Taking Stock of the Block: Blockchain, Corporate Stock Ledgers, and Delaware General Corporation Law—part Ii

• Jurisdiction: Delaware,United States,Federal
• Publication year: 2018
• Citation: Vol. 1 No. 4

John C. Kelly and Maximilian J. Mescall^*

Delaware recently amended the Delaware General Corporation Law to authorize Delaware corporations to replace their paper and electronic stock ledgers with a blockchain. Blockchain, also known as a distributed ledger, can promote efficient recordkeeping, but there are several legal and practical hurdles that corporations need to address before they can reap the full benefits of blockchain legalization. In the first part of this two-part article, which appeared in the May-June 2018 issue of The Journal of Robotics, Artificial Intelligence & Law, the authors discussed blockchain and its applications. This second part of the article explains Delaware's legislation and blockchains potential uses and hurdles.

Delaware's Legislation

The Context of Legislative Adoption

The Modern Shareholding System is Outdated

Delaware enacted blockchain with a single goal in mind—simplifying stock ledger maintenance via distributed ledger technology. Delaware legalized blockchains under the Delaware General Corporation Law ("DGCL"), allowing corporations to improve the speed and accuracy of their corporate record systems. At its core, Delaware's blockchain legislation is an overhaul of the shareholding system in the United States.¹⁰⁵ To understand how these DGCL amendments change the foundations of the shareholding system, this section provides a brief overview of that system.

The modern shareholding infrastructure has not changed significantly since the Dutch East India Trading Company became the first publicly traded company in Amsterdam in 1602.¹⁰⁶ Like the Dutch East India Trading Company, companies today create an initial public offering to raise money for ventures, which many shareholders in turn sold on the secondary stock market.¹⁰⁷ In the

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secondary market, a central registrar maintains the records of all trades and stock ownership.¹⁰⁸ As the market became larger and more regulated, exchanges, trading venues, clearinghouses, trade repositories, and securities depositories filled niches to expedite sales.¹⁰⁹ America adopted this system, and until the 1970s exchanged paper shares during transactions on the secondary market.¹¹⁰

An economic expansion in the 1960s, and a subsequent contraction a decade later, respectively caused and revealed major problems with how stock sales and purchases were executed. Stock exchanges through the 1960s saw available shares quadruple.¹¹¹ To compensate for the increase, the New York Stock Exchange closed one day a week and shortened trading hours to allow traders to complete backlogged paperwork.¹¹² Brokerage firms fell behind in their transactions and when the economy slowed in 1970, hundreds closed as firms defaulted on shares that brokers had lost or misplaced.¹¹³ The Securities and Exchange Commission ("SEC"), reacted by limiting the physical movement of stock certificates to reduce paperwork and protect against lost shares.¹¹⁴

The SEC's solution was centralization. The SEC and Congress created what would become today's Depository Trust and Clearing Corporation ("DTCC"), which held and owned virtually every share traded in the United States.¹¹⁵ Complete immobilization of shares solved the problem that became known as the Paper Crunch but created new ones. Since the DTCC technically owns every share, those who own shares are now "beneficial shareholders" who must engage with intermediaries to enforce their rights.¹¹⁶ These intermediaries must approve a transaction or sale, leading to longer settlement times for transactions. Additionally, each intermediary charges a fee, leading to higher costs for transactions. The system's inefficiency came to a head in some recent Delaware cases.

Delaware Recently Experienced the Problems of the Modern Shareholder System

The DGCL amendments will allow corporations to maintain more accurate records. Prior to the amendments, there were several cases involving costly errors deriving from poor corporate record-keeping. Two opinions written by Vice Chancellor J. Travis Laster, a proponent of blockchain technology, highlighted the inefficiencies of prior paper and electronic stock ledgers.¹¹⁷

The first was In the Matter of the Appraisal of Dell Inc.¹¹⁸ In that case, Dell approved a merger and submitted the merger agreement

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to its shareholders for approval.¹¹⁹ Some Dell shareholders ordered their voting intermediary, Institutional Shareholder Services Inc. ("ISS"), to vote against the merger.¹²⁰ Due to confusion arising from ISS's voting program, the shareholders accidentally voted in favor of the merger.¹²¹ The shareholders sought appraisal of their shares, arguing that ISS voted against their wishes.¹²² The Chancery Court decided "the mistake in this case did not arise at the [DTCC] level as a consequence of the federal policy of share immobilization."¹²³Rather, it arose due to ISS's failures, not Dell's failures.¹²⁴ The court denied relief under Delaware law, because the shareholders assumed the risk by using ISS as an intermediary.¹²⁵ Without ISS's programing failure, there would be no need for the suit.

