Delaware Revises Corporation Laws

Date 1903

When the state of Delaware liberalized its corporation code to attract more companies to the state, it became a mecca for corporate headquarters, benefiting the state, the thousands of corporations eventually located there, and executives and board members seeking refuge from legal action.

Locale Delaware

Key Figures

• Woodrow Wilson (1856-1924), governor of New Jersey, 1910-1912
• Alfred I. du Pont (1864-1935), chief executive of the Du Pont Corporation
• Ebe Tunnell (1844-1917), governor of Delaware, 1897-1901
• Simeon Pennewill (1867-1935), governor of Delaware, 1909-1913
• Charles R. Miller (1857-1927), governor of Delaware, 1913-1917

Summary of Event

Under the leadership of Governor Ebe Tunnell, Delaware passed its original corporation law in 1899. The law was modified for the first time in 1903, after which the legislature made periodic changes to increase the state’s attractiveness to business owners outside Delaware. By 1915, Delaware had acquired a reputation as one of the easiest states in the country in which to incorporate. The legislature nurtured Delaware’s reputation as a business-friendly state and continued to make changes to entice businesses. Many of these changes were encouraged by members of the state’s famed du Pont family. Others were prompted by outsiders, such as Governor Woodrow Wilson of New Jersey, whose changes in New Jersey’s laws gave Delaware the chance to attract businesses that fled New Jersey.

That the du Ponts would influence Delaware’s approach to incorporation was no surprise. Ever since Pierre du Pont established his thriving explosives business in Delaware in the early 1800’s, the family had influenced events in the state. By the end of the nineteenth century, the Du Pont organization had established a virtual monopoly in the explosives industry. In fact, the government filed an antitrust suit against the company in 1907. That suit forced Du Pont to compete with two new companies created in response to the government’s action, Atlas and Hercules. Both companies, however, were owned largely by members of the du Pont family. Both were incorporated in Delaware, but neither manufactured any explosives in the state. The du Ponts learned early how to circumvent antitrust laws, and they applied their knowledge to create liberal corporation laws in Delaware.

Several members of the du Pont family, most notably Alfred, Pierre, and Henry, encouraged the revisions in the state’s corporation laws in the early 1900’s. For example, at the urging of Governor Simeon Pennewill, the legislature modified its corporation code in 1911 to permit incorporation of the Du Pont Boulevard Corporation, which formed to build and operate Delaware’s first cross-state highway as a private enterprise. This was one of the earliest indications that the state legislature would revise the corporation laws as necessary to attract businesses and the income they provided.

Ironically, the governor of New Jersey, Woodrow Wilson, inadvertently became one of the biggest benefactors to Delaware’s drive to attract businesses through liberalization of its corporation laws. New Jersey was one of the first states in the country to pass corporation laws. By the mid-nineteenth century, New Jersey, along with Connecticut, Massachusetts, and New York, had passed general corporation laws that applied to manufacturing, banking, and transportation companies. The Delaware government, on the other hand, was in no hurry to lose control over businesses.

In general, state governments in the late nineteenth century did not recognize, or chose to ignore, the benefits of corporations. They thought that corporations were by and large devices for making legal many acts that were detrimental to the public interest. In general, corporate leaders were viewed as people who used their power to exploit labor, stockholders, and the public, and there certainly was good cause for this view. For example, on October 8, 1882, in response to a reporter who asked whether he would compete with the Pennsylvania Railroad’s newly introduced express service, William H. Vanderbilt, president of the New York Central Railroad, allegedly said, “The public be damned.” He subsequently denied making the statement, after a popular uproar ensued. Whether he said it or not, the words typified the attitude of some tycoons toward business and the public, an attitude that accounted in part for Delaware’s reluctance to establish corporation laws.

Legislators in Delaware, like their counterparts in many other states, preferred to pass a specific act to create each company instead of enacting general laws of incorporation. Therefore, more progressive eastern states, particularly New Jersey, more often became homes to large corporations. It took Delaware a while to recognize the benefits of general laws of incorporation. Once the state’s leaders did, however, Delaware became the home of thousands of corporations of all sizes engaging in a wide variety of businesses.

Perhaps the biggest boost to Delaware’s switch from strict regulation of business to liberal corporation laws was the antitrust movement that swept the United States in the late nineteenth and early twentieth centuries. There was a growing tendency to form trusts in many industries in the country in the late 1800’s. Perhaps the most significant trust was that formed by the Standard Oil Company. The company, incorporated in New Jersey, became a symbol of all that was wrong with trusts. John D. Rockefeller used his position as the head of the world’s largest oil company to squash competition ruthlessly, force railroads into giving him secret rebates, and influence political contests. By 1879, his company controlled 95 percent of the refining capacity in the United States. Rockefeller gave trusts a bad name.

