On February 20, Delaware Supreme Court Chief Justice Collins Seitz met with members of the state’s General Assembly and delivered some sobering words: “Along with our respect for your legislative judgments, I ask you to consider the importance of judicial independence.”

Judicial reticence prevented Chief Justice Seitz from saying more about pending legislation and pending litigation, so let me spell it out.  Delaware’s system of judicial oversight over corporate directors and officers will be undone if the General Assembly votes next month to enact Senate Bill 21, legislation hastily introduced to appease Elon Musk and similarly situated founders with major stockholdings.

Last year, the Court of Chancery struck down Musk’s $56 billion Tesla pay package. Musk responded by engineering the reincorporation of Tesla to Texas and by tweeting that no one should incorporate companies in Delaware.  Tesla and Musk are represented on appeal by leading law firms, and everyone will have their say before the Delaware Supreme Court.  But in the meantime, Musk has attacked Chancellor Kathaleen McCormick as corrupt, just as he calls for the impeachment of the federal judge who denied him access to Treasury Department records.

Musk possesses immense political power in Washington, D.C., as well as immense influence through his social media platform X, where he controls the algorithm and content moderation.  But so far only a small handful of companies with controlling stockholders have followed Musk’s lead and reincorporated out of Delaware.  Alarmist claims of a corporate exodus have not materialized.

One might expect Delaware’s legal and political elites to take pride in our state’s Court of Chancery and Supreme Court and not be spooked by a few tweets and a couple of departures.  After all, Delaware remains the preeminent domicile for the largest corporations and most prominent start-ups.

Additionally, Delaware historically markets itself globally based on the strength of its judiciary and its case law. In the words of a booklet published by a leading Delaware practitioner a generation ago that remains on the Delaware Secretary of State’s website:

The case law, created over the years by the Court of Chancery and the Delaware Supreme Court, is the tangible evidence of Delaware’s corporation law expertise. It is this highly developed body of case law, more than the statute, which is “the Delaware corporation law.”

The existence of this body of law has great practical advantage for those deciding where to incorporate. First, Delaware law is the common currency of corporations. Lawyers and judges everywhere are familiar with the law and respect it.[1]

But there is a new political climate in Delaware.  Law firms representing Elon Musk and other founders have manufactured a crisis atmosphere and seized an opportunity.  They realized that they could magnify their clients’ concerns and draft legislation that insulates them from future litigation, which would be a greater victory than trying to prevail on every case in court.  This legislation will also bolster Musk’s position in his appeal.

Meanwhile, Delaware’s newly elected governor, Matt Meyer, seeks to make amends with Musk and satisfy wealthy supporters.  The biggest financial backer of the governor’s primary campaign was Phil Shawe, himself a disgruntled litigant who spent years bashing the Delaware courts and urging companies to reincorporate out of Delaware.  Rhetorically and politically, the governor has not stood up for Delaware’s judiciary.

Delaware’s current system of stockholder litigation already makes it difficult for a public stockholder to succeed in court when challenging a self-dealing transaction.  Judge-made law sets the parameters of what types of internal corporate documents are available before filing suit.  Legal precedent similarly establishes whether the pleading standards are satisfied for assessing if individual directors are truly independent, or if the board of directors or the stockholders were fully informed.

Only the most thorough complaints survive a motion to dismiss and entitle a plaintiff to obtain additional documents and question deal participants.  To succeed at trial is no small feat, and succeeding on appeal is rare.  Delaware judges are appropriately skeptical of challenges to a board vote or a stockholder vote.

If passed, Senate Bill 21 would sweep away this system and overturn more than 30 decisions of the Delaware Supreme Court.  New rules would restrict access to internal corporate documents, create new statutory safe harbors for defendants, and make it harder to establish that a director lacks independence from a controlling stockholder.

In short, the bill would make it all but impossible for a stockholder plaintiff to argue that outside directors or public stockholders were misled by insiders.  Controlling stockholders such as Musk would be empowered to engineer transactions that extract wealth from public stockholders without accountability in a courtroom. And this new legal regime would disempower the judiciary.  Stockholder litigation in Delaware would evaporate.

Senate Bill 21 is misguided.  It damages Delaware’s reputation and undermines the state’s preeminence by rendering its distinctive case law obsolete.  National journalists, concerned citizens, academics, and institutional investors are all raising serious questions.  Why are Delaware Democrats eager to bend the knee to Musk and his counterparts at other controlled companies with publicly traded stock?  Why is Delaware so concerned about protecting self-dealing transactions by ego-driven founders, who represent a tiny fraction of the entities that pay franchise taxes? Aren’t self-dealing transactions deserving of judicial scrutiny?

The rush to pass this legislation – bypassing the traditional drafting process – only compounds these concerns.  Legislators need to heed the words of Chief Justice Seitz and pay respect to our judiciary and the decisions they have rendered.

ENDNOTE

[1] Lewis S. Black, Jr., Why Corporations Choose Delaware 7 (2007), https://corpfiles.delaware.gov/pdfs/whycorporations_english.pdf.

This post comes to us from Joel Friedlander, a founding partner at Friedlander & Gorris, P.A., who has more than 30 years of experience litigating breach of fiduciary duty actions and corporate governance disputes in Delaware.