Any state that aspires to be a serious contender in the competition for corporate charters must have a specialized corporate law court. Delaware leads this competition in part because of its Court of Chancery, which has produced an exceptional body of case law that governs many of the most significant corporations. Some jurisdictions are attempting to create high-quality corporate law courts to attract corporations, and a recent article contends that specialized courts are essential to resolving corporate law cases that raise questions about whether it is more efficient to compensate shareholders through legal remedies or leaving them to rely on self-help measures.

In a new article, I take a different approach. I look outside of Delaware and argue  that generalist courts can serve as a sufficient protector of minority shareholders and have some unappreciated advantages over specialized courts.

Generalist courts decide numerous cases each year involving disputes that touch on corporate governance. Most of these cases involve a claim that a corporation violated federal securities law by issuing materially misleading disclosure to shareholders. For the most part, these cases have not generated memorable opinions. Scholars and practitioners would be hard pressed to name a corporate law opinion by a generalist court comparable to Delaware decisions such as Weinberger, Unocal, Revlon, or Caremark. These iconic Delaware cases illustrate how specialized judges have the incentive and ability to create exceptional law that is taught, debated, and routinely applied to resolve corporate disputes.

Our system of state regulation of corporate governance has faced unprecedented pressure as controlling shareholders have become more common in large U.S. corporations. The Berle and Means corporation that is characterized by dispersed shareholders with little control over management is not as dominant as it once was in the United States. Many of the largest technology companies have shareholders with significant voting stakes and influence over the board. Some controlling shareholders have been vocal about their displeasure with adverse decisions in shareholder litigation. A few decisions by Delaware courts have prompted some controlled corporations to leave Delaware for jurisdictions such as Nevada and Texas, which are establishing their own specialized courts and offer more protection from liability than Delaware. Delaware has responded by providing additional protection to controlling shareholders that reduce the ability of the Delaware Court of Chancery to evaluate controlling shareholder transactions for fairness. A significant number of articles, here and here, have examined these developments and some have proposed reforms within Delaware to better regulate controlling shareholders.

Generalist courts, however, are not unfamiliar with resolving disputes between controlling and minority shareholders. Because many controlling shareholders often exploit their access to information to take advantage of minority shareholders, they often misrepresent facts or fail to disclose material information about transactions that are unfair to minority shareholders. The U.S. Supreme Court has erected procedural barriers that have reduced federal suits by minority shareholders to a trickle, but there are still viable federal avenues for minority shareholders to challenge the decisions of controlling shareholders.

Generalist courts have some unappreciated advantages over specialized courts in making corporate law. They do not have the expertise of specialized courts, but their obscurity is a strength in a world where controlling shareholders have been willing to pressure states when specialized courts issue decisions against their interests. Generalist judges who may decide only a single controlling shareholder case over their career will be less subject to pressure than specialized judges who will decide many such cases. While they may not have the incentive of specialized courts to develop prominent corporate law doctrines, many generalist judges have sufficient experience to competently decide in an individual case whether a controlling shareholder deceived a minority shareholder.

Federal law, which is typically administered by generalist judges, thus provides a backstop to state corporate law, which can become more lenient as states compete to attract corporations. The states cannot completely eliminate minority shareholder rights because federal remedies will remain. Indeed, generalist federal courts reduce some of the competitive pressure on Delaware in that they limit the ability of Nevada and Texas to provide radically different protection for controlling shareholders than Delaware. While there is reason to be concerned that generalist courts will make lower-quality law than specialized courts, federal law lessens some of the concern that Delaware’s SB 21 and a renewed competition for charters will eliminate protection for minority shareholders.

If the race for corporate charters results in a world where specialized state courts are unable to adequately regulate controlling shareholder transactions, generalist federal courts should take note. They should be less willing to defer to state corporate law regulation when the states are forced by competitive pressures to eliminate meaningful regulation. While specialized courts may be the best option in adjudicating controlling shareholder transactions, generalist courts have sufficient competence to police important aspects of such transactions.

Significant federal preemption of state corporate law is not yet warranted, but Congress could engage in selective federal preemption by loosening procedural restrictions on private suits alleging material misrepresentations arising out of abusive controlling shareholder transactions. Such a reform would increase the ability of generalist federal courts to deter controlling shareholder misconduct. While such a course of action might increase the costs of litigation, targeted measures could be justified to check the power of controlling shareholders. The Securities and Exchange Commission (SEC) should also take note of these developments. It is not subject to the same doctrinal limitations as private plaintiffs and should increase its scrutiny of controlling shareholder transactions and when appropriate file enforcement suits in generalist courts.

In an ideal world, specialized courts would decide the fairness of controlling shareholder transactions without interference. The expertise of the Delaware Court of Chancery has produced a rich body of law governing the relationship between controlling and minority shareholders. In a second-best world, generalist courts can provide the opportunity for minority shareholders to bring suit against controlling shareholders. Generalist courts can competently decide claims that minority shareholders were misled by a controlling shareholder. The obscurity of generalist judges protects them from the pressure of powerful interests.

As the number of controlled public corporations increases, the regulation of public corporations may need to evolve. A system with minimal federal regulation of corporate governance may not be optimal in a world where states cannot resist the pressure of a race to the bottom. At least for now, some minor adjustments to federal rules and a more active role for the SEC in policing controlling shareholder transactions may be sufficient.

James J. Park is a professor at the University of California, Los Angeles (UCLA) School of Law. This post is based on his recent article, “Generalist Courts and Controlling Shareholders,” available here.