Thursday, October 21, 2010

How to choose state of incorporation for start-ups: a comparative study of Delaware, Nevada and Wyoming legislation. Part IV.

Below is Part IV of my article comparing certain aspects of Delaware, Nevada and Wyoming business-related legislation. As I said earlier, I wrote this in April of 2010, so the information here may have become outdated. Information contained is this article is for informational purposes only, so please check each state’s laws before making any legal or other decisions with respect to your business. In this Part I discuss two issues that are of interest to business owners: managerial liability and antitakeover provisions.

Managerial Liability

The following discussion pertains to corporations only. Section 102(b)(7) of Delaware General Corporate Law allows shareholders to include a provision in the corporation’s certificate of incorporation exculpating a director for breach of fiduciary duty, except if the director breached duty of loyalty, for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, or if a director derived an improper personal benefit. This provision does not extend to officers. However, recently the Supreme Court of Delaware held in Gantler v. Stephens29 that corporate officers owe the same fiduciary duties as corporate directors. The Court suggested in footnote 37 that in this case corporations should have the ability to exculpate officers as they are allowed to do in the case of directors. It remains to be seen whether legislature will extend Section 102(b)(7) to corporate officers.

While Delaware’s Section 102(b)(7) does not itself limit personal liability of directors but allows shareholders to do so in the charter, Nevada’s Private Corporations Law uses the opposite approach and provides that a director or officer is not individually liable to the corporation, its stockholders or creditors unless there is a breach of fiduciary duties, fraud, intentional misconduct or a knowing violation of law, and unless the articles of incorporation provide for a greater personal liability.30  Unlike Delaware’s law, Nevada’s law covers officers.

Similarly, Wyoming Business Corporation Act provides that officers and directors are not personally liable to the corporation or its shareholders absent certain factors (different standards apply to officers and directors).31

Comparing the three approaches to the statutory limitations on directors’ and officers’ personal liability, it is clear that Nevada’s is the broadest, as it applies to both groups and exculpates directors and officers from personal liability to the corporation, shareholders as well as creditors.

Antitakeover Provisions

This section also focuses on corporations. An issue which primarily concerns companies with many shareholders32 is the state’s stance on antitakeover provisions. Shareholder rights plans or “poison pills” are generally legally vulnerable because they discriminate against specific shareholders. Although these may not be immediate concerns for a start-up company, choosing a state with strong antitakeover laws may save the company costs of reincorporating in a different state down the road.

Nevada and Wyoming have very strong antitakeover laws because, unlike Delaware, they do not impose enhanced fiduciary duties on directors in takeover situations. Instead, they apply the business judgment rule to the use of antitakeover tactics. Nevada does not restrict directors from issuing defenses in response to hostile takeover threats even if they “deny rights, privileges, power or authority to a holder of a specified number of shares or percentage of share ownership or voting power.”33  Although, given the powers granted to directors by Section 78.138.4 of the Nevada Private Corporations law, a “poison pill” may not be necessary to enact at all, since the directors are free to reject a hostile bid in the interests, for example, of the State economy or society:34

Directors and officers, in exercising their respective powers with a view to the interests of the corporation, may consider:
(a) The interests of the corporation’s employees, suppliers, creditors and customers;

(b) The economy of the State and Nation;

(c) The interests of the community and of society; and

(d) The long-term as well as short-term interests of the corporation and its stockholders, including the possibility that these interests may be best served by the continued independence of the corporation.
This is an extremely management-friendly provision that allows directors to consider the interests of shareholders as just one factor among others. Wyoming’s legislature offers an almost identical management-friendly language in Section 17-16-830 of its Wyoming Business Corporation Act.

Delaware, on the other hand, requires heightened fiduciary duties from their directors, as elaborated in the Unocal and Revlon35 decisions. Delaware courts apply the Unocal standard to ensure that the directors’ defensive actions are reasonable in relation to their belief regarding the danger of the takeover to the corporate policies and proportionate to the magnitude of the perceived threat to the corporate policies.36  Therefore, it may be more difficult for Delaware directors to resist a takeover attempt. In response to the concerns with the heightened fiduciary duties of directors, as per the Unocal and Revlon decisions (decided in 1985 and 1986, respectively), in 1988 Delaware’s legislature adopted an antitakeover law (Section 203 of the Delaware General Corporation Law). This section prevents buyers of more than 15% of a target company’s stock from completing its acquisition for three years. A takeover could be completed if (i) the buyer purchased over 85% of the stock, (ii) the target’s board approved it prior to the transaction or (iii) the target’s board and the holders of two-thirds of outstanding shares (excluding shares held by the buyer) approve the takeover at or after the transaction. However, in January 2010, the constitutionality of Section 203 was challenged by the Harvard Professor Guhan Subramanian et al. in his paper “Is Delaware’s Antitakeover Statute Unconstitutional? Evidence from 1988-2008.”37 The debate continues, and the future of this antitakeover provision remains to be seen.


29  See Gantler v. Stephens, No. 132, 2009 Del. LEXIS 33 (Del. Supr. Jan. 27, 2009) (unpublished decision).

30  See NEV. REV. STAT. § 78.138.7 (2001).

31  See WYO. STAT. ANN. § 17-16-842(d) and 831.

32  Bishop, supra note 3 at 4. In closely held firms, there is often little or no separation of capital and management, therefore there is less likelihood of the interest of the owners and managers to diverge.

33  NEV. REV. STAT. § 78.195.5.

34  NEV. REV. STAT. § 78.138.4.

35  Revlon duties come into play when the sale of the company is inevitable. See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A. 2d 173 (Del. 1986).

36  See Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (1985), Moore Corp. v Wallace Computer Services, 907 F. Supp. 1545, 1556 (D. Del. 1995).

37  Available at's%20Takeover.pdf.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

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