Nevada v. Delaware with Michal Barzuza

In this episode, CII General Counsel Jeff Mahoney sits down with Michal Barzuza, a Professor of Law at the University of Virginia School of Law. Professor Barzuza is the author of a recent article "Nevada v. Delaware," which compares and contrasts the corporate laws of Nevada and Delaware.  Among the topics discussed on this episode: (1) the Professor’s views on the key factors that institutional investor should consider when voting on a proposed reincorporation from Delaware to Nevada; (2) the Professor’s research findings regarding the accounting practices of Nevada companies; and (3) the Professor’s recommendation that either the courts or federal law should require a supporting vote by a majority of the minority of shareholders as a condition for reincorporation.

Transcript

SPEAKER_02 0:12

Welcome everyone. Thank you for listening to the Council of Institutional Investors Voice of Corporate Governance, the number one best corporate governance podcast in the United States for 2025 as determined by Million Podcasts. I'm your host, Jeff Mahoney, General Counsel of CII. Our topic for this episode is a recent research article titled Nevada versus Delaware. And my special guest today is the author of that article, Mikhal Barzuza, Professor of Law at the University of Virginia School of Law. Welcome to the program, Professor. Thanks for taking the time to speak with us today.

SPEAKER_00 0:50

Thank you for having me. It's a pleasure being here.

SPEAKER_02 0:53

So, Professor, your new research article compares Delaware and Nevada corporate law. So, what was the motivation for this article?

SPEAKER_00 1:04

Great. So I've been working on Nevada for a while. My first article was like a decade ago. And now I think that first the this question has become important. It has a lot of implications. It has implications for firms that uh shareholders who have to decide how to vote on rain corporation. It has implications for the potential uh law that will apply to rain corporations. So when I started working on it, TripAdvisor just started. It could have been the case that uh the Delaware courts will have to make this comparison. They didn't have to, but now there is actually a new case in Delaware court that actually might require that. And also, I've done my first research on Nevada when there was an assumption in the literature that Nevada actually copies Delaware law. And I did research on different things, and Nevada kept coming as different to me. And then I started, you know, going deep into the law, and I found out that already in 1987 they adopted an exculpation statute that was very different from Delaware Law. Now, the assumption used to be that they try to attract corporations, but they do it by copying Delaware law, really, and in some sense even committing to the future cases of Delaware and so forth. So it was striking to me to see that already in 1987 they took a very sharp turn consciously. So the the in the legislative session, they talk about it. They say we should adopt a broader exploitation statute that covers also the duty of loyalty because this is the way to attract uh companies, and that we don't know about it yet. And you know, it was the beginning of 2010, and it was striking to me to see uh we talk a lot about efficient markets, but in that sense, it was a very surprising gap of information. So now when this issue came up, and already then when I published the paper, I I talked about the exploitation statute. Now, when this issue came up again, Nevada already made a lot of other changes uh since that paper, which I knew about because I followed that. Uh so it was important to provide this information. And also, uh, my impression was that there is still a lot of like confusion and kind of of uh uh about what Nevada law exactly is and and debates and so forth. And and since it's an important question, since there are new information, facts about it since my last research, and I found more when I digged into it. Uh, and since the information is still not out there and there are debates about it, I thought this is a very important uh subject. It was a significant motivation.

SPEAKER_02 3:37

So, Professor, let me let me give you a hypothetical. So I'm an institutional investor, I'm voting on a proposed reincorporation of a U.S. public company from Delaware to Nevada. What do you believe to be the key differences between Delaware and Nevada corporate law that I, as an institutional investor, should consider before casting my vote on a reincorporation?

