The differences between Nevada and Delaware corporate law – which I call “Nevadaware divergence” – are the subject of media attention, scholarly critique, and current litigation. The common wisdom is that Nevada is, as some say, “the place to reincorporate when you’re sick of Delaware’s micromanaging.” In a new article, I aim for a fuller understanding of Nevada corporate law, both substantively and theoretically, as compared with Delaware corporate law.
Nevada corporate law is more nuanced than common wisdom suggests. I assume that Nevada, like Delaware, has sought to balance the competing policy considerations underlying corporate law but has reached a different result with respect to some aspects. Building on that premise, I highlight Nevadaware divergence – not only in substantive corporate law, but also in each state’s balancing of the competing policies underlying corporate law.
Nevadaware Divergence on Exculpation
Contrary to most scholars, I argue that the most significant impact of Nevada’s exculpatory statute, which protects officers and directors from monetary liability for certain breaches of fiduciary duty, is neither its status as a default rule that must be opted out of, rather than opted into, in the charter, nor its potential applicability to duty of loyalty claims. Rather, I contend that its broad applicability to officers and its placement of the burden of proof on the party seeking to impose monetary liability are far more impactful. I also contend – controversially – that breaches of the duty to act in good faith are not exculpated in Nevada, because Nevada’s interpretation of the exclusions to exculpation aligns with Delaware’s interpretation of “bad faith.” Thus, I argue that the only divergence in the scope of exculpation is Delaware’s non-exculpation of good faith breaches of the duty of loyalty.
When balancing the competing policy implications of exculpatory provisions as applied to directors, both Delaware and Nevada seek to limit the negative impacts of exposure to monetary liability. However, in several respects, Delaware’s exculpation is more circumscribed than Nevada’s, demonstrating that Delaware affords greater weight to the countervailing deterrence and compensation goals of monetary liability. First, Delaware does not exculpate good faith breaches of the duty of loyalty – such as interested transactions that fail the entire fairness test – while Nevada does. Second, Delaware places the burden of proof on the party seeking to be exculpated, while Nevada places the burden of proof on the party seeking monetary damages. These differences have the greatest effect in the context of interested transactions. In Delaware, exculpation does not apply to the interested parties; in Nevada, exculpation still potentially applies, imposing the burden of proof on the party seeking monetary relief to prove the directors’ knowledge of wrongfulness.
As applied to officers, Nevada prioritizes limiting the negative impacts of exposure to monetary liability more than Delaware does, while Delaware prioritizes the deterrence and compensation goals of monetary liability far more than Nevada does. In Nevada, officer exculpation is automatic, while in Delaware it requires a charter provision (which, unlike director exculpation provisions, have not yet been widely adopted). In Nevada, officers are exculpated in both direct and derivative suits, while Delaware limits exculpation to direct suits. Finally, this differential treatment of officers in Delaware and Nevada is compounded by the different scopes of exculpation and burdens of proof.
Nevadaware Divergence on Appraisal
Although Nevada’s appraisal statute provides for more triggering events than Delaware’s, including reverse stock splits, the breadth of Nevada’s “market-out” exception – which applies even to cash-out mergers – renders the appraisal remedy far less potent in Nevada than in Delaware.
When balancing the competing policy implications of the appraisal remedy, neither Delaware nor Nevada seeks to compensate all dissenting shareholders for the fair value of their shares. Delaware’s appraisal remedy is limited to mergers and consolidations. Even if there is a triggering event, the Delaware market-out exception forecloses the appraisal remedy when public shareholders receive shares instead of cash, and the de minimis exception forecloses the appraisal remedy, even for cash-out mergers, if the requisite dissent threshold is not met. Nevada’s appraisal remedy is triggered by a slightly broader set of transactions but, like Delaware’s remedy and unlike the Model Business Corporation Act’s, not by sales of assets. In addition, Nevada’s broad market-out exception applies even to cash-out mergers of public shareholders. For shareholders of non-public companies, Nevada’s appraisal remedy reflects slightly greater concern for the compensation of dissenting shareholders than Delaware’s; for shareholders of public companies, Delaware’s appraisal remedy reflects significantly greater concern for the compensation of dissenting shareholders than Nevada’s.
