Is Delaware Losing its Cases?

• Author: John Armour,Bernard Black,Brian Cheffins
• DOI: http://doi.org/10.1111/j.1740-1461.2012.01268.x
• Published date: 01 December 2012
• Date: 01 December 2012

Is Delaware Losing its Cases?

John Armour, Bernard Black, and Brian Cheffins*

Delaware’s expert courts are seen as an integral part of the state’s success in attracting

incorporation by public companies. However, the benefit that Delaware companies derive

from this expertise depends on whether corporate lawsuits against Delaware companies are

brought before the Delaware courts. We report evidence that these suits are increasingly

brought outside Delaware. We investigate changes in where suits are brought using four

hand-collected data sets capturing differenttypes of suits: class action lawsuits filed in (1) large

M&A and (2) leveraged buyout transactions over 1994–2010; (3) derivative suits alleging

option backdating; and (4) cases against public company directors that generate one or more

publicly available opinions between 1995 and 2009. We find a secular increase in litigation

rates for all companies in large M&A transactions and for Delaware companies in LBO

transactions. We also see trends toward (1) suits being filed outside Delaware in both large

M&A and LBO transactions and in cases generating opinions; and (2) suits being filed both

in Delaware and elsewhere in large M&A transactions. Overall, Delaware courts are losing

market share in lawsuits, and Delaware companies are gaining lawsuits, often filed elsewhere.

We find some evidence that the timing of specific Delaware court decisions that affect

plaintiffs’ firms coincides with the movement of cases out of Delaware. Our evidence suggests

that serious as well as nuisance cases are leaving Delaware. The trends we report potentially

present a challenge to Delaware’s competitiveness in the market for incorporations.

*Address correspondence to John Armour, University of Oxford, Faculty of Law, St Cross Bldg., St Cross Rd.,

Oxford OX1 3UL, UK; email: john.armour@law.ox.ac.uk. Armour is Hogan Lovells Professor of Law and Finance,

Faculty of Law and Associate Fellow, Saïd Business School, University of Oxford; Black is Nicholas J. Chabraja

Professor of Law and Finance at Northwestern University, Law School and Kellogg School of Management; Chef-

fins is S.J. Berwin Professor of Corporate Law, Faculty of Law, Cambridge University, UK.

We thank Jessica Erickson for providing her derivative suits data; the law firms that provided us with information

on option backdating suits; Douglas Campbell, Nathan Chuang, Mitch Fagen, Tim Gerheim, Jonell Goco, Caroline

Hunter, Patrick Luff, Stephen McKay, Jose Mendoza, Alex Ruge, Cephas Sekhar, Li Weng, and, especially, Ji Min Park

for excellent research assistance, and Columbia Law School, Oxford University, University of Texas Law School, and

the Searle Center on Law, Regulation and Economic Growth at Northwestern University for financial support. We

thank Keith Bishop, Jill Fisch, Jeff Gordon, Colin Mayer, Tom Noe, Delaware Vice-Chancellor Travis Laster, and three

anonymous JELS referees for helpful comments. The article has benefited from feedback at the American Law and

Economics Association (2011 annual meeting), Canadian Law and Economics Association (2010 annual meeting),

Conference on Empirical Legal Studies (2010), Harvard Law School, Stanford Law School, University of Illinois Law

School, University of Leeds Law School, University of Oxford Saïd Business School, University of San Diego

Law School, USD Law Center on Corporate and Securities Law, Vanderbilt Law School Conference on Corporate Law

(2010), and Columbia Law School Conference on the Delaware Court of Chancery: Change and Continuity (2011).

We are grateful for helpful discussions with various corporate lawyers, including Randall Baron, Peter Carter, Travis

Downs, Joel Friedlander, Stuart Grant, William Lafferty, Mark Lebovitch, Roger Magnuson, Joe Metzler, Ted Mirvis,

Stephen Radin, Lee Rudy, and Bryn Valler.

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Journal of Empirical Legal Studies

Volume 9, Issue 4, 605–656, December 2012

605

The important . . . benefits created by our judiciary’s handling of corporate disputes are endangered if

our state’s compelling public policy interest in deciding these disputes is not recognized.1

I. Introduction

Delaware dominates the competition between states for incorporations of U.S. public

companies. More than four out of five U.S. public companies that incorporate outside their

home state choose Delaware, and nearly three-fifths of all U.S. public companies are

incorporated there.2Delaware’s Chancery Court is thought to be an important factor in

