Incorporating in Delaware – Small State, But Big Business

Have you noticed that every large company is incorporated in Delaware, if you have noticed that have you ever wondered why? The short answer is because our federalist system creates competition among states and free flowing commerce through the states.

Federalism Makes States Compete

Once incorporated in a state, a business may generally use that state's laws to govern most of their interactions with their customers, even those customers who are out of state. Thus, most companies choose the state which has the most advantages for their business. Delaware has become the clear winner because of a mixture of its business laws, extensive case history, low taxes and the ease in which a business may incorporate.

A company is not obligated to have any actual employees or business in the state in which it incorporates in. Not only is Pepsico, Inc. (Pepsi) incorporated in Delaware but several regional bottling subsidiaries are incorporated there as well: Pepsi-Cola Bottling Company of Ohio, Pepsi-Cola Bottling Company of Rocky Mount, NC and as well as Wisconsin's Pepsi-Cola Bottling Company of Kenosha and Racine.

Delaware's Advantages

Every corporation has to be incorporated in at least one state. Incorporation simply means the company must file the proper articles of incorporation with the state's Secretary of State, pay the required franchise fees and taxes, and have a listed corporate agent in the state. Compared to other states Delaware has lower incorporation fees and annual franchise taxes, and corporations that incorporate in the state but do not conduct any business in the state are not subject to corporate income tax. Also, shares of stock in a Delaware corporation are not taxed if the owner lives outside of the state. Delaware's rules have translated into positive results; over 50% of publicly traded corporations and 58% of Fortune 500 companies are chartered in Delaware.

A company's state of incorporation is important also because when it is sued, the lawsuit must normally be filed in the company's state of incorporation. Delaware is a popular destination for corporations partly because of its low taxes, but also partly because of its unique legal system. Most states have a general trial court which handles all civil and criminal cases, and in most cases the parties have a right to a jury trial. Delaware has two trial courts, the Superior Court and the Court of Chancery. The Superior Court is the general trial court for all criminal and most civil matters and functions like most every other trial court in the country. The Court of Chancery however is what makes the state unique.

Delaware Court of Chancery

The constitutional right to a jury trial does not extend to civil cases in equity, and most lawsuits involving corporations are equity cases. The Delaware Court of Chancery is a specialized court of equity and hears mainly business related cases. Because it only hears equity cases it may do so without a jury, this leads to faster trials and more consistent verdicts.

This unique structure creates its own wave of success. The large number of corporations based in Delaware corresponds to more cases being brought there involving complex transactions, sales, mergers or acquisitions. The more cases a judge hears increases each judge's experience and contributes to the predictability of the state's case law. This legal consistency in turn is seen as a positive by companies looking to incorporate, so more companies decide to incorporate in Delaware, growing the wave even larger.

Competition

States can compete with Delaware for corporate charters by making their laws more business friendly. One example is Nevada. Nevada has actively changed its corporate laws to target companies incorporated in Delaware. Nevada has acted to reduce corporate taxes and make the laws more manager friendly. It is almost impossible for an officer or director of a Nevada corporation to be held personally liable for their business actions. Only twice in the last 20 years has a Nevada court "pierced the corporate veil" of limited liability.

But money may not be the seminal reason to incorporate. As stated above, businesses like the consistent manner in which Delaware law is applied. For a state to create a stand alone court of equity the state's entire judicial system would have to be rewritten. In this area of corporate competition Delaware has a 200 year head start with its Court of Chancery.