SPEAKER_00 4:04

I think the first would be the broad exculpation statute, the lack of inspection rights for that are uh required for shareholder litigation, and the interaction between them. I think together it's a very potent and significant difference from Delaware. It creates. So, first the exculpation statute, the exculpation statute, so Delaware exculpation statute allows firms to opt out for monetary liability for the breach of duty of care with shareholder approval in the charter. Oh, and Delaware has exceptions. You're not allowed to do that from the duty of loyalty, the duty of care, intentional misconduct, and non-violation of law. In Nevada, first the explication is at the default right now. So directors and officers are not liable unless they breach the fiducial duty and the behavior also amounted to intentional misconduct, fraud, or non-violation of law. Only in these cases they're liable. So basically, what Nevada did is replacing the exceptions of the duty of loyalty and the duty of good faith with fraud. Both states have the intentional misconduct and the non-violation of law. Delaware has also the duty of loyalty and the duty of good faith as exceptions to exploitation, and Nevada instead has fraud. And as I said, the legislative history shows that that was conscious, it was uh directed to be broader, and in order to attract corporations. Now, Nevada legislature came back again in 2017 to reinforce, to clarify and reinforce this differentiation. So some courts followed this and some courts less followed this. So then in 2017, Nevada legislature uh passed another amendment saying that in Nevada the law is different from other states, and especially 78138, which is the extirpation, and 78139, which is the fiduciary duties in in change of control situations, are different in Nevada and should be applied by courts and should not be supplemented by cases from other states. Uh so here we see, you know, not only the intention, but also a very strong commitment to enforce this uh and to adhere to this differentiation, clear differentiation. And indeed, after 2017, I think that courts really uh uh, as far as I've seen, all followed it. Also before that, but after 2017, it will become became more uniform. Um and courts decided in Nevada that this is the sole avenue to find directors and officers liable. So it trumped entire fairness in cell-dwilling transactions, it trumped any other, it's really the sole uh avenue to apply a liability in Nevada. And they also uh interpreted it to require shareholders. So, what does it mean, intentional misconduct, fraud or non-invalation of law, they also interpreted it to require um shareholders to plead either wrongful intent or knowledge of wrongfulness. We have to remember that we're talking about shareholder lawsuits. The first stage is the uh demand futility stage. The shareholders have to argue that demand is futile. And this stage is prediscovery. Showing intention, wrongful intent in this stage, or um a knowledge of wrongfulness in the sense that directors not only knew that what they're doing, but they also knew that it's prohibited by law. The way shareholders usually pass the motion to dismiss is by using board minutes. But board minutes are not always would reflect this and the intent. So that's already a significant impediment, especially since in Delaware you don't need to show intent for self-dilling transactions. In Delaware, just by the structure of the transaction, uh Chief Justice Strine has even an article that talks about that uh it's enough that we have a conflict of interest, and we we just know that with the conflict of interest you have to do more scrutiny. But but here you have to show intent, and that's already very different from Delaware. On top of that, in Delaware, uh shareholders have access to board minutes. This is how they manage to pass the motion to the state, even though it's prediscovery. In Nevada, apparently, publicly traded companies are not uh required to provide their shareholders with inspection rights. They're not required to provide them with internal documents. As long as they file with the SEC as they should, this is enough. This is what shareholders should have according to uh the Nevada statute. And that's actually an important point because it was not, this is actually something that even I didn't know when I wrote my previous paper, and then I found out about it later. And the reason is that it is confusing. The Nevada statute has a very long section on inspection rights that talks about 15% shareholders, but all of the section is about private companies. And then the last, last subsection says, but all of this section does not apply to publicly traded companies. Basically, publicly traded companies, you have no inspection rights. Now, I think until I wrote this piece, uh actually it was really unknown. And if you look, for example, at the TripAdvisor uh proxy materials to reincorporate to Nevada, when they compare, they make the comparison, which you should do, they um include inspection rights and they just include the entire section from the Nevada law. Now, 90% of the section, or or just something similar to the entire section, but really is not relevant at all. TripAdvisor is a publicly related company. And I think you know, when when shareholders, even institutions, you know, see this, their impression is okay, there's some differences, but here maybe you you get some, you give some, or and this was also reflected in the amicus that that the Secretary of State submitted to Delaware Supreme Court Act. So it was really something that that was not known. Uh, and it's it's very important, it's especially important given the the highly, even if even if Nevada did not have a broader extirpation statute, lack of inspection rights is significant. Inspection rights helped uh shareholders to pass the motion to dismiss in many cases. Uh, there's also nice research about that. But the combination of having no inspection rights and also a high pleading standards as a result of the extirpation statute, that you have to show uh wrongful intent uh or knowledge of wrongfulness, and that this Trump's entire fairness, again, Trump's oversight, everything is decided according to this uh intentional misconduct, fraud, or non-violation of law. Now, the only exception to this, oh, and and by the way, actually, also the the website, the silver flume of of uh Nevada state for for years now had like a memo that said why in Nevada there was a title like uh board uh directors immunity from lawsuit, and it explains these differences and the differences in exclipation. Now, excurpation applies to directors and officers. So it applied to directors in self-dreeding transactions in the Guzman case, it applies to uh directors in oversight in in Las Vegas case, but it did not apply to controlling shareholders because excurpation does not apply to controlling shareholders. However, recently, uh May 2025, Nevada uh legislator stepped in again with a response basically to SB21. Um and this response significantly narrowed the fiduciary duties of controlling shareholders and in practice basically extended excurpation to controlling shareholder. Because under AB 239, uh which is the amendment to Nevada law, the controlling shareholder, first the controlling shareholder is only a shareholder that has at least 50% of the voting rights. Second, the controlling shareholder has only one fiducial duty, which is to refrain from exerting influence on directors and officers in a way that will result with them breaching the non-exculpated duties. And there are also other requirements on top of that. Okay, it has to be a sub-dilling transaction, there are other requirements, but and there is also a presumption if the three directors, independent directors, approved that that the controlling shareholder did not breach their fiducial duties. But what happens is that if you want to find the controlling shareholder liable to subdue, or even to scrutinize the sub-divid transaction, you have to show that the directors are conducted intentional misconduct for the non-violation of law without inspection rights. And it's not enough that there's just conflict of interest in the transaction. You have to bring some particular fact for intentional misconduct or non-violation of law. And then if you manage to do that, uh then you'll have to show that the controlling shareholder exact executes some influence, some pressure on these directors that led to that, and that if three independent directors approve that, you'll also have to overcome the presumption that still he's not, he didn't breach his fiducial duty. So uh this is the recent addition to Nevada law, which is very important. And I think it's really also didn't get enough attention or coverage, and it's something that institutional investors should definitely know. It's uh the expansion to uh controlling shareholders. As far as I know, I haven't seen that in other states, usually controlling shareholders are not exculpated. Another difference that is important is the fiduciary duties that apply in change of control situations. So um in 1999 already, it was after the Hilton Hotel case. In Hilton Hotel, uh there was a situation of interference with shareholder franchise. So what what used to be in Delaware Blasius, the judge applied Blasius, and but also said in a dicta, here Nevada follows uh uh Delaware standards, Yoneko, Revlon, and Blasius. So in 1999, the legislator stepped in, responded to that with again, legislative history is very clear. Um they discussed the Hilton Hotels, they say we do not uh believe in enhanced duties in change of control situations, and therefore we changed the law to replace as long as there is no intervention in shareholder franchise, then the business judgment rule applies. So that means that in situations in Delaware when there was no intervention in shareholder franchise, and Delaware applied either UNECO or Revlon, then these are replaced by the business judgment rule. Now remember that Revlon applies when the company is for sale, right? And it it requires managers to conduct a sell process and to sell to the highest bidder, right? So applying the business judgment to the situation means deference, uh it could, it could result with no uh scrutiny of the process of the sale or the choice of the bidder. And and the last thing I'll say in the basis of this, there is a commitment to provide significantly more protection to directors and officers, to continue to provide that, to reinforce that, to change the law when needed to differentiate further at the state. So I think that's also a difference in the bottom line between uh uh Nevada and Delaware.

