Dive Brief:

• Nevada tends to be portrayed in the media as more business friendly than Delaware but the differences between the two incorporation hubs are more nuanced than is reported, says Wendy Gerwick Couture, a law professor at the University of Idaho.
• “Nevada has developed a reputation as ‘the place to reincorporate when you’re sick of Delaware’s micromanaging,’” says Couture, quoting from a Bloomberg article on Elon Musk’s high-profile decision to move his Neuralink company from Delaware to Nevada earlier this year. 
• But the reality is more mixed, Couture says in an analysis published in Virginia Law & Business Review.

Dive Insight:

Couture starts her analysis with exculpation of directors and officers from liability when they’re accused of breaching their fiduciary duties, one of the main ways Nevada is said to be business friendly.   

When companies incorporate in Nevada, directors and officers are given exculpation by default. Companies can opt out, but few do. In Delaware, directors and officers also get exculpation, but it’s opt-in.

Opting in is something companies tend to do when it comes to directors, but when it comes to officers, they tend not to. That leaves officers of Delaware companies more exposed to liability, Couture says. What’s more, in Nevada directors and officers can get exculpation unless their breach of duty is intentional; in Delaware, they don’t get exculpation in a breach even in cases where they weren’t acting with bad intent.

These differences are the ones most widely known, but they’re not necessarily the most important, Couture says.

In Nevada, if shareholders sue, they’re the ones who face the burden of proof to show the directors or officers breached their duty. That makes lawsuits less likely, she says. In Delaware, the opposite is the case. If shareholders sue, it falls on the directors and officers to show they didn’t breach their duties, or that their breach wasn’t intentional. That makes it more likely shareholders will sue. 

In another ding against officers in Delaware, exculpation applies only in direct suits, not derivative suits. In Nevada, officers can be exculpated in both types of suits. 

Shareholder protections

Couture’s analysis goes beyond exculpation to include differences on appraisal rights and freeze-out mergers, both of which are about protecting shareholders. 

Appraisal rights are intended to protect shareholders who don’t like a merger the company is entering into if they think the deal price is too low. When they exercise their appraisal rights, they can get a court to decide what the appropriate price should be, and the company must pay that price to buy out the shareholders. In a freeze-out merger, minority shareholders are essentially bought out of the company in a strategic merger engineered by controlling shareholders. 

On its face, Nevada would seem to favor shareholders in its treatment of appraisal rights because there are more events, including reverse stock splits, that trigger the right, Couture says. That helps ensure shareholders can’t be forced to accept a value they think is too low. But Nevada is actually harder on shareholders than Delaware on appraisal rights when it comes to what’s known as market-out exceptions. These are restrictions on appraisal rights for shareholders of publicly traded companies. 

The idea behind a market-out exception is that, since the company is publicly traded, there’s no need for a court to step in to determine share value; market trading takes care of that. In Nevada, based on how the law is written, there is virtually no way shareholders of a publicly traded company can exercise their appraisal rights, leaving them vulnerable to a deal they think is bad. In Delaware, public shareholders are given a bit more help and can exercise that right in a cash-out merger. It’s not a lot but it’s something, Couture suggests. 

Shareholders have a little better deal in Delaware as well when it comes to freeze-out mergers. These are strategic mergers engineered by controlling shareholders to get rid of unwanted minority shareholders. If minority shareholders resist not just because of the low price they would get but because they think the controlling shareholders are acting in breach of their fiduciary duties, they can get their complaint looked at in court from an entire fairness standard, which could lead to restrictions on the controlling shareholders and invite strike suits against the deal.

If breach of duty isn’t an issue and the objection is only about the share price, minority shareholders still have access to their appraisal rights.  

In Nevada, minority shareholders face a considerably steeper road to get the deal looked at both under an entire fairness standard and from an appraisal-rights standpoint. 

Given these differences, the analysis shows, Nevada tends to lean in favor of officers and directors and Delaware to shareholder protections, especially for minority shareholders. 

“Ultimately, investors will decide whether the balance that Nevada has struck, albeit divergent from Delaware’s, is an attractive balance of the countervailing policies underlying corporate law for some firms and, if so, at what price,” Couture says.