Over many decades, the State of Delaware has established a preeminent position as the jurisdiction of choice for businesses to organize, ranging from S&P 500 companies (a majority of which are incorporated in Delaware) to countless startups and LLCs.
This is not by accident; the state’s flexible corporate statutes, very well-developed business case law, highly sophisticated and experienced judiciary (including the renowned Court of Chancery), receptiveness to innovations such as the “poison pill,” and generally friendly commercial orientation offer efficiency and predictability to businesses and their equity holders and counterparties. From the standpoint of this small state with a population under 1 million, corporate franchise taxes are a vital source of revenue.
In recent years, other states have heightened their efforts to attract out-of-state businesses and to erode Delaware’s franchise, and while recently enacted tax reform should essentially halt so-called corporate inversion to lower tax jurisdictions outside the U.S., Delaware has lost untold millions in franchise taxes as a result of this practice.
Another transformative change is underway that could in the not-too-distant future negatively impact Delaware’s popularity as a jurisdiction of choice. This change is not related to lower taxes, but to the popularity of blockchain companies that raise capital through the issuance of tokens or coins, often referred to as initial coin offerings (ICOs), and, relatedly, to so-called “smart securities” or blockchain-based securities with smart contract functionality issued by non-blockchain companies.
Blockchain issuers raised an estimated $5 billion in 2017 through ICOs and, while these transactions varied widely in their quality (and compliance with securities laws), the popularity of ICOs has persisted into 2018 despite well-publicized scams, declining cryptocurrency prices, enforcement actions and strong cautionary pronouncements by the SEC and other regulators.
As evidenced by Telegram’s $850 million follow-on offering of purchase agreements for cryptocurrency earlier this month, the market appetite for tokens remains voracious, at least episodically. Given the continued development of public blockchain use cases and that tokens are the fuel of public blockchains, we expect interest in token offerings to persist.
Unlike shares of stock, tokens or coins generally do not confer ownership in any company and may not include security-like features at all. Token holders are not owed fiduciary duties by the board of directors (or anyone else). Rather, the tokens confer something akin to a license or a coupon, that gives the token holder the right to use the company’s blockchain platform and/or service, which may or may not exist at the time that the token is issued.
For example, the FileCoin ICO, one of the largest on record, confers a future right to digital storage.
Why should Delaware care about ICOs and tokens?
As the space matures and grows in legitimacy, we expect that more and more innovative companies (both start-ups and well-established) will choose to issue tokens or smart securities. For these companies, the appeal of Delaware’s brand of expertise that focuses on shareholder rights in traditional business frameworks could wane, particularly as other states, such as Wyoming and Nevada, actively vie to become the go-to states for blockchain companies and technology.
A new breed of blockchain entrepreneurs as well as traditional companies deploying blockchain technology to issue tokens can be expected to seek out other (token-friendly) jurisdictions that can provide clear regulatory guidance on the issuance of tokens and the rights of token holders.
As time goes by, these companies and their corporate boards are likely to be attracted to jurisdictions that have built up a body of case law that specializes in blockchain, tokens and related issues, in much the same way that Delaware developed jurisprudence in issues related to fiduciary duties and corporate governance, with the potential end result of Delaware being left behind in this rapidly growing sector.
This is not to say that the blockchain boom poses an existential threat to Delaware’s formidable corporate franchise. But Delaware’s primacy should not be taken for granted.
It is perhaps instructive that up until the early part of the twentieth century, New Jersey dominated corporate formations. But then-Governor Woodrow Wilson of New Jersey waged a campaign to curry favor with the populist faction in his bid for president. This campaign included anti-corporation rhetoric and the passage of antitrust legislation, leading to a mass exodus of New Jersey corporations. The exodus was a boon for Delaware, one which Delaware has nurtured over the last 100 years.
To the credit of its leadership, in August 2017, the State of Delaware was the first in the nation (and in the world) to enact legislation expressly authorizing corporations to maintain their corporate shares in a stock ledger on a blockchain. Since that time, several other states have introduced blockchain legislation relating to incorporations, tokens, transacting business, and much more.
In fact the State of Wyoming recently passed several pieces of legislation that not only copied Delaware’s blockchain amendments but went a step further by providing guidance on how blockchain companies that issue tokens can do business in the State compliantly.
The State of Delaware is currently making thoughtful efforts to facilitate the use of blockchain technology so companies can file UCC financing statements and issue shares directly on a blockchain.
These are important initial steps, and certainly the State should proceed with care. But in order to maintain a leadership position in the blockchain space, more will be needed in the not-too-distant future.
In particular, Delaware could benefit by, and should seriously consider, providing additional guidance around the issuance of tokens and cryptocurrency (including by being receptive to new legislation, if appropriate), and by leveraging the state’s refined body of business law and expert judiciary to attract responsible blockchain projects; indeed, the industry would stand to benefit from Delaware’s unique brand of expertise regarding governance.
If we have seen anything in the blockchain space it is that blockchain companies will need a strong governance regime if they are to succeed both individually and as a sector.
Delaware can help with that.