Introduction
One of the most discussed question within the field of corporate law is whether the competition among States in the ‘incorporation’ business leads to the enhancement of corporate law, or to its detriment. After New Jersey’s primacy,[1] Delaware established itself as the undisputed winner of the race, notwithstanding Nevada’s attempt to dethrone it.[2]
Supporters of the “race to the bottom” theory claim that Delaware, by relying on incorporation fees and franchise taxes for a substantial share of its revenues,[3] is incentivized to offer managerial-oriented corporate law, as directors decide where to incorporate.[4] Moreover, Delaware law promotes shareholder value maximization through the allocation of duties of loyalty and care on directors; this entails heavy reliance on court-litigation, not incidentally consistent with a substantial turnover for local lawyers,[5] rather than on direct shareholders’ engagement.
As noted by former Securities and Exchange Commission’s Chairman Professor Cary in his famous article that introduced the modern “race to the bottom” argument,[6] Delaware law was not initially considered a model for the Model Business Corporation Act (“MBCA”),[7] prepared largely by lawyers of the Chicago Bar, because, according to their spokesman, “(it) makes little or no effort to protect the rights of investor[.]”[8] At the end, the race “contaminated” also the MBCA, watering it down to compete with Delaware rather than offering an original alternative model.[9]
Furthermore, as recently pointed out by a scholar, Delaware’s competition in the ‘incorporation’ business could come from offshore jurisdictions such as Bermuda, Cayman Islands, and British Virgin Islands, where shareholders’ rights are deteriorated to a level at which even derivative suits are constricted.[10]
For correcting these distortive effects, supporters of the “race to the bottom” theory argue that a shareholder-friendly playing field should be introduced at the federal level.[11] However, although the threat of Washington’s intervention can put pressure on Delaware,[12] the ‘shadow’ of the federal government has not significantly stretched over Delaware’s corporate law yet.[13]
As a matter of fact, federal intervention today is limited to securities law[14] and to specific issues merely incidental to substantial shareholders’ rights. For example, congress enacted federal proxy rules, but avoided legislating the subject matter that shareholders could vote on.[15] Other areas in which the federal government stepped in are disclosure duties, accounting standards, independent audit committees, executive loans, fraud, and misconducts.[16]
Not content with this status-quo, supporters of the “race to the bottom” theory claim that, since Delaware lawmakers and its prestigious Court of Chancery are incentivized to produce director-friendly corporate law, a federalization of shareholders’ rights is needed.[17]
Interestingly, on the other shore of the Atlantic, the European Union recently concluded a two-decade harmonization process of shareholders’ rights. The next paragraph aims at underlining the main characteristics of this fascinating experiment, namely the creation of a common European corporate law playing field, and at confronting it with the (missing) federalization of shareholders’ rights in the United States.
The European experience
The difference between European Countries is extreme compared to the one between States in the United States. With the progressive enlargement of the European Economic Community (from 1957), and of the European Union (from 1993), the complexity of the integration process increased sharply. Today, the Union counts 27 member States that vary in legal traditions, concentration of share ownership, corporate structure systems, and models of corporate governance.[18]
If the Commerce Clause legitimizes federal intervention in corporate law,[19] the Treaty on the Functioning of the European Union[20] contains provisions which fulfil a dual task, both recognizing a right of establishment[21] and calling for an “approximation of laws” functional to the integration of the common market.[22]
In this sense, the necessity to break through the heterogeneous mix of national legal barriers to further integrate national economies has justified the incessant efforts of the European Union in the harmonization of corporate laws.[23]
When European Court of Justice’s decisions such as Centros Ltd. v. Erhvervs- og Selskabsstyrelsen (1999)[24] expanded freedom of incorporation, that in the United States is based on the Internal Affairs Doctrine,[25] scholars began to wonder whether the creation of a European Delaware was in sight.[26] As someone predicted,[27] 20 years later no State has actively engaged in the ‘incorporation’ business yet.[28] In the meantime, the European Union heavily harmonized shareholders’ rights, so that an eventual development of regulatory competition will find an already established common framework; this will prevent excessive convergence towards managerialism.
One example is the law governing takeovers. Delaware is accused of being strongly oriented to the protection of directors, which are allowed to take defense measures.[29] Controversies are not prevented through shareholders’ voting rights but resolved through court litigation.[30] When the federal government regulated takeovers with the Williams Act (1968), amending the Securities Exchange Act of 1934, it did so by mandating only disclosure requirements.[31] The European Union adopted the opposite approach: the Takeover Directive,[32] notwithstanding a complex system of national opt-outs and opt-ins, mandates a shareholders’ approval of defense measures,[33] therefore avoiding directors entrenchment.
