The big loser in Tesla’s shareholder vote is Delaware

About two-thirds of S&P 500 companies—regardless of where they are actually based—are incorporated in Delaware, largely because the tiny state has specialized courts that handle business matters and stacks of legal precedents for addressing such disputes. (AP Photo)
About two-thirds of S&P 500 companies—regardless of where they are actually based—are incorporated in Delaware, largely because the tiny state has specialized courts that handle business matters and stacks of legal precedents for addressing such disputes. (AP Photo)

Summary

Tesla’s proposal to reincorporate in Texas is about much more than saving on state fees: It’s Elon Musk’s attempt to loosen Delaware’s grip on American corporations.

Tesla’s reincorporation in Texas is about much more than saving the electric-car juggernaut $250,000 a year in state fees. It is an attempt by Elon Musk to loosen Delaware’s grip on American corporations.

About two-thirds of S&P 500 companies—regardless of where they are actually based—are incorporated in Delaware, largely because the tiny state has specialized courts that handle business matters and stacks of legal precedents for addressing such disputes.

Musk asked shareholders to approve the move after the Tesla chief executive lost a case in a Delaware court over his pay package, recently valued at about $46 billion. Shareholders on Thursday re-approved the package as well as the plan to reincorporate in Texas, where Tesla has its headquarters and some of its manufacturing facilities. The company filed paperwork to implement the change the same day.

By voting to leave the First State, shareholders could be ratifying the view among some that Delaware’s shareholder protections have gone too far, some legal experts said. An alternative, however, is that Musk is simply so important that investors are willing to take a chance on Texas.

“I do think that Elon Musk is this singular figure," said Renee Zaytsev, a corporate- and securities-law attorney at Boies Schiller Flexner. “Is Tesla what other companies are looking to, to decide where they’re going to incorporate or how they’re going to run their governance? Probably not."

Texas officials have been wooing businesses with promises of lower taxes and, more recently, by setting up the state’s own specialized business court system. A startup is developing plans to create a new Texas Stock Exchange that its backers say will be more CEO-friendly than the incumbents in New York.

“It’s not just the laws, it’s how the judges are going to implement them," said Anat Alon-Beck, a Case Western Reserve University law professor, who has a paper scheduled for this fall on risks to Delaware from other state incorporation practices.

It isn’t clear who will serve as judges in the new Texas business courts, and as appointees with two-year terms, they may be more easily swayed by political considerations, Alon-Beck said. “Uncertainty is not good for business."

Tesla isn’t the first corporate giant to make the move out of Delaware. Microsoft, which first incorporated in Washington state in 1981, reincorporated in Delaware in 1986 when it went public, then moved back to Washington in 1993 after the state revamped its business laws to indemnify officers. Tripadvisor has been fighting in court with shareholders to move its incorporation to Nevada from Delaware.

Texas was the legal home of four S&P 500 companies before Tesla’s vote, Southwest Airlines, CenterPoint Energy, Atmos Energy and Camden Property Trust—on par with Missouri and California, data from Standard & Poor’s show.

Other big public companies incorporated outside Delaware include PepsiCo (North Carolina), Abbott Laboratories (Illinois), International Business Machines (New York) and Target (Minnesota).

Most of the explicit legal differences between Delaware and Texas are minor, corporate attorneys said, echoing Tesla’s argument that the states’ laws are substantially equivalent.

“There are minor differences ," said Stephen Bainbridge, a law professor at the University of California, Los Angeles. “Most of those are technical, and likely to come into play in relatively few circumstances." Mergers, for example, can require a higher shareholder vote in Texas, while it is harder for a shareholder to inspect a company’s books there, he said.

One of the biggest advantages Delaware has: extensive precedents on nearly every facet of corporate law, giving boards and attorneys a better sense of likely outcomes and how to make their cases. “It’s much harder for anybody to predict how Texas courts are going to rule," Bainbridge said.

In making its case for redomiciling in Texas, Tesla dismissed the idea that the newly established business courts in Texas were riskier because they were new. “Doing new things is part of Tesla’s DNA, and how it has become one of the most valuable companies in the world," Tesla said in its proxy filing.

Tesla also said it would also save about $250,000 a year in Delaware franchise-tax payments. One thing that might not change, though, is the legal fight over Musk’s pay package. That dispute will likely stay in the hands of a judge in Delaware Chancery Court.

Write to Theo Francis at theo.francis@wsj.com

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