Last week, a federal judge declared that Delaware’s lawallowing Chancery judges to preside over secret arbitrations was unconstitutional. The Delaware Coalition for Open Government challenged the law on the grounds that a judge-presided arbitration functioned essentially like a non-jury trial before a Chancery Court judge, and Judge McLaughlin agreed, noting, “Because it is a civil trial, there is a qualified right of access and this proceeding must be open to the public.”
The purpose of this law was to keep Delaware’s Court of Chancery in business as a money-maker for the Forgotten State (I know it’s technically the “First State”, but my nickname is better). Delaware uses its corporate laws as a money maker: half of all US public companies are incorporated there, and it’s not just because of Delaware’s accommodating tax laws(Delaware doesn’t tax certain intangibles, like trademarks, royalties, and leases, so its great for IP-based companies, but less so for other companies. Still, this can generate some serious tax savings). Delaware’s Chancery Courts arguably have developed the most complete corpus of corporate law in the world. Delaware fills its states coffers with corporate income taxes (which, at 8.7%, are actually relatively high), filing fees, and other such payments and penalties from its 945,326 corporate entities (which outnumber its mere 897,934 residents, who benefit by not having a sales tax). The rise in popularity of private arbitration clauses in commercial contracts, which stipulate that the parties submit any disputes to cheaper, quicker arbitration rather than turn to the courts, made Delaware worry about its bottom line. Thus, Delaware said “for the low, low fee of $12,000 per petition, you can have real live Chancery Judges run your private arbitration!”
But the District Court of Delaware’s decision last week put an end to Delaware’s Secret Arbitration Discount Emporium. Some commentatorsthink this is a good thing, noting that court precedent helps develop the law and allow dealmakers to structure future transactions accordingly. Which would be great if this decision really changed anything.
You see, the Chancery judges only heard 5 of these arbitrations last year, netting a whopping $60,000. To the extent businesses are opting for arbitration, its been completely private arbitration. The fact that the Delaware Coalition for Open Government challenged the law almost immediately probably didn’t make anyone real eager to use it. But I also suspect a more pragmatic problem: most of the companies incorporated in Delaware are actually located somewhere else. When drafting an arbitration clause, one of the questions I ask my clients is “where?” If the parties are both somewhat local, the answer is Philly, and if the other side is located somewhere far away, we often pick a spot somewhere in the middle. Occasionally, we pick the other side’s hometown, and, sometimes, my clients seem disconcertingly excited about the prospect of arbitration, especially if its held somewhere like Rio or Mumbai. But we never seem to pick Delaware… the Forgotten State.