Delaware’s dominance.3The Delaware chancellors are selected primarily on the basis of

their corporate law expertise, and most of their caseload involves corporate matters.4They

have full scope to deploy their expertise in cases that come before them because they decide

on both facts and law—there are no juries. Delaware-incorporated companies stand to

benefit from this expert judging ex post through sound decisions and ex ante through the

precedents generated by prior cases.5These benefits are said to be enhanced by Delaware’s

substantive law avoiding sharp rules in favor of open-ended ex post standards of fiduciary

duty, a structure that both capitalizes on the Delaware courts’ strengths and is hard to

emulate elsewhere.6

The value of expert judges, as part of the overall value of Delaware incorporation,

hinges on Delaware courts actually hearing disputes in corporate law cases. Until recently,

that case flow was taken for granted. It should not have been. Under the “internal affairs”

doctrine, the law of the state of incorporation governs corporate law disputes, regardless of

where a suit is brought.7This ensures that Delaware’s substantive rules govern suits under

corporate law against Delaware companies, but it does not guarantee that those disputes

will be litigated in Delaware. Rather, plaintiffs can sue wherever they can achieve both

personal and subject matter jurisdiction. Both of these are available in Delaware, so Dela-

ware is one possible and often convenient forum. However, plaintiff lawyers can typically

also obtain jurisdiction and thus sue a company’s directors and officers in the state courts

of its “home state” (where its headquarters are located), and sometimes also in federal

courts in the company’s home state. Changes in the factors affecting their decisions where

to file could affect Delaware’s case flow.

1Vice-Chancellor Strine, In re Topps Shareholders Litig., 924 A. 2d 951, 959 (Del. Ch., 2007).

2Bebchuk and Hamdani (2002: tbls. 2, 5).

3For a review of this and other factors, see Romano (1993).

4Thompson and Thomas (2004a).

5See, e.g., Romano (1985) and Klausner (1995). This claim receives support from empirical findings that firms have

a propensity to incorporate in states with higher quality judicial systems (Kahan 2006).

6Kamar (1998).

7See CTS Corp. v. Dynamics Corp. of Am., 481 U.S. 69, 89–90 (1987); Tung (2006).

606 Armour et al.

In earlier work comparing corporate litigation in the United States and the United

Kingdom, we reported preliminary evidence that a rising fraction of suits against Delaware

companies under Delaware corporate law were being filed outside Delaware,8but we

deferred a careful assessment of this possible “out of Delaware” trend to a separate

project—this one. Here, we investigate that trend and seek to explain changes over time in

the choice of forum for corporate litigation.9To do so, we use four different hand-collected

data sets that together capture a broad range of corporate law litigation: (1) lawsuits, mostly

class actions, filed in large merger and acquisitions (M&A) transactions announced

between 1994–2010; (2) lawsuits, again mostly class actions, filed in leveraged buyout

(LBO) transactions announced between 1995–2010; (3) derivative suits alleging option

backdating; and (4) cases—a mix of derivative suits and direct suits, often class actions—

against public company directors that generate one or more publicly available written

judicial opinions between 1995–2009.

All four data sets present a consistent story: there has been a large decline in the

proportion of corporate lawsuits involving Delaware companies (by which we mean share-

holder suits against the directors, officers, or controlling shareholders of these companies)

filed in Delaware courts. This has been associated with a separate trend toward a higher

overall rate of corporate litigation involving large M&A transactions and LBOs. The trend

toward higher litigation rates has affected all public companies, but is especially pro-

nounced for Delaware companies, with the increase largely coming through suits filed

outside Delaware. There is some evidence that the out-of-Delaware trend began in the late

1990s, but strengthened around 2002. The trend toward more overall corporate litigation

begins around 2002. There has also been a more recent trend, principally in the last two

years of our sample period, toward suits concerning the same facts being filed in more than

one jurisdiction.

Some caveats. First, some of the trends we document may reflect a general tendency

for companies incorporated outside their home state to be different in various ways from,

or to be sued in ways that differ from, companies that incorporate at home, rather than a

difference between Delaware law and the corporate laws of other states. In our regressions,

we assess and discuss the extent to which our results for Delaware firms differ from

“away-non-Delaware” firms.10 However, especially for LBOs, the number of away-non-

Delaware firms is small, so we have limited statistical power to distinguish between these two

groups.

8Armour et al. [hereinafter, ABCN] (2009:fig. 1).

9Two companion articles develop hypotheses about potential causes of the trend and assess its policy implications. See

Armour et al. (2012) [hereinafter, ABC Balancing Act]; Cheffins et al. (2012) [hereinafter, CAB Plaintiffs’ Bar]. This

article focuses on analysis of the data and testing of hypotheses.

10Litvak (2011) develops the concept of out-of-state incorporation as a proxy for unobservable firm characteristics,

which might differ between firms that incorporate in their home state and firms that incorporate elsewhere, and

stresses the importance of comparing Delaware public companies to other out-of-state-incorporated public compa-

nies, rather than to all public companies.

Is Delaware Losing its Cases? 607