The Contested Edges of Internal Affairs

During a four-month span in late 2018, two events occurred at opposite ends of the country that could dramatically reshape the regulation of corporations in America. First, in September 2018, California enacted the nation’s first law mandating board gender diversity for all public corporations that are physically headquartered in California.[1] Second, in December 2018, the Delaware Court of Chancery in Sciabacucchi v. Salzberg ruled that a corporation may not in its governing documents regulate the rights of its shareholders arising under federal securities law.[2] Although seemingly unrelated, I argue in a forthcoming article that both events share at their core a challenge to the internal affairs doctrine – a doctrine that is at the foundation of the state-based system of corporate law in the United States.

The internal affairs doctrine is a widely accepted choice-of-law principle. It provides that the internal affairs of a corporation – that is, “matters peculiar to the relationships among or between the corporation and its current officers, directors, and shareholders”[3] – are governed by the laws of the state in which the corporation is incorporated. The internal affairs doctrine is what has enabled Delaware to play a unique and outsized role in regulating corporate America. Although Delaware represents less than one-third of 1 percent of the U.S. population, more than half of all publicly traded companies, including two-thirds of the Fortune 500, are incorporated under Delaware law. Thus, because of the internal affairs doctrine, Delaware sets the rules of corporate governance for most of the nation’s largest businesses. But California’s new statute, together with Sciabacucchi, raise new questions about the scope of the internal affairs doctrine – and, consequently, Delaware’s lucrative regulatory domain.

In the past, Delaware courts, in cases like McDermott, Inc. v. Lewis[4] and VantagePoint Venture Partners 1996 v. Examen, Inc.,[5]  have invoked the internal affairs doctrine to jealously protect the state’s corporate law from encroachment by other states. And the judicial response in Delaware to California’s new gender diversity statute is likely to be no different than those earlier precedents. But Sciabacucchi represents something new in Delaware law. Rather than invoking the internal affairs doctrine to fend off incursions into Delaware’s regulatory domain, the court in Sciabacucchi invoked the doctrine to limit the regulatory reach of Delaware. Although Sciabacucchi is novel in that sense, viewed more broadly, it is consistent with the Delaware courts’ past use of the doctrine. The difference is that, in invoking the internal affairs doctrine, Sciabacucchi sought to protect Delaware’s regulatory domain, not from encroachment by other states, but from the risk of a damaging collision with federal law.

But to the extent Delaware relies on the internal affairs doctrine to preserve its role as the nation’s preeminent regulator of corporate governance, California’s new statute, together with Sciabacucchi, highlight a vulnerability in Delaware’s position: The boundaries of “internal affairs” are inescapably indeterminate. One cannot draw a neat line separating internal corporate affairs from external matters because the two inevitably bleed into one another.  Internal corporate affairs can readily have external consequences. And external matters can readily implicate internal corporate affairs.  In either case, the relevant question is the degree of the spillover.  California’s gender diversity statute and shareholder rights arising under federal securities law each underscores this reality.

To be sure, Delaware courts may attempt to provide clearer definition to the boundaries of the internal affairs doctrine through cases like Sciabacucchi. But for Delaware courts to assert something is an “internal” corporate affair – for example, the gender composition of a corporation’s board – is to say it is excluded from regulation by other states. And for Delaware courts to assert something is an “external” matter – for example, shareholder rights arising under federal securities law – is to say that no state’s corporate law can address the matter either. Naturally, other states may have a different perspective. Thus, even if other states profess adherence to the internal affairs doctrine, they may not sheepishly acquiesce to the doctrinal boundaries drawn unilaterally by Delaware.

The ability of other states to contest the scope of the internal affairs doctrine puts Delaware – and, therefore, the many corporations that rely on Delaware law – in a precarious position.  Some states may take a more cramped view of the doctrine, enacting laws like California’s gender diversity statute that encroach on matters otherwise governed exclusively by Delaware. And other states may take a more expansive view of the doctrine, authorizing their domestic corporations to adopt governance provisions of the type that Sciabacucchi invalidated and thus attracting corporate charters away from Delaware. In either scenario, the scope of Delaware’s lucrative regulatory domain shrinks.

Notably, the challenges that other states may press at the boundaries of the internal affairs doctrines are not something that Delaware can fend off by simply relying on the internal affairs doctrine’s purportedly constitutional underpinnings. Because even if other states are constitutionally compelled to adhere to the internal affairs doctrine, as Delaware courts and some commentators assert, that still leaves open the question of the doctrine’s precise boundaries.  The indeterminacy at the edges of the doctrine, and the ability of other states to exploit that indeterminacy, is what makes Delaware’s regulatory domain susceptible to challenges.

For Delaware to be protected from such challenges, the U.S. Supreme Court would need to not only find a constitutional basis for the internal affairs doctrine, but also provide firmer definition to the doctrine’s boundaries. Given the inherent indeterminacy of the internal/external distinction, however, finding a constitutional basis for the internal affairs doctrine would only ensnare the U.S. Supreme Court in haphazard, case-by-case line drawing.  That reality alone may be enough to dissuade the court.  But in any case, relying on the U.S. Supreme Court to define the edges of the internal affairs doctrine will not fully resolve Delaware’s vulnerability. The vulnerability merely shifts from the self-interested challenges of other states to the whims of a distant federal court unconcerned with Delaware’s parochial interests.

Challenges at the edges of the internal affairs doctrine, like those that emerged in late 2018, are a problem unlikely to go away for Delaware. Since California enacted its first-in-the-nation board diversity statute, state legislatures in Illinois and New Jersey have considered similar bills. And earlier this year, an activist  shareholder initiated litigation against the New Jersey-chartered Johnson & Johnson, pressing it to adopt a bylaw provision mandating arbitration for all shareholder claims brought under federal securities law. These developments suggest that skirmishes at the frontiers of the internal affairs doctrine are likely to persist. And these skirmishes could both erode Delaware’s hegemony and fundamentally reshape the regulation of corporate America.


[1] See 2018 Cal. Legis. Serv. Ch. 954 (S.B. 826) (West).

[2] See Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018).

[3] Edgar v. MITE Corp., 457 U.S. 624, 645 (1982); accord McDermott Inc., 531 A.2d at 215 (quoting Edgar).

[4] McDermott Inc. v. Lewis, 531 A.2d 206 (Del. 1987).

[5] VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005).

This post comes to us from Professor Mohsen Manesh at the University of Oregon School of Law. It is based on his recent article, “The Contested Edges of Internal Affairs,” available here.