Corporate Court Acting in Secret, Citizens Locked Out
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Last week, the state of Delaware radically altered the playing field between corporations and consumers by offering to hear lawsuits against Fortune 500 companies under conditions of secrecy, for a fee. Instead of receiving an open hearing before the general public, the Delaware News Journal reports that the Delaware Chancery Court's new "fast-track" system will allows disputes involving the state's tremendous cache of corporations to be considered in a private backroom meeting, not with a jury, but with a special jurist known as a chancellor.
In this new form of arbitration, the chancellor will act as a hired consultant, listening to both sides of an argument and dispatching a private ruling within 90 days. Although this new judicial innovation in the state that houses 60 percent of the nation's publicly traded companies has not raised the same uproar as the U.S. Supreme Court's infamous Citizens United decision, the new law has equally ominous implications for the future of American democracy.
Most ordinary citizens have never even heard of the Court of Chancery, but among America's executive class, the Chancery has long been a prized legal venue thanks to its pro-business, pro-management rulings. The Delaware Chancery Court has been consistently rated the #1 court in the country by corporate lawyers and the U.S. Chamber of Commerce (PDF). Combined with the state's lax corporate governance regulations, the Chancery is one of the prime reasons so many companies chose to incorporate in Delaware. When boards and CEOs are threatened with shareholder lawsuits and hostile mergers, they're competing with a home-court advantage in the pro-business Chancery. The Chancery is also notoriously hostile to federal agencies of every stripe that might penalize the state's corporate class—intemperate even to CEO-friendly agencies like the Securities and Exchange Commission.
The 200-year-old and entirely juryless Chancery is one of the most powerful judicial bodies in the country, a holdover from the British Empire that most other states had abandoned by the 18th century. Instead of judges or juries, the Chancery is chaired by a set of chancellors and vice-chancellors, each appointed by the Delaware governor to serve out a 12-year term making what equates to the national policy toward big business. William T. Quillen, former Delaware chancellor, attributes Delaware's throwback judicial system to the state's "basic conservatism."
The court's homogeneity is astounding—all the chancellors come from corporate law backgrounds, mainly from the firms of Morris, Nichols and Skadden Arps, and there has never been a chancellor of color.
The Delaware chancellors have consistently played the legal rear-guard in the executive compensation debate. Since most companies are incorporated in Delaware, just about every dispute over CEO pay ends up playing out in the Chancery. In a landmark 1996 decision, the Chancery rejected a Disney shareholder lawsuit and allowed a former president Michael Ovitz to walk away with $140 million in severance. Since then, the Chancery has continued to shield the corporate management that provide their court with its raison d’être, and have swatted away lawsuit after lawsuit from citizens and "activist shareholders"—those with the audacity to demand that companies they own act in their own interests.
In 2009, the Chancery had its chance to weigh in on the financial crisis when Citigroup faced down a major shareholder lawsuit. Shareholders alleged the board of the company had shunted its responsibility to investors, failing to recognize and manage risky subprime investments. Citigroup, of course, was so poorly managed that the company needed to beg for $45 billion in direct bailouts under the Troubled Asset Relief Program, and received hundreds of billions more in indirect government guarantees. But instead of acknowledging any wrongdoing by a team of executives that had turned their company into a ward of the state, the Chancery sided with management, issuing a dismissive shoulder-shrug of a ruling.
Chancellor Chandler wrote of the shareholder lawsuit, "When one looks past the lofty allegations of duties of oversight and red flags used to dress up these claims, what is left appears to be plaintiff shareholders attempting to hold director defendants personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company."
Tiny, Napoleonic Delaware has never had much in the way of natural endowments, but the state's cutthroat cleverness has allowed it to flourish at the expense of its neighbors. Delaware has a long history of treating government as a business and undercutting the competition—other U.S. states.
At the turn of the century, New Jersey was nationally considered to be the "Corporate State," providing a safe haven for the massive trusts of the Gilded Age, which mostly operated out of New York. In 1899, Delaware silently enacted a carbon copy of New Jersey's business laws, and in 1913, fortune smiled on Delaware with a gift from Woodrow Wilson. As one of his final acts as the governor of New Jersey before assuming the presidency, Wilson pushed through rigorous anti-trust legislation called the "Seven Sisters," that promised to clampdown on the robber barons and promote what he called a "new era in business life."
But rather than sparking more stringent regulation of the large, often economically abusive trusts, the Seven Sisters laws caused companies to flee en masse into the arms of nearby Delaware, which provided a business safe haven. Today, the majority of Fortune 500 companies are incorporated in Delaware. The nation's credit card and finance industry remains based in Wilmington, where among many advantages, companies enjoy a fast-and-loose incorporation process and what is widely considered to be an open and "accessible" state legislature. (In Delaware, anyone, even non-U.S. citizens, can get incorporated 24 hours a day. One only has to pay a special fee.) Additionally, Delaware's generous tax code allows companies to hide intangible assets from the IRS, making the state the closest thing we have to a tax haven on U.S. soil. When I asked one former Delaware state official what the difference between Delaware and the Cayman Islands was, he laughed and said, "We speak English."
In recent years, Delaware has seen its significant advantage as the nation's corporate safe haven noticeably diminished as the deregulatory zeitgeist has gone federal. Other states have attempted to undercut Delaware in what amounts to a slash-and-burn race to the bottom to woo fickle industries inside their borders. Cash- and job-strapped states are practically standing out on the street corner, displaying their corporate incentive packages, desperately hoping that a limo with a Fortune 500 executive will drive by, pick them up and rescue their economy.
Much of the consumer finance and credit card industry is still based in Wilmington, Delaware. In the early '80s, Delaware was one of the first states to eliminate its cap on bank interest rates, a move that brought hordes of banks into the state, where they could charge consumers who lived all over the nation whatever interest rates they wanted. This was bad news for the American people, who quickly fell into debt vassalage to the banks, but good for Delaware's economy. With its new finance fiefdom, Wilmington blossomed into a modern East Coast technocratic capital, and to this day owes its prosperity and skyscraper-filled downtown to Barclays, Chase and Citigroup.
But just as important, other states have since mimicked Delaware's strategy, eliminating their usury laws one by one in an effort to capture Delaware's deregulatory jackpot.
So the Delaware Chancery's recent usurpation of the legal process is only the latest development in the state's grifter approach to state governance, where all laws and institutions are for sale to the right price from a classy corporate client. But the Chancery's power-grab has the frightening potential to transform the nature of American justice where any corporation is concerned. If the court system itself becomes just another bargaining chip in the inter-state battle to win corporate addresses, we're in for serious trouble. But even the problem stays contained to Delaware, the huge proportion of U.S. corporations housed in the state give the move tremendous significance.
The Chancery's latest bid for secret corporate sessions marks a radical reduction in judicial transparency, one whose primary function is to spare unscrupulous firms the embarrassment of having to hold a public trial. As Frank Pileggi, host of Delawarelitigation.com, told the News Journal, "A lot of people do business together and may not want to air their dirty laundry in public."
Some senators, like New York's Chuck Schumer, are pushing for large public corporations to be registered at a federal level, where they can be held accountable in more even-handed federal courts. With former Delaware Senator Joe Biden serving as vice president and looking out for his home interests, however, it's unlikely that we will see the incorporation process federalized any time soon. But the companies hiding out in Delaware need to be held responsible to the public at large. American corporations should serve the national interest: not just the budget of the tiny state that harbors them.