The Shareholder Rights Directive[34] (hereinafter ‘SRD’) and its amendment[35] further contributed to the creation of a common shareholders’ rights framework[36] in three different ways; firstly, it enhanced the centrality of the shareholders’ general meeting; secondly, it facilitated the exercise of existing shareholders’ rights (especially the cross-border exercise of voting rights, necessary to the integration of the common market); thirdly, it promoted a corporate governance model friendly to shareholders.
The federal proxy rules contained in Sec. 14(a) of the Securities Exchange Act and the SRD share a similar rationale, ensuring that well informed shareholders are able to actively participate to general meetings.[37] However, the SRD went well beyond the regulation of proxy statements[38] and shareholders’ proposals;[39] it introduced a principle of equal treatment for all shareholders who are in the same position with regard to participation and the exercise of voting rights;[40] it also facilitated access to relevant information, participation and vote,[41] even through electronic means[42] or by correspondence,[43] and also established a right to ask questions.[44]
The amendment to the Directive dealt with shareholders’ identification,[45] transmission of information,[46] further facilitation of the exercise shareholders’ rights,[47] engagement policies of institutional investors,[48] and transparency of asset managers[49] and proxy advisors.[50] All these provisions, combined with the introduction of a right to vote on remuneration policies,[51] sharply increased shareholders’ rights and partially equalized the role that they play in European corporate governance. A ‘Say on Pay’ regime was also introduced in the United States by the Dodd-Frank Act,[52] proving that public opinion[53] can push for the introduction of federal-mandated substantive shareholders’ voting rights, although neither the European nor the American regulations requires a binding-vote on compensations, only an advisory one.[54]
Conclusion
Although no European Delaware is in sight, a future development of infra-State regulatory competition within the European Union will hit a common framework of shareholders’ rights that will probably prevent a sharp decline towards managerialism. A ‘package’ of shareholders’ rights sparing from rights functional to the participation to general meetings to substantial voting rights and corporate governance provisions, have been introduced in a Union in which diversity between national corporate laws is extreme. This article compared this harmonization process with the (missing) federalization of shareholders’ rights in the United States, advocated by the supporters of the “race to the bottom” theory.
[1] Frederick Tung, Before Competition: Origins of the Internal Affairs Doctrine, 32 J. Corp. L. 33, 36-37, 42-43, 74 (2006).
[2] See Michal Barzuza, Market Segmentation: The Rise of Nevada as a Liability-Free Jurisdiction, 98 Va. L. Rev. 935 (2012).
[3] Peter Molk, Delaware’s Dominance and the Future of Organizational Law, 3 (Univ. of Fla. Levin Coll. of L. Rsch. Paper No. 20-24, 2020), https://ssrn.com/abstract=3552317.
[4] Anne Anderson et al., How State Competition for Corporate Charters Has Changed the Delaware Effect, The CLS Blue Sky Blog (Oct. 16, 2017), https://clsbluesky.law.columbia.edu/2017/10/16/how-state-competition-for-corporate-charters-has-changed-the-delaware-effect/.
[5] Faith Stevelman, Regulatory Competition, Choice of Forum, and Delaware’s Stake in Corporate Law, 34 Del. J. Corp. L. 57, 69-70 (2009).
[6] William L. Cary, Federalism and Corporate Law: Reflections upon Delaware, 83 Yale L.J. 663 (1974).
[7] Id. at 665.
[8] Id.
[9] Id.
[10] William J. Moon, Delaware’s New Competition, 114(6) Nw. U. L. Rev. 1403, 1445 (2020).
[11] See Cary, supra note 6 at 700-704.
[12] This dichotomy has been explored in Mark J. Roe, Delaware’s Competition, 117 Harv. L. Rev. 588 (2003).
[13] See Omari Scott Simmons, The Federal Option: Delaware as a De Facto Agency, Wash. L. Rev. (forthcoming), https://ssrn.com/abstract=3786444.
[14] See the Securities Act of 1933, 15 U.S.C. § 77a et seq., and the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq.
[15] See Stevelman, supra note 5 at 89.
[16] See Stephen M. Bainbridge, The Creeping Federalization of Corporate Law, 26 Regulation 26 (Spring 2003). It should be noted that an intervention at the ‘federal’ level can originate from government, directly or by delegation to the Securities and Exchange Commission, or through listing standards.
[17] See Cary, supra note 6 at 702. Professor Bebchuk, a supporter of the enhancement of shareholders’ rights, acknowledged that the “very forces that have shaped state corporate law in a managerialist direction … might also prevent state law from changing course …. Indeed, … the control over reincorporations that management has under states’ corporate laws is in itself a key factor that discourages states from making rule changes that management disfavors”. For that reason, he proposes that to “the extent that state law will continue to provide management with control over rules-of-the-game decisions”, the adoption of shareholders’ rights should require federal intervention. Lucian A. Bebchuk, The Case for Increasing Shareholder Power, 118(3) Harv. L. Rev. 833, 874 (2005).
[18] In the European Union, common law jurisdictions coexist with civil law ones, closely held companies with Public Companies, one-tier systems with two-tier systems, stakeholder-oriented models with shareholder-oriented models.
