increase profits. She was especially annoyed that Wilmington plaintiffs’ lawyer Stuart Grant was one the panelists.

Grant, a longtime Democratic donor and ardent supporter of Markell’s political campaigns, was suing Dole in Delaware Chancery Court on behalf of hedge fund clients, challenging the chief executive officer’s proposal to buy the company for $1.6 billion and take it private.

“It’s panels like the one described in the attached that show companies why there is a need to re-incorporate in more business friendly states,” Kelly told Michael Barlow, the governor’s top aide, in the email obtained by The News Journal through a Freedom of Information Act request.

However, Dole’s lobbying effort in Dover might have come to an abrupt end on Thursday.

The company lost its lawsuit, with Vice Chancellor J. Travis Laster writing that company executives fraudulently drove down Dole’s stock price to make it cheaper for the CEO David Murdock to take the company private.

Laster ordered Murdock and former Dole Chief Operating Officer C. Michael Carter to repay shareholders $148 million. Dole officials would not comment.

Grant, the Wilmington lawyer who sued Dole and represents shareholders in similar lawsuits, dismissed the complaints and threats from corporate America. He says companies are merely trying to leverage their status as taxpayers to pry legal changes favorable to corporate management.

Shareholders still believe Delaware is too management friendly, Grant says.

“My view is Delaware probably has it just right since the bitching and moaning is about the same on both sides,” Grant said.

Delaware policymakers have carefully guarded Delaware’s incorporation business since 1899, when the General Assembly first passed a broad, business-friendly incorporation law.

Corporations registered here also gain access to Delaware’s Court of Chancery, a preeminent venue for corporate litigation since 1911.

This year, the share of Fortune 500 companies incorporated in Delaware for access to its corporate laws and courts reached an all-time high of 66 percent. On paper, Delaware’s corporate dominance is strengthening, despite complaints and threats from corporations to take their businesses and run.

Delaware’s share of new initial-public-offerings hit a record last year, and the number of new public companies registering in Delaware was the highest since the dot-com era, according to state government data.

Revenue collected by the Delaware Department of State, the agency responsible for registering corporations and protecting Delaware’s corporate-friendly image, also is higher than ever, tracking near $1.1 billion. Corporate revenue, mostly sourced from outside Delaware’s borders, now funds about 41 percent of Delaware state government operations.

“The corporate franchise is the strongest it has ever been,” said Jeff Bullock, the Delaware Secretary of State.

Yet the problems are real.

When Markell signed the fee-shifting ban in June, the president of the Chamber’s Institute for Legal Reform, said the group was “disappointed that Delaware chose not to enact measures to deter abusive merger-and-acquisition lawsuits while prohibiting an important and useful tool for combating these unjustified lawsuits.”

As Dole targeted lawmakers last fall, the Delaware Business Roundtable, led by a DuPont Co. tax lawyer, publicly advocated for changes to Delaware’s unclaimed property law, including a softening of rules around corporate tax audits.

Disputes over Delaware’s unclaimed property law pose the most immediate financial threat to taxpayers, and to policymakers in Dover.

Projected revenue from unclaimed property sources has tanked 20 percent since the spring, when a federal judge refused to dismiss a lawsuit filed by Temple-Inland Inc., a division of Memphis-based International Paper Co.

Delaware’s law allows the state to seize unclaimed assets like uncashed checks and unused gift cards, if companies do not voluntarily turn them over.

But Temple-Inland Inc. claimed in federal court that Delaware audits rely too heavily on estimation techniques, not actual records, in calculating liability dating back to the early 1980s. Delaware has hied two outside law firms — paying up to $816 hourly — to defend the state against Temple-Inland’s claims in federal court.

And after the March ruling that allowed the lawsuit to proceed, lawmakers took steps to nurse Delaware’s image.

In the final hours of the legislative session this summer, lawmakers gave approval to reforms that shortened the window of unclaimed property audits, long a request of Delaware corporations. They also made permanent a voluntary program that allows corporations to prevent more aggressive probing of their books.

Michael Houghton, a partner at Morris Nichols in Wilmington who represents corporations in unclaimed property disputes with Delaware, said the reforms represented “major changes” that would help protect Delaware’s corporate franchise.

But Houghton said relying on money from the program to balance Delaware’s budget — it paid for 15 percent of Delaware operations in 2013 — still contradicts the purpose of the law itself, which is intended to help reunite unclaimed property with its rightful owners.

“Unclaimed property has never been intended, under the law, to be a revenue source for the states,” Houghton said.

Lawmakers will not be able to avoid more discussions on Delaware corporate law come January, when they return to Dover.

The corporate council of the Delaware State Bar Association, an influential panel that recommends Delaware corporate law changes to the General Assembly, is planning to meet again to make recommendations on ways to address complaints around shareholder lawsuits, a debate that likely will persist even after the Dole decision.

At the center of the debate are costly shareholder suits known as “appraisal” challenges that contest the share price of an acquisition or management-led corporate buyout.

Many of those cases are set in Delaware courts because the state is the legal home to two-thirds of Fortune 500 and more than 50 percent of all American publicly-traded companies. And Delaware has seen a boom in recent years, with the number of cases up more than two-fold in recent years.

Shareholders who contest buyout share prices in court stand to increase their share at the settlement table, or in a judge’s ruling. They are also guaranteed interest that accrues while the legal fight is ongoing, a particular source of concern for corporate management.

“There has been a change in the way stockholder litigation gets conducted in the last 10 years that has caused problems and there are some legitimate gripes on the corporate side about that litigation,” said Hammermesh, the Widener expert.

A measure recommended earlier this year would have allowed corporations to pay shareholder balances up front, thereby avoiding interest payments. Lawmakers never considered the change.

“There’s naturally going to be push and pull on these things,” said Matthew O’Toole, a partner at Potter Anderson in Wilmington who chairs the corporate council. "That’ll work its way out in the legislative process.

“The Bar Association tries to strike a balance,” O’Toole said, “between the different constituencies that are involved in corporations and in terms of the legislative proposals that we recommend to the General Assembly.”

Contact Jonathan Starkey at (302) 983-6756, on Twitter @jwstarkey or at jstarkey@delawareonline.com.