SPEAKER_02 15:06

Professor, I'm I'm an accountant as well as a lawyer. So I found of interest that your article indicates that Nevada attracts companies with aggressive accounting practices and frequent restatements. So could you talk about the evidence supporting that conclusion and how might that evidence be relevant to institutional investors, audit committees, independent external auditors, or audit regulators?

SPEAKER_00 15:36

Sure. So so this is a project made by a colleague David Smith from our McIntyre school. It was published in the RFS, and there we found we looked at the type of companies that Nevada attracts. We found first that they were different. They were much significantly smaller back then. I think now what we are seeing is different. Now we have larger companies with controlling shoulders. But back then these were small companies, and we used the restatement as a proxy for their corporate governance, for their agency costs, for the potential problems. Because it's regulated primarily by the securities law. So we use it as a proxy. And what we found is that Nevada companies are significantly more likely to restate their earnings, that around 30% more likely than companies in Delaware and in other states. We found that that is true also to those with statements that reduce earnings, and it's true also to those with statements that are uh there is a suspicion of fraud. Now, so the first conclusion is Nevada attract companies uh with uh high level of restatement. We also looked at the GMI uh ranking of aggressive accounting aggressiveness also there, they they are uh ranked high. So basically, companies that are uh attracted to lax law are companies actually with a high agency cost, ones that could benefit from more regulation. But then we also try to tease causality, which is usually what we do in these situations, and we got some suggestive uh evidence for causality. Of course, you know, um we this it's very uh difficult and not careful to jump to conclusions in in this kind of studies. But what we found is that if we use an instrument of bordering state with Nevada, uh because there is there are more companies that that incorporate there in Nevada from the boarding states, and we thought, you know, sometimes it's for arbitrary reasons, like maybe the lawyer, local lawyer and so forth, then in these companies there was also like a higher likelihood and an increase in accounting restatements. So that that is also suggestive of maybe when you go to Nevada, maybe because the board is less concerned about liability, the board less, you know, less monitors the management and so forth. And also we found that for companies that that that re-incorporated to Nevada prior to the 1987 change, those companies did not have a significantly statistically significant higher uh uh level of accounting restatements.

