In response to fears that companies would reincorporate in states like Texas or Nevada, the Delaware legislature recently enacted a controversial bill (SB-21) that makes the state’s law friendlier to persons controlling corporations. Many writers have commented on the Delaware caselaw that triggered this change, on whether the fears of reincorporation were justified, and on whether the law’s disrespect for Delaware courts might discourage Delaware incorporations in the long run[1]. In a forthcoming article, I examine a basic problem with the statute that has been ignored in all the Sturm and Drang surrounding its enactment.

Simply put, two key parts of the statute’s provisions addressing transactions with controlling stockholders are fundamentally at war with each other. They are the definition of controlling stockholder[2] and the provisions dealing with approval by so-called disinterested directors of transactions with a controlling stockholder.[3]

These two parts of SB-21 respond to the primary complaint motivating the statute. As illustrated in recent cases involving Elon Musk, Delaware courts had increasingly expanded the definition of controlling stockholder for the purpose of triggering the Delaware Supreme Court’s holding in MFW – which requires controlling-stockholder transactions to receive approval by independent directors and a majority of the minority shareholders to avoid judicial scrutiny under the entire fairness test. Critics argued that this expansion made it unclear who qualified as a controlling stockholder and that MFW’s burdensome cleansing formula should be confined to freeze-outs and the like.

To meet these complaints, SB-21 focuses the definition of controlling stockholder on a stockholder’s power to elect a majority of the board and treats controlling stockholder transactions, other than freeze-outs and the like, largely the same as Section 144(a) of Delaware’s corporation statute treats director and officer conflicts. This allows approval by so-called disinterested directors alone to preempt judicial scrutiny of the fairness of controlling stockholder transactions. This dual response creates an oxymoron.

SB-21’s definition of controlling stockholder and its provisions on disinterested directors juxtapose fundamentally inconsistent assumptions. One is that the power to elect and remove directors creates the power to bend the decisions of those directors. The other is that individual directors will protect the corporation and minority stockholders from a stockholder who elected and can remove them – unless the individual directors have some outside relationship with this stockholder. The result is a conflict between the reasons for defining controlling stockholder status in terms of voting power and the impacts of allowing so-called disinterested directors to insulate from careful judicial scrutiny a transaction involving the stockholder who elected them.

While defining controlling stockholder in terms of voting power was meant to stop courts from considering all the ways a person might have influence over a majority of directors, this accounts only for what the definition excludes and not for what it includes: in this instance, why the definition focuses on voting power, and specifically the power to elect a majority of the board, instead of another criterion.

The rationale for focusing on the power to elect a majority of the board is obvious even if rarely stated: This power normally creates sufficient influence over the directors to cause a reasonable person to question whether the directors can be objective in dealing with the person who elected them. Reject this assumption and SB-21’s definition of controlling stockholder makes no sense.

SB-21 then allows approval by directors to avoid judicial scrutiny of the fairness of transactions with the stockholder who elected them so long as those directors lack any material relationship with that stockholder. The result conflicts with the purposes behind both what the controlling stockholder definition excludes and what it includes.

In terms of the former, determining whether directors are disinterested can reintroduce the uncertainty that narrowing the definition of controlling shareholder sought to exclude, such as the potential influence over the directors by a “superstar CEO”.

To mitigate this uncertainty, SB-21 contains a couple of provisions addressing the determination of director disinterest. These provisions, however, seemingly conflict with the reason for what the definition of controlling stockholder includes – —that control stems from voting power. One provision[4] states that a party’s nominating, designating, or voting for a director does not itself prevent a finding of disinterest, while the other[5] establishes a strong presumption of disinterest for directors meeting an applicable stock exchange definition of independence. Since stock exchange definitions necessarily exclude being a director from the relationships undermining independence, controlling stockholders can invoke the heightened presumption of disinterest for the very directors they elected. These two provisions fuel an argument that plaintiffs must point to some relationship other than being a director serving at the sufferance of a controlling shareholder in order to establish a lack of disinterest – which, of course, makes one wonder why the statute defines control in terms of the power to elect directors. Moreover, the irony is that neither of these two provisions prevent a court, in determining director disinterest, from looking at all the sources of influence other than voting power, which is what set off the complaints when it came to determining controlling stockholder status.

My article discusses three possible outcomes of this fundamental inconsistency in SB-21: The good (interpreting the statute, despite the provisions just discussed, to follow the premise which underlies defining control in terms of the power to elect directors); the bad (interpreting the statute to facilitate the tunneling of a disproportionate amount of corporate wealth to controlling stockholders who rely upon approval by the very directors they elect); or the ugly (judicial muddying of the waters by working backward from what the court thinks of the merits of the challenged deal to find the gross negligence, lack of good faith, or lack of disinterest that will allow it to invalidate a transaction despite the fact that these standards are designed to avoid evaluating the merits).

Fortunately, this last and most likely outcome will probably limit the worst tunneling. Unfortunately, deal lawyers will then complain about a lack of transactional certainty, powerful parties will threaten reincorporation outside of Delaware, and we will begin the cycle again.

ENDNOTES

[1] Eric Talley, Sarath Sanga & Gabriel V. Rauterberg, Delaware Law’s Biggest Overhaul in Half a Century: A Bold Reform – or the Beginning of an Unraveling?, The CLS Blue Sky Blog, https://clsbluesky.law.columbia.edu/2025/02/18/delaware-laws-biggest-overhaul-in-half-a-century-a-bold-reform-or-the-beginning-of-an-unraveling/ (February 18, 2025).

[2] Del. Gen. Corp. L. § 144(e)(2).

[3] Id at (b)(1).

[4] Id at (d)(3).

[5] Id at (d)(2).

This post comes to us from Franklin A. Gevurtz, Distinguished Professor of Law at the University of the Pacific, McGeorge School of Law. It is based on his recent article, “The Oxymoron at the Heart of Delaware’s Making Elon Happy Legislation” forthcoming in the San Diego Law Review and available here.