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It was 1965, three years before the Summer of Love. The Vietnam War was heating up. Civil rights, student protests and the flowering of the counterculture were all unfolding. Wall Street was showing new dynamism after more than three decades of hibernation. For all of that, Wilmington, Del., was probably not the American city most sensitive to generational tremors rumbling throughout the land. Wilmington was a conservative place, a city with a Southern feel dominated by the du Pont family, the Wilmington Trust and its corporate law franchise. Delaware, its Court of Chancery, its Supreme Court and its three major law firms had dominated corporate law since early in the 20th century, fattening the state fisc with corporate domicile fees.
And yet, Delaware's elite were sensitive to the need for change in corporate law. By the early 1960s, Delaware's politicians and lawyers worried that other states were trying to usurp their state's leading role as a corporate law venue. New Jersey and New York had overhauled their corporate codes, and even Nevada had adopted a new one in an effort to take aim at Delaware. In response, Delaware Secretary of State Elisha Dukes suggested the Wilmington corporate bar undertake a revision of the state's code. In 1964, W.S. Potter, the senior partner at what is now Potter Anderson & Corroon LLP, recommended that the state's corporate bar tap Ernest Folk III, a professor at the University of North Carolina School of Law, to re-examine its corporate law and recommend changes. Potter was on the board of visitors at the University of Virginia and was trying to recruit Folk back to his law school alma mater. (He succeeded in 1968, and Folk spent the rest of his career as UVA's William S. Potter Professor of Law.) Folk produced a 400-plus-page memo that summer on the corporate code Delaware first adopted well over a century ago. In Wilmington, the three local law firms each selected an associate and a partner to revise the old law. With Folk's memo as a starting point, they gathered each Saturday morning beginning in 1965 in offices that Morris Nicholas Arsht & Tunnell LLP had in that bastion of Wilmington high society, the Hotel du Pont, then just a block from the Court of Chancery and Supreme Court. The group reviewed the statute, considered Folk's proposed revisions, argued legal points and generally freshened it up for the legislature. In a year, they were done, and the Delaware Legislature passed the revisions in 1967. Technically, the revision of the so-called Delaware General Corporation Law is now 41 years old. It would be of mere antiquarian interest -- if that -- had the revision not succeeded in preserving Delaware's dominance as a home for large American companies during a period that may well have been the most turbulent, even transformational, in the history of American corporate finance.
Delaware lawyers love to trumpet their state's hegemony in corporate law, and at a May 5 conference in Wilmington honoring the 40th anniversary -- again, the 41st, but who's counting? -- of the revision of the DGCL, it was Edward Welch's turn. Welch, a partner at Skadden, Arps, Slate, Meagher & Flom LLP's Wilmington outpost, began his presentation by noting that Delaware corporations now account for 63% of the Fortune 500, up from 61% last year. More than half the companies on the New York Stock Exchange, Nasdaq, and Amex -- including the first two exchanges themselves -- are Delaware corporations, Welch told the audience of lawyers and judges. And, he added, more than 80% of all U.S. companies taken public since 2003 became Delaware corporations. The recitation of the statistics, and the conference itself, testifies to Wilmington lawyers' keen awareness of the importance of Delaware's corporate law franchise, which forms the core of their legal practice and generates about a fifth of the state's annual budget through franchise taxes -- in 2008, a projected $664 million of the state's $3.4 billion budget. While the state's politicians want to preserve a rich revenue stream, its lawyers and judges want to maintain their prominent role in corporate America -- desires that also animated the 1967 revision. Then, the threat was competition from other states, which were updating their corporation codes. That 1967 revision effectively crushed other states' hopes to compete with Delaware. But since the early 1970s, the greatest threat to Delaware has come not from state rivals but from Washington, where the reach of the Securities and Exchange Commission has extended further and further into corporate governance and Congress has shown greater interest in regulating corporate behaviour. That evolution arguably began with the Williams Act regulating tender offers in 1968, just as the DGCL was going live. In the late 1970s, the Wilmington bar worried about the possibility that Congress would pass a federal corporate code -- the initiative faded and was not revived -- and fretted in the early part of this decade that the Sarbanes-Oxley Act, a response to corporate scandals atEnron Corp. and WorldCom Inc. , improperly intruded onto its turf. As Charles Crompton Jr., a retired partner at Potter Anderson and one of the DGCL associates says, "[Sarbanes was] the first federal statute that gets into the details of corporate governance." Now another threat has emerged, as Delaware Vice Chancellor Leo E. Strine Jr., discussed in a speech at the May 5 conference. The judge touched on calls for congressional action that would grant shareholders a say on executive compensation and make it easier for them to nominate and elect directors. Most corporate lawyers strongly oppose the first measure and are at best lukewarm on the second. Strine predicted that pressure for such reforms were not about to abate. Presidential candidates Hillary Clinton, John McCain and Barack Obama all support the idea of "say on pay," the notion that shareholders should have more direct power over management pay, and institutional investors have long clamored for cheaper, easier access to proxies. Strine suggested that concessions on the second point could