Delaware's Preeminence and the Internal Affairs Doctrine (Part 2)

In the last post, I discussed the reasons why Delaware’s chartering franchise is vulnerable to other states’ choosing not to adhere to the internal affairs doctrine. Aware of this threat, the Delaware Supreme Court has acted to protect the state’s interests in an unconventional, and, in terms of judicial norms, questionable fashion.

InVantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005), the Court declared that the internal affairs doctrine is a constitutional mandate, and hence, that other states are barred from regulating the internal affairs of Delaware firms.As detailed in my article, its analysis reveals serious overreaching. Although, on the margins, there may be Dormant Commerce Clause limitations on state regulation of corporate internal affairs, the court’s misuse of precedent and misapplication of the doctrine to the facts before it suggests an unusual disregard for the judicial craft. Moreover, the court’s assertion that a state has no interest whatsoever in regulating the internal affairs of a foreign corporation -- even if the firm has substantial operational and ownership ties to the jurisdiction -- is specious. Taken seriously, such elevation of the parties’ choice of law to a constitutional imperative would have Lochner-like ripple effects, erecting constitutional barriers to state regulation of contractual relations.

Thus, doctrinally suspect, the decision alone is not likely to persuade other jurisdictions through the unforced force of reason. But perhaps that is not what the court intended. Rather, maybe it took such an uncompromising stance to further its goal indirectly: by creating the prospect of ongoing interjurisdictional conflicts distasteful to lawmakers at all levels, the court hoped to deter other states from applying their own entity law to Delaware firms or, alternatively, to create the very conditions that might convince federal lawmakers to bar preemptively other states from doing so.

How might the Delaware Supreme Court have thought this would work? First, other states might defer reflexively to Delaware, as they often do on corporate-law matters, or, lacking the stomach for ongoing interjurisdictional battles, might simply back down. This has already happened, including in the court of appeals decision in the Grosset case mentioned in the last post, although the California Supreme Court just recently affirmed while avoiding the choice-of-law issue.

Second, the prospect of ongoing interstate conflict between Delaware and other states over internal affairs regulation might make federal judges – often uncomfortable with prolonged interjurisdictional tussles – more likely to extend existing constitutional doctrine in ways that favor Delaware. Taking the cue from the Delaware Supreme Court, the 2006 petition for certiorari to the United States Supreme Court in the Friese case (also mentioned in the last post) deployed VantagePoint not only as primary authority for its constitutional assertions, but also as evidence of the need for judicial intervention to resolve interstate conflict over corporate legal norms:

• The decision below not only sweeps aside these fundamental constitutional principles; it brings the California courts into severe tension with the Delaware Supreme Court. That court recently invalidated an effort by California to interfere with the internal affairs of Delaware corporations. . . . Holding that “application of the internal affairs doctrine is mandated by constitutional principles,” VantagePoint Venture Partners 1996 v. Examen, Inc., the Delaware Supreme Court invalidated [the] “quasi-California corporation” provision as applied to a Delaware corporation.
• In this case, by contrast, the California courts have upheld a California law that intrudes at least as seriously into a Delaware corporation’s internal affairs. At issue here is California Corporations Code Section 25502.5. As authoritatively construed by the state courts below, this statute permits a Delaware corporation to sue its own officers and directors, subject to California shareholder demand and board voting rules, for breach of internal duty to the corporation—regardless of what Delaware law might provide. This Court’s intervention is warranted to resolve this deep conflict between the principles adopted by the California and Delaware state courts.

Petition for Writ of Certiorari, Friese, 127 S. Ct. 138 (05-1590).

The Court denied the petition, but the case might make VantagePoint’s claims more appealing to federal jurists by contributing to the appearance of “ongoing interstate conflict.”

Finally, let’s connect the dots. The U.S. Chamber of Commerce has expressedgreat affection for Delaware and its courts; andDelaware and itsjurists have welcomed the adoration. In addition, industry groups have ensured Delaware’s interests were protected in the past, including by helping to press for facially neutral carve-outs under CAFA and SLUSA that primarily benefit the state. And pursuing a Dormant Commerce Clause limitation on state corporate-law reform efforts is consistent with the Chamber’s broader deregulatory agenda (as recently highlighted byJeffrey Rosen). In light of this, the members of the Delaware Supreme Court would have anticipated that the Chamber and its other powerful allies would receive the signal and utilize VantagePoint to try to protect the state. And indeed they have. The Chamber and others have been active in internal affairs litigation elsewhere, including offering similar arguments as amici curiae in support of the Friese petition:

• In sum, whereas Delaware holds as a matter of federal constitutional law that a corporation’s internal affairs are governed “exclusively in accordance with the law of its state of incorporation,” . . . California holds that it may regulate internal affairs of Delaware corporations. The conflict is real, pervasive[,] and entrenched. Only this Court can resolve it." 

Brief for Technology Network as Amici Curiae Supporting Petitioners, Friese, 127 S. Ct. 138 (05-1590).   

Although none of these conflicts (VantagePoint, Grosset, Friese) creates a genuine threat to interstate commerce, the Delaware court might have foreseen that the Chamber would eventually persuade federal jurists – now operating under a “deregulatory presumption” – to bite, at least in terms of imposing some greater impediment to regulation by other states. Moreover, if that approach were to fail, the court likely anticipated that the Chamber and others would seek to use VantagePoint and the disputes over state regulatory prerogatives that followed to press Congress to preempt “further interference” by other states with a national choice-of-law rule privileging Delaware.

Rather than a good faith attempt to interpret and apply legal doctrine, the VantagePoint decision marked the beginning of a campaign to discourage other states from regulating and to lay the groundwork for converting the internal affairs doctrine into a federal mandate. It is worth noting the irony here. Despite the Delaware judiciary’s efforts to stave off federalization of corporate law, VantagePoint suggests these jurists are seeking federal protection to stave off threats from other states.