Under a trust agreement, the stockholders of the companies whose boards of directors formed the trust deposited their certificates of shares of common stock with a board of trustees and received in exchange certificates of deposit from trustees. Boards of trustees were invested with the power to vote the number of shares of the operating companies they held. This meant they were able to elect members of the boards of directors of the operating companies whose common stocks were deposited with them and thereby control those companies’ policies. These interlocking boards of trustees controlled entire industries, with trusts operating in railroads, tobacco, and oil. By December 31, 1903, 266 trusts were in existence, 234 of which had been formed between 1898 and 1903. The growth in trusts occurred despite the fact that federal laws such as the Sherman Antitrust Act (1890) and Interstate Commerce Act (1887) had been put in place to curb them.

The zeal to limit trusts filtered down to the state level. Governor Woodrow Wilson of New Jersey was a staunch antitrust advocate. Consequently, he strove to reduce the powers of the large corporations incorporated in New Jersey. In so doing, he opened the door to other states, most notably Delaware, to lure companies away. Before leaving office to assume the presidency of the United States, Governor Wilson induced the New Jersey legislature to pass laws that severely inhibited corporations domiciled in the state. For example, the acts forbade holding companies, curtailed interlocking directorates, and provided for the revocation of charters as penalty for infractions of the laws. The laws were not received well in New Jersey, but their passage was welcomed in Delaware.

Corporate leaders believed that Wilson had transcended common sense in promoting these laws, which they viewed as personal affronts. Not only did the laws place severe restrictions on corporate activities, but they also attempted to make corporate guilt personal. One of Wilson’s goals was to make corporate leaders responsible for their companies’ misdeeds. This did not sit well with executives, who believed that corporate charters should protect them from responsibility. Faced with the possibility of personal culpability, corporate leaders preferred to move elsewhere. Delaware was a promising choice.

By the beginning of the twentieth century, Delaware’s legislators had grown envious of New Jersey’s reputation as a home to corporations. Government leaders realized that tremendous financial potential lay in the liberalization of corporations laws. The turmoil in New Jersey presented them with a unique opportunity to lure companies to their state. New Jersey legislators were not about to lose, without a fight, their state’s status as a home to thousands of companies and the financial advantages they presented. In 1920, under the leadership of Democratic governor Edward I. Edwards, the New Jersey legislature repealed the laws Wilson had promoted, but the damage was already done.

Delaware liberalized its corporation laws considerably during the early 1900’s in an effort to attract businesses. Governors such as Simeon Pennewill (1909-1913) and his successor, Charles R. Miller (1913-1917), pushed for new laws designed to facilitate incorporation. The legislature gave up its traditional method of incorporating one company at a time in recognition of the fact that the practice discouraged entrepreneurs from establishing businesses in the state. General incorporation quickly became the practice in Delaware.

One of the by-products of the new approach was an easing of the severe limits on executives’ abilities to run their companies as they saw fit. The state’s new laws allowed managers to run things as they liked with little or no interference from stockholders, directors, or government officials. The laws also addressed the issue of executive responsibility. The corporation code, which became the model for other corporation codes across the country, empowered companies to purchase and maintain insurance against liability for their executives in the event of any wrongdoing, “whether or not the corporation would have the power to indemnify [them] against such liability under the provisions” of the rest of the code. Loosely interpreted, Delaware’s code was an invitation to corporations to provide executives with insurance protection that went beyond the lax indemnification standards that had previously existed. This inclusion in the code provided added incentive for corporations seeking to move.

Other provisions in the code cut back on stockholders’ interference in corporate operations. For example, the certificate of incorporation included the phrase “creating, defining, limiting and regulating the powers of . . . the stockholders . . . if such provisions are not contrary to the laws of this State.” The vague wording did not actually stipulate that stockholders could not inspect company books. It did, however, give the corporation the right to establish exactly when stockholders could inspect the books and for what purpose, limiting inspections to times when they did not interfere unreasonably with the company’s business.

The laxity in the code encouraged executives to experiment with their corporate bylaws with an eye to letting the courts decide whether the provisions were legal. One company included in its bylaws a provision that its board of directors alone would have the power to determine when—if at all—stockholders would be able to inspect the company’s books. The specific bylaw stated explicitly that “except as provided above, no stockholder shall have any right to inspect any account, record, book or document of the Corporation.”

The Delaware legislature imposed lower corporate franchise taxes than did competing states such as New York and Illinois. When corporate leaders in New Jersey looked for a new home, they did not have to search any farther than the state’s southern boundary. Companies made a mass exodus to Delaware from New Jersey as well as other states, and new companies increasingly made Delaware their legal home.