blunt calls for a say on pay and head off federal regulation or legislation that might well turn out to be unwieldy or ill conceived. "One of the things we have to do is think wisely about our own predicament," the judge advised his peers in the Delaware bar, "corporate law federalists" who, like him, believe the area should be left to the states. Such thinking inspired the 1967 act that Strine, Welch and others were honoring. The Delaware Legislature adopted the forerunner of the current DGCL in 1899. The initial version was modeled on New Jersey's corporate law, at the time the venue of choice for most U.S. companies. That changed when Woodrow Wilson was elected New Jersey governor in 1913 and set about toughening its corporate law, which drove many companies to reincorporate in Delaware. Then as now, three firms dominated the bar -- Morris, Nichols, Arsht & Tunnell LLP, Potter Anderson and Richards, Layton & Finger PA -- and the revision of the DGCL was in large measure turned over to lawyers at that threesome -- the Delaware General Corporation Law Revision Committee. Potter found Folk, who spent the summer of 1964 in Chapel Hill writing the DGCL report; he was paid $5,000. "He worked without air conditioning, perhaps with the whir of a fan," wrote Mae Kuykendall, a professor at Michigan State University College of Law, in a law review article on Folk's career. "His office supplies would still have included mimeograph stencils and, if he were lucky, an electric typewriter." Why Folk? Beyond Potter's interest in recruiting him for UVA Law School, Folk had served as the reporter for the South Carolina code revision two years earlier. Despite suffering from polio, he would become a leading corporate law scholar until his death in 1989. The report was exhaustive, says Crompton. "It contained a summary of almost every different variation of state statutes on [various aspects of corporate law], how each was treated by important jurisdictions, commentary made on those topics and Folk's views on what he thought would be the best approach to take. The most vital thing he did was to compile all the approaches that had been taken by the various states." Folk filed his report with the revision committee on Aug. 3, 1964. The next April, three senior members of the Wilmington corporate bar -- Samuel Arsht of Morris Nichols, Richard Corroon of Potter Anderson and Henry Canby of Richards Layton -- took up his report. Each tapped a young associate for assistance, a clear signal of who they thought was the finest young talent in their respective firms. Arsht turned to Walter K. Stapleton, who was appointed to the U.S. District Court in 1970 and then to the 3rd Circuit Court of Appeals in 1985, where Strine clerked for him. Corroon tapped Crompton, who ran Potter Anderson from 1988 to 1997. And Canby turned to Charles Richards Jr., who headed Richards, Layton from 1988 to 1991. The six men met on Saturday mornings in Stapleton's office at the Hotel du Pont. As Stapleton noted in an interview on the process that ran in Delaware Lawyer entitled "Folk at 40," "Where our conference room was located, there was a door into the hotel. You could call from the conference room and get room service." They worked through the statute line by line, going over each section several times. Informed by those discussions and comments from other members of the Delaware and national corporate bars, the younger lawyers drafted revisions of various sections. Conservatism and flexibility were the watchwords of the revision. On the one hand, Richards told Delaware Lawyer, the revision committee didn't change language the lawyers understood, even if Folk argued for clearer wording in his report. But, Crompton says, the committee also hoped to craft a statute "that would allow corporate owners, stockholders, management to create whatever kind of business venture they wanted and to clarify what requirements there were and what they meant." As thorough as the revisers were, they paid almost no attention to federal law. "We had very little interactions with the SEC," Crompton says. "There wasn't really any tension between state and federal rules then that I recall. We knew what areas and topics the SEC rules would cover and what other regulations, like the NYSE rules, might apply to public companies, but the Delaware statute as an enabling act was never in conflict with these other requirements." Richards agrees. "I don't recall us discussing the Securities and Exchange Commission at all," he told Delaware Lawyer. "There was some communication with the SEC as to what their view was about things, but I don't recall ever getting any input from them." At the time, the SEC narrowly focused on disclosure, a concern that has since come to involve many aspects of governance. The committee was sensitive to competition from other states, but after the Delaware legislature passed the revised DGCL in 1967, that game ended. "It's fair to say that after the statute was amended, the fear of competition from other states was never anywhere near as intense," Crompton says. Delaware has never overhauled its corporate code again. Instead, the state institutionalized the revision process. A committee of 21 lawyers reviews the DGCL annually and makes occasional changes to it that the state's legislature approves "as a matter of course," says Lawrence Hamermesh, a corporate law professor at Widener University School of Law and a former Morris Nichols partner who's the only nonpractitioner on the committee. "The group is conservative in resisting change for change's sake," he adds. "You don't see a lot of big substantive changes." Hamermesh offers a recent example of the committee's strong desire to avoid such changes. "Two years ago, the fate of the world seemed to hinge on what to do about majority voting for directors. We were under a great deal of pressure to make majority voting the default rule, which we didn't do. We did do a couple of things that weren't very controversial that did gently facilitate majority voting." But as Strine outlined in his speech, As a result, Delaware courts allowed target boards to foil hostile bids with poison