SPEAKER_02 18:00

Professor, your paper recommends that either the courts or federal law should require a supporting vote by a majority of the minority of the shareholders as a condition for reincorporation? So I I have three related questions in response to your recommendation. First, what's the basis for your recommendation? Second, how would you define minority shareholder for the purposes of your recommendation? And three, how might an institutional investor who may want to support your recommendation, what would be the most effective way for an institutional investor to demonstrate support for your paper's recommendation?

SPEAKER_00 18:46

Sure. Willie, I I was referring here to the what it is called majority of minority or the MOM requirement that applies also even under uh SB21 as a cleansing mechanism for self-dwelling transactions. So that means uh the majority of the votes who are not conflicted in the sense that the votes of the controlling shareholders are not going to be counted. Now, in TripAdvisor, for example, that was not met in a very significant way because TripAdvisor re-domestication requires shareholder approval and board approval. TripAdvisor, Greg Mafee had a very significant block from the other shareholders. Only 5% of the minority shareholders voted in favor. 95% voted against. And this is, you know, it's it's really quite significant for um shareholders to. So clearly, shareholders were not in favor. And, you know, when a controlling shareholder can make decisions that benefit them to some extent and deprive shareholders from some of their litigation rights without uh requiring shareholder approval. What we think, you know, what law and economic analysis believes is that this may result, the controlling shareholder, if he has these opportunities, it may result with decisions that are not in the benefit of the company, that do not maximize the the entire value of the company. So because of that, uh uh we have constraints also on self-telling transactions. Now, in TripAdvisor, the the Supreme Court decided that this was not uh this did not uh trigger entire fairness because there was no issue on the table that that caused this reincorporation. But uh, you know, the question is what's going to happen if there is an issue on the table that the company is maybe trying to avoid uh and therefore is re-incorporating. And actually, there is now a case in Delaware Supreme Court with GPGI where there is a shareholder lawsuit where the shareholders are arguing that this is different from three-print advisor in that sense, that there was an issue here on the table. And my view of this, that this should be considered as a sub-den transaction, and that therefore there should be constraints. Now, applying SB21 really will require either shareholder vote or uh vote of the independent directors, of a committee of independent directors. But I think that, and and the insurance it actually was raised in TripAdvisor from the defendant that it's going to be very difficult to find directors that are really independent enough to approve this because they also benefit from the reincorporation. It's true that that SB21 has a presumption of independence if they meet the SEC requirements, but still, you know, maybe you could rebut the presumption if they're going to benefit by that. So I think in that case, you know, there is the venue of shareholder approval. And with respect to redomestication from Delaware and re-incorporation, there are shareholder approval is needed anyway. So there's going to be a vote anyway. So it's not going to be costly. And I think it's hard to justify re-incorporation when they are when shareholders are against it. Now you asked what uh institutional investors can do. I think you know, advocate now with respect to the GPGI case, advocate uh for this to be considered a self-dreaming transaction and for them to have a voice in in the re-incorporation, as SB21 would require, probably, unless you know you manage to have a committee of independent directors somehow.

SPEAKER_02 22:09

That concludes our podcast episode on behalf of the Council of Institutional Investors. I want to thank my special guest, Micole Barzuza, professor of law at the University of Virginia School of Law. If you have any questions or comments regarding this podcast, please feel free to contact me at Jeff. That's J E F F at CII.org. Until next time, I'm Jeff Mahoney. Thanks again for listening to the voice of corporate governance.

SPEAKER_01 22:43

Thank you for listening to this episode of the Voice of Corporate Governance, brought to you by the Council of Institutional Investors. The Voice of Corporate Governance is a free, non-sponsored podcast that highlights critical developments in corporate governance and other important issues affecting institutional investors. The views expressed by those interviewed on the podcast do not necessarily reflect the views of CII or its members. For more information on CII and its policies on corporate governance, please visit our website at www.cii.org.