Significance

Applications for incorporation flooded Delaware, and the number of corporations headquartered there has continued to grow over the years. By 1974, 76,000 corporations were headquartered in the state, including such giants as General Motors, General Electric, and IBM (International Business Machines). By 2005, more than 600,000 businesses had established their legal homes in Delaware. Many of the companies emigrated from other states to take advantage of Delaware’s liberal corporation code. As of 2005, more than half of U.S. publicly traded enterprises and nearly 60 percent of the Fortune 500 companies made Delaware their home.

The state’s liberal corporation laws gave people engaged in all types of businesses the opportunity to incorporate without ever setting foot in the state. According to the state’s code, corporations do not have to have any employees. In fact, they do not even have to maintain a physical presence in the state. All they have to do is operate legally within the liberal provisions of the code and pay the necessary franchise taxes. That means simply that they must, according to the code, “engage in any lawful act or activity for which corporations may be organized.”

The income Delaware derived from the liberalization of its laws represented an enormous benefit to the state and had a major effect on its tax structure. The franchise taxes collected as a result of the influx of corporations became the state’s second-largest source of revenue. In addition, liberalization of the code created a thriving business among lawyers and incorporating firms whose primary function was to assist people from outside Delaware in establishing their own corporations.

Perhaps the biggest advantage to Delaware lay in the way the corporation code affected the state’s fiscal policies. In effect, the large number of corporations led to a two-tiered financial structure. The state government obtained its revenues mostly from business and corporate taxes. Local income, on the other hand, came primarily from property taxes. Eventually, the state’s tax structure changed to include a progressive income tax, but corporate franchise taxes continued to play an important role in Delaware’s finances. Moreover, as a large number of the corporations headquartered in Delaware did not maintain a presence in the state, there was no need for large numbers of government workers to process paperwork, and Delaware could operate on a budget smaller than the budgets of some major cities in the area, such as Baltimore and Philadelphia.

Companies also benefited from the liberalized laws. Executives realized early that Delaware’s corporation code presented them with a set of well-established corporate law precedents. Over the years, many cases that reached the courts were settled quickly in management’s favor. The stability in the judicial system alleviated executives’ fears about falling prey to whimsical court decisions and strengthened their resolve to remain in Delaware. This stability had a dual effect: It discouraged people such as disgruntled stockholders from filing lawsuits against corporations, and it provided managers with a knowledge of exactly what they could and could not do. Executives knew that if they did end up in court for some reason, decisions would be handed down quickly, generally in management’s favor. These were simply added incentives for corporations to move to Delaware.

Delaware’s political and government leaders took advantage of other states’ shortsightedness at the beginning of the twentieth century to build a strong, lucrative corporate base. Their success led other states to emulate Delaware’s approach to liberalization in corporate codes. Consequently, competition among the states cut into Delaware’s success to some extent. The number of new incorporations in the state diminished somewhat over the years, but Delaware remained the acknowledged leader in providing a liberal home for corporations of all types.

Bibliography

Aranow, Edward Ross, and Herbert A. Einhorn. Proxy Contests for Corporate Control. 2d ed. New York: Columbia University Press, 1968. This scholarly but easily understood book focuses on aspects of corporation life to which Delaware paid special attention.

Cunningham, John T. New Jersey: America’s Main Road. Maps by Homer Hill. Garden City, N.Y.: Doubleday, 1966. Presents an excellent analysis of Woodrow Wilson’s governorship in New Jersey and how his legislation encouraged Delaware to liberalize its corporation laws.

Myers, William Starr, ed. The Story of New Jersey. 5 vols. New York: Lewis Historical Publishing, 1945. This multivolume history thoroughly documents New Jersey’s status as a home to corporations and details Wilson’s role in driving companies to Delaware.

Peirce, Neal R., and Michael Barone. The Mid-Atlantic States of America: People, Politics, and Power in the Five Mid-Atlantic States and the Nation’s Capital. New York: W. W. Norton, 1977. Provides a concise history of Delaware with particular emphasis on the state’s corporation code.

Stone, Christopher D. Where the Law Ends: The Social Control of Corporate Behavior. New York: Harper & Row, 1975. Provides an excellent description of the relationship between corporations and society and discusses the importance of corporate charters and the responsibilities of executives.

Tuttle, Frank W., and Joseph M. Perry. An Economic History of the United States. Cincinnati: South-Western, 1970. An excellent overview of antitrust sentiment in the early 1900’s and how it contributed to Delaware’s rise as a home to major U.S. corporations.