pills while also ruling that boards facing all-cash bids had to take the best offer reasonably available rather than just dig in their heels. But even as the Delaware courts tried to balance the rights of management and shareholders, the latter continued to clamor for a larger role, a crusade they have taken to Washington. Robert Thompson, a professor of corporate law at Vanderbilt University Law School, argues that shareholder voting is especially ripe for federal incursion because the DGCL says so little about it, despite being a cornerstone of the code. "Continued silence [on the issue] will invite an ever-broadening reach of federal regulation that will make Delaware's statutes, judges and lawyers less relevant in corporate law," Thompson predicted in a piece for Delaware Lawyer. "Where state law has been silent on questions such as shareholder nominations and agenda proposals, federal law has provided affirmative rules." At the conference, Thompson argued that if Delaware doesn't address shareholder voting, Congress will, and in a more "happenstance, idiosyncratic" way than corporate lawyers would prefer. But amending the DGCL isn't the only way Delaware can respond to a changing environment. In listing the state's advantages for corporations, lawyers invariably nod to its Court of Chancery, the most sophisticated business court in the country and one whose judges know corporate law as well as the lawyers who come before them. Other states have attempted to copy Chancery, just as they've tried to compete with the DGCL, but none has come close to succeeding. Chancery not only interprets the DGCL; as a court of equity, it has broad leeway in fashioning decisions, a freedom it uses to respond to situations and structures that the DGCL doesn't explicitly contemplate, such as hostile bids and poison pills. If the lawyers charged with revising Delaware's corporate code tread very lightly upon it, Chancery's rulings keep the state's law current without advancing it too aggressively. It's a delicate balancing act. Shareholder voting is a classic example. Strine's speech on shareholder access closely followed two decisions in which judges on the Court of Chancery read a corporate bylaw narrowly so as to allow dissident shareholders to propose their candidates for election to a company's board. On March 13, Chancellor William B. Chandler III issued Jana Master Fund Ltd. v. CNET Networks Inc., in which he found that a CNET Networks Inc. bylaw did not give the company grounds to prevent activist hedge fund Jana Master Fund Ltd. from nominating its candidates. And on April 14, Vice Chancellor John Noble concluded similarly in Levitt Corp. v. Office Depot Inc. Both cases closely parsed the language in specific bylaws, but lawyers saw a broader message in them, as numerous law firms intoned in memoranda to clients. Mark Morton, a partner at Potter Anderson, said at the conference: "Members of the bench are acutely aware of the political winds, of what stockholders think, what pressure could be brought to bear in Washington. If you're looking at bylaws, you should be looking at them with that in mind." Strine's speech, which will appear in the August issue of Business Lawyer, showed how much Delaware's judges sense those pressures for change. Strine began by saying most Americans are "forced capitalists." With the demise of defined-benefit pension plans, they have to invest money in the stock market to fund their retirement and their children's college educations. Most of this investment flows to institutional investors. And even though those investors tend not to be activist shareholders, Americans' broad participation in the stock market does give activists a powerful political argument that shareholders deserve a greater say in corporate governance. That argument has centered on say on pay and corporate-funded shareholder access to the proxy, debates Strine followed closely enough to be able to offer a nuanced history of them. And, he added, both he and fellow Vice Chancellor Stephen Lamb discussed the relationship of state corporate law and federal proxy rules with members of the SEC on several occasions -- a stark contrast from 1967, when the DGCL committee had almost no interaction with the SEC. Strine was absolutely clear in arguing that the SEC should stick to regulating the information public companies disclose to the public and leave corporate law to the states. But he noted the paradox that the SEC already allows shareholders access to a company's proxy for nonbinding shareholder resolutions -- that a company remove its poison pill or have only a single class of directors. Yet the SEC does not allow shareholders to nominate directors on the proxy. Despite intense pressure over the past few years from institutional investors for access to the ballot, the SEC chose to retain its current position. Many Delaware lawyers argue that this is the right result, since director elections are a matter of state law, but Strine argued the shortsightedness of that view. If shareholders have access to the proxy, he said, then their arguments for say on pay are reduced, since they can elect directors who set CEO pay, which under state law is exclusively the province of the board and on which shareholders can have no say. If shareholders are denied such access, Congress may step in, an outcome no "corporate law federalist" would want. A one-time counsel to former Delaware Gov. Thomas Carper, Strine remains passionate about politics, and his speech featured an acceptance of horse-trading that not all Delaware judges share. Still, the CNET andOffice Depot Inc. decisions show that Strine's colleagues on the bench are just as capable of responding to pressures from outside the state as he is. The Delaware bar is quick to sense those messages and advise their clients accordingly, even if the state doesn't respond by amending the DGCL. Such accommodation lets Delaware make interstitial changes in its corporate code while outflanking threats to its pre-eminence in corporate law. Folk would have wanted it that way. - David Marcus Categories Deal Video
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