The other notable case is In the Matter of Dole Food Co.¹²⁶There, Dole converted from a public to a private company, leading its 36,793,758 shareholders recorded in its stock ledger to receive payouts for their shares.¹²⁷ However, Dole actually had 49,164,415 outstanding shares at the time of the merger.¹²⁸ Due to its inability to track the short sale of shares during the three-day settlement period, Dole failed to record the additional 12,370,657 shares.¹²⁹The court noted "the problems raised by short sales and trades during the three days before closing appear endemic to the depository system and hence likely infect every claims process. Nothing about either factor was unique to Dole. The only difference was the magnitude of the discrepancy, which made the issues visible."¹³⁰The court noted that Dole's failure to maintain an accurate stock ledger is a common occurrence and the only difference between this case and others was the magnitude of the harm.

These cases highlighted two failures of the stock ledger system. First, the existence of more intermediaries increases the likelihood that intervening causes will derail a shareholder's voting rights. Second, paper or electronic ledgers are insufficient for maintaining corporate records when settlement requires several days. By legalizing blockchain, Delaware addresses these inefficiencies and enables corporations to experiment with the technology to ensure it was the right solution to the problem.

The Amendments to the DGCL

The Legislature's amendments made several changes to the DGCL that are worth mentioning. The Legislature's summation noted that the amendments "are intended to provide specific

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statutory authority for Delaware corporations to use networks of electronic databases (examples of which are described currently as "distributed ledgers" or a "blockchain") for the creation and maintenance of corporate records, including the corporation's stock ledger."¹³¹ These amendments therefore explicitly allow blockchain technology.¹³² However, the Legislature also made several additional changes relevant to maintaining corporate records on blockchain, and provided several definitions and requirements.

Section 219(c): Defining a Stock Ledger

The Legislature also provided a precise definition for a stock ledger in its amendments. DGCL Section 219(c) now requires that a stock ledger (1) contain the names of all stockholders of record, (2) list the address and number of shares registered by each stockholder, and (3) track all issuances and transfers of stock.¹³³ That same section also notes that "[t]he stock ledger shall be the only evidence as to who are the stockholders entitled by this section to examine the list required by this section or to vote in person or by proxy at any meeting of stockholders."¹³⁴ Thus, the Legislature provides a broad definition of stock ledgers that encompasses paper, electronic and blockchain formats. Additionally, the stock ledger must meet the requirements set forth in Section 224.

Section 224: Requirements for a Stock Ledger

Section 224 of the DGCL was also amended and sets forth certain requirements for a stock ledger, blockchain, or otherwise.¹³⁵ A stock ledger now must (1) be printable, (2) be viewable, (3) record transferable stock, and (4) contain stock that provides rights to the owner.¹³⁶

Printable Ledger

First, like previous versions of Section 224, electronic storage of corporate records is permissible only "provided that the records so kept can be converted into clearly legible paper form within a reasonable time."¹³⁷ These paper printouts of electronic blockchains are admissible as evidence in court.¹³⁸ While a printout of the entire blockchain is unwieldy, Delaware's court rules allow admission of electronic versions of corporate documents.¹³⁹ Courts should therefore accept electronic versions of the blockchain as evidence of the corporation's stock ledger.

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Providing a List to Stockholders

Second, "it must enable the corporation to prepare the list of stockholders specified in Sections 219 and 220."¹⁴⁰ Section 219(a) still requires that the list is provided to shareholders ten days prior to a shareholder meeting.¹⁴¹ Section 220, meanwhile, requires that corporations make copies of the stock ledger available to all shareholders upon request.¹⁴² If a stock ledger is placed on a distributed ledger that shareholders can access, the corporation could potentially meet this requirement by simply directing the stockholder to the blockchain.

Title 6: Blockchain Shares Must be Transferable

Third, "[the stock ledger] must record transfers of stock as governed by Article 8 of subtitle I of Title 6 as required by Section 159."¹⁴³ Title 6, the investment securities article of the Delaware UCC, remains largely unchanged under these amendments.¹⁴⁴ The only notable change is in Section 202(b)(3)...