Most companies have no reason to incorporate in Delaware until they are large enough to go public. However, if you want to eliminate the rights of shareholders to inspect your company’s records you may want a Delaware corporation.
In Juul Labs v. Grove, a Delaware Court held that inspection rights are a matter of internal affairs, and therefore California Corporations Code Section 1601, which grants inspection rights to shareholders of California corporations and foreign corporations with headquarters in California, is invalid as applied to Delaware corporations.
Juul arose in the context of a private company that required shareholders to waive their inspection rights under Delaware law. The Court did not expressly determine if the waiver was valid.
However, it is inspection rights could be left a functional dead letter for both private and public companies.
This development may also have serious implications for the internal affairs doctrine. The limitations of the internal affairs doctrine have always been unclear. Delaware has always had a much broader view of the scope of the internal affairs doctrine than other states – particularly California – and this is not the first time Delaware has held that California’s corporate code is invalid as applied to Delaware entities.
It appears that California will never be able to weigh in on the issue of waiver of shareholder inspection rights by a Delaware corporation even if the corporation is entirely operated in California. As soon as a Delaware
company suspects that a shareholder plans to invoke its rights under California law, the company can now immediately file a declaratory action in Delaware. When the shareholder filed its own action in a California court, California precedent requires the California Court to stay its own proceedings in favor of the first-filed Delaware action.
In Juul the shareholder was required to make a demand for inspection under California law, which put the company on notice that of a potential shareholder dispute. The company immediately filed a declaratory judgment action in Delaware based on its contention that the company had a forum selection clause in its charter requiring that internal affairs disputes be heard in Delaware, and because inspection rights are governed by the internal affairs doctrine, any California court would be powerless to resolve the issue. The shareholder subsequently filed an action in California, but California stayed its ruling in favor of Delaware case.
The Delaware Court then held that inspection rights are part of internal affairs, California’s law did not apply, and no suit could be filed in California. It appears the Delaware Court’s holding is immune from attack in California courts, even though there is California precedent for the idea that Section 1601 does not deal with internal affairs.
If you are concerned about shareholders bringing actions against your Company, then Delaware might just be the best choice for the company’s state of incorporation, although, there are additional taxes and fees for a Delaware
corporation to do business in California.
Unsure what is best for your company, contact competent business legal counsel to explore all of your options.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