[19] See Stevelman, supra note 5 at 60.
[20] Consolidated version of the Treaty on the Functioning of the European Union (2012 O.J. C 326).
[21] Articles 49, 50(2)(g), and 54. Previously, Article 44(2)(g) of the Treaty Establishing the European Community (ex. Art. 54(3)(g) of the Treaty of Rome). See Brigid Gavin, Shareholders’ Rights in the European Union, 93 (1997); Luca Enriques & Matteo Gatti, The Uneasy Case for Top-Down Corporate Law Harmonization in the European Union, 27 U. Pa. J. Int’L L., 939, 945-946 (2006).
[22] Article 114. Previously, Article 95 of Treaty Establishing the European Community (ex. Article 100 of the Treaty of Rome).
[23] Areas of corporate law fully or partially harmonized (mainly through directives, instruments that require national implementation) include company registrations, disclosure requirements, transfers of registered offices, maintenances and alterations of capital, mergers and acquisitions, divisions of companies, accounting standards and transparency for listed companies. Moreover, the European Union introduced two corporate forms: the European Company and the European Cooperative.
[24] Case C-212/97, Centros Ltd. v. Erhvervs- og Selskabsstyrelsen, 1999 E.C.R. I-01459.
[25] Stevelman, supra note 5 at 60.
[26] Eddy Wymeersch, Centros: A Landmark Decision in European Company Law, 18 (Fin. L. Institute Working Paper 99-15, 1999).
[27] Tobias H. Tröger, Choice of Jurisdiction in European Corporate Law – Perspectives of European Corporate Governance, 6(1) Eur. Bus. Org. L. Rev. 3 (2005).
[28] See Carsten Gerner-Beuerle et al., The Illusion of Motion: Corporate (Im)Mobility and the Failed Promise of Centros, 20 Eur. Bus. Org. L. Rev. 425 (2019).
[29] See Stevelman, supra note 5 at 68-69.
[30] Id. at 74.
[31] Id. at 73.
[32] 2004 O.J. (L 142) 12 (CE) Takeover Directive (Directive 2004/25).
[33] Article 9 (so called ‘passivity rule’, which avoids non-approved post-bid defenses). The Directive also introduced a Mandatory Bid Rule, still unknown to Delaware law, and a provision on pre-bid barriers (article 11, so called ‘breakthrough rule’).
[34] 2007 O.J. (L 184) 17 (CE) Shareholder Rights Directive (Directive 2007/36).
[35] 2017 O.J. (L 132) 1 (EU) Shareholder Rights II Directive (Directive 2017/828), hereinafter ‘SRD II’.
[36] The European Union is a supra-national organization, not (yet) an official federal entity. See Matej Avbelj, The Treaty of Lisbon: An Ongoing Search for Structural Equilibrium, 16(3) Colum. J. Eur. L. 521 (2010).
[37] “State protection of shareholders’ voting rights and the integrity of corporate proxy machinery had been inconsistent and inadequate, and Congress acted to fill the perceived void that threatened to relegate shareholders in public issue corporations to the unenviable position of passive investors at the mercy of entrenched management[.]” Daniel E. Lazaroff, Promoting Corporate Democracy and Social Responsibility: The Need to Reform the Federal Proxy Rules on Shareholder Proposals, 50 Rutgers L. Rev. 33, 35-36 (1997).
[38] SRD, supra note 34 at article 5 (‘Information prior to the general meeting’).
[39] Id. at Art. 6 (‘Right to put items on the agenda of the general meeting and to table draft resolutions’).
[40] Id. at Art. 4.
[41] Id. at Arts. 7, 13.
[42] Id. at Art. 8.
[43] Id. at Art. 12.
[44] Id. at Art. 9.
[45] SRD II, supra note 35 at Art. 3a.
[46] Id. at Art. 3b.
[47] Id. at Art. 3c.
[48] Id. at Art. 3g.
[49] Id. at Art. 3i.
[50] Id. at Art. 3j.
[51] Id. at Art. 9a. The Directive also introduced a regulation of Related Party Transactions (Art. 9c), originally conceived as a shareholder voting rights, then watered-down to a more flexible corporate governance provision.
[52] Sec. 14A of the Securities Exchange Act of 1934 (‘Shareholder Approval of Executive Compensation’), introduced by Sec. 951 of the Wall Street Reform and Consumer Protection Act of 2010 (‘Dodd-Frank Act’), Pub. Law 11-203 (July 21, 2010).
[53] See Tyler Huddleston, Say on pay in the Dodd-Frank Act: implications of the results in the United Kingdom, 11(2) Wash. U. Glob. Stud. L. Rev. 483 (2012).
[54] Supra note 52; SRD II, supra note 35 at Art. 9a (the provision was watered-down within the legislative process: the original European Commission’s proposal would have introduced a binding vote).