With respect to the traditional liquidity rationale of appraisal and the modern anti-opportunism rationale of appraisal, Delaware’s market-out exception primarily furthers the liquidity rationale, with a nod (in light of the exclusion for cash-out mergers) to the anti-opportunism rationale. Nevada’s market-out exception, which applies equally to cash-out mergers, furthers the liquidity rationale without regard for the anti-opportunism rationale. Neither Delaware’s nor Nevada’s market-out exception follows the MBCA’s lead of excluding “interested transactions” from the market-out exception to directly further the anti-opportunism rationale of appraisal.
Nevadaware Divergence on Freeze-Out Mergers
When balancing the competing policy implications of freeze-out mergers, Delaware affords the greatest weight to minority-shareholder protections and, accordingly, creates an incentive for approval by an independent committee of directors and an informed majority of the minority shareholders. Minority shareholders are not confined to the appraisal remedy unless their complaints are based solely on price. Absent these two approvals, the entire fairness standard of review applies, which allows for second-guessing directors’ decisions, limits controlling shareholders’ ability to act in their own best interest (and may even inhibit shareholders from attaining controlling status) and creates an incentive for strike suits that are nearly impossible to dismiss on the pleadings. Only if these approvals occur does the deferential business judgment rule standard of review apply. In addition to protecting the minority shareholders, however, these approvals risk killing the deal altogether or increasing the merger price, perhaps inefficiently.
When balancing the competing policy implications of freeze-out mergers, Nevada prioritizes deferring to the board’s discretion, encouraging mergers, and deterring strike suits and de-emphasizes protecting minority shareholders. If appraisal is available, minority shareholders who seek to challenge a merger must plead and prove “actual fraud” to avoid the exclusivity of appraisal. Moreover, even absent any minority-shareholder protections, to establish a breach of fiduciary claim against directors, minority shareholders must rebut the business judgment rule and overcome the exculpatory provision. To plead a breach of fiduciary duty claim against the controlling shareholder, the minority shareholders must satisfy the heightened Rule 9(b) pleading standard with respect to the transaction’s entire fairness. Because there are fewer incentives for the adoption of minority-shareholder protections, they are less likely to be adopted in Nevada, akin to pre-MFW[1] mergers in Delaware. As a result, minority shareholders are less protected, and mergers are more likely to occur (and potentially at reduced prices). In addition, because controlling shareholders’ conduct during freeze-out mergers is less likely to lead to liability than in Delaware, controlling shareholders are more likely to act in their own best interests and are less likely to be discouraged from achieving controlling status. In light of Nevada’s de-emphasis on protecting minority shareholders, investors may be unwilling to invest as minority shareholders, may demand greater protections through private ordering, or may demand share price concessions in light of their greater risk of being frozen out without remedy.
Conclusion
Across the board, Nevada more than Delaware prioritizes the policy goals of minimizing the negative impacts of potential monetary liability on officers and directors (such as discouraging qualified individuals from serving or making risky decisions) over the competing policy goals of deterring breaches of fiduciary duty, compensating shareholders and corporations for fiduciaries’ breaches, and creating incentives for minority-shareholder protections. One would expect shareholders to include these potential benefits and risks when deciding whether to invest in a Nevada corporation and when valuing its shares. Ultimately, investors will decide whether the balance that Nevada has struck, albeit divergent from Delaware’s, is an attractive balance of the countervailing policies underlying corporate law for some firms and, if so, at what price.
ENDNOTE
[1] Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014).
This post comes to us from Professor Wendy Gerwick Couture at the University of Idaho. It is based on her recent article, “Nevadaware Divergence in Corporate Law,” forthcoming in the Virginia Law & Business Review and available here.