Extraterritorial Courts for Corporate Law

A central goal in devising a system of courts is to make judicial services easily accessible. As a result, justice is usually administered in a geographically decentralized fashion: trial courts are distributed across the territory in which the jurisdiction’s law is applied. Corporate law, however, does not fit this pattern: courts are often located far away from the companies subject to their jurisdiction. This is a consequence of choice of law rules providing that a corporation’s internal affairs are governed by the laws of its state of incorporation, and that a corporation need not be incorporated in a jurisdiction where it does business. The result is that Delaware law governs most publicly-traded firms in the U.S., and is now extending its reach to encompass corporations headquartered around the globe. But Delaware courts are located only in Delaware. Consequently, there is a large and growing disparity between the geographic area where Delaware law is applied and the location of Delaware courts. This disparity is all the more striking because the quality of the Delaware judiciary is a prime reason why firms incorporate under Delaware law. This situation provokes a simple question: would it not be both desirable and feasible to have Delaware, and other jurisdictions whose law has substantial extraterritorial reach, hold hearings and trials out of state? The creation of such extraterritorial courts might well yield significant benefits: litigation costs could be lowered, and regulatory competition between jurisdictions could be increased with regard to both substantive law and judicial services. This paper explores the issues involved in such a regime of extraterritorial courts. We consider those issues as they arise within the U.S., within the EU, and globally. We largely limit our analysis to courts whose jurisdiction is confined to corporate law. We note, however, that much of what we say applies as well to other areas of commercial law. Moreover, in exploring their promise we gain important perspective on the basic relationships among substantive law, adjudication, territoriality, and sovereignty, and on the differences between private arbitration and public adjudication. Dammann & Hansmann, Extraterritorial Courts P. 3 EXTRATERRITORIAL COURTS FOR CORPORATE LAW Jens Dammann and Henry Hansmann I. Are Extraterritorial Courts in the Public Interest? ......................................................................... 6 A. Advantages of Extraterritorial Courts ............................................................................................. 6 1. Lowering the Costs of Litigation................................................................................................. 6 2. Invigorating Regulatory Competition........................................................................................ 10 a. Within the United States ....................................................................................................... 11 b. Between Nations................................................................................................................... 11 3. Creating Competition in the Area of Judicial Services.............................................................. 13 B. The Potential Drawbacks ............................................................................................................... 15 1. The Lack of a Uniform Environment ........................................................................................ 15 2. Would There Be Enough Business? .......................................................................................... 16 3. Abusive Litigation? ................................................................................................................... 16 4. Forum Shopping ........................................................................................................................ 17 C. Extraterritorial Courts versus Arbitration ..................................................................................... 19 2. The Parties’ Perspective ............................................................................................................ 19 a. The Benefits of Arbitration................................................................................................... 20 b. The Drawbacks of International Commercial Arbitration .................................................... 23 2. Society as a Whole .................................................................................................................... 24 D. Should Access to Extraterritorial Courts be Restricted? ............................................................... 24 1. Protecting Litigants ................................................................................................................... 25 2. Protecting the Interests of the Host State................................................................................... 25 II. Are Extraterritorial Courts in the Interest of Popular States of Incorporation?........................ 26 A. The Costs........................................................................................................................................ 26 B. The Benefits.................................................................................................................................... 26 III. Other Obstacles to Extraterritorial Courts ............................................................................... 27 A. Traditional Concerns about Sovereignty ....................................................................................... 27 B. Opposition from Delaware Law Firms .......................................................................................... 28 C. Lack of Demand ............................................................................................................................. 29 IV. Extraterritorial Courts outside Corporate Law........................................................................ 30 A. Extraterritorial Application of a Jurisdiction’s Law...................................................................... 30 B. Uniform Law .................................................................................................................................. 31 C. Other .............................................................................................................................................. 31 V. Legal Obstacles to Extraterritorial Courts ..................................................................................... 31 A. Between Unrelated Sovereigns....................................................................................................... 32 B. Within the United States................................................................................................................. 34 VI. Implications for the Understanding of Sovereignty .................................................................. 36 Dammann & Hansmann, Extraterritorial Courts P. 4 VII. CONCLUSION............................................................................................................................. 38 A central goal in devising a state, national, or supranational court system is to make judicial services easily accessible. To reach that goal, justice is usually administered in a geographically decentralized fashion: lower level courts tend to be distributed across the territory of the jurisdiction to which they belong, and that territory is typically identical with the area where the relevant law is applied. From an economic perspective, this tendency towards a geographically decentralized court system is easy to explain: It will generally be cheaper to locate courts near potential litigants than to force litigants and witnesses to attend hearings in far-away courts. The judicial administration of corporate law, however, does not fit this pattern. At least where publicly traded corporations are concerned, courts are often located far away from the companies subject to their jurisdiction. This is the result of the state of incorporation doctrine, which is applied in all U.S. states and in many other jurisdictions around the world. Under that doctrine, corporations are free to choose the state whose law will govern their internal affairs. Particularly in the United States, but also in other parts of the world, corporations make use of that doctrine to opt for corporate law from a jurisdiction other than the one where their primary place of business is located. A striking 2 It is easy to see, for example, that the structure of the federal court system in the United States follows this pattern: The district courts and even the courts of appeal are spread across the United States. Similarly, the European Community Treaty, while using a different technique, also makes sure that the relevant conditions are met: To the extent that Community law is applied in litigation between private parties, the courts of the Member States, which are distributed across the United States, have jurisdiction. 3 Denmark, Ireland, the Netherlands, and the United Kingdom have traditionally applied the state of incorporation doctrine. See, e.g., Karsten Engsig Sörensen & Mette Neville, Corporate Migration in the European Union: An Analysis of the Proposed 14th EC Company Law Directive on the Transfer of the Registered Office of a Company from One Member State to Another with a Change of Applicable Law, 6 COLUM. J. EUR. L. 181, 185 (2000); Jens C. Dammann, Freedom of Choice in European Corporate Law, 29 YALE J. INT'L L. 477, 479 n.9 (2004) [hereinafter Dammann, Freedom]. Finland and Sweden also appear to fall into this category. See Paul Krüger Andersen & Karsten Engsig Sörensen, Free Movement of Companies from a Nordic Perspective, 6 MAASTRICHT J. EUR. & COMP. L. 47, 54-56 (1999). A number of other Member States have traditionally applied the so-called real seat doctrine under which the law of the headquarters state governs a corporation’s internal affairs. However, the Court of Justice of the European Communities has recently made it clear that this latter approach generally violates the Freedom of Establishment granted by the Treaty Establishing the European Community provided that the corporation has been validly formed in another Member State. For a description of the relevant case law see Dammann, Freedom, at 483-486. 4 See FRANKLIN A. GEWURTZ, CORPORATION LAW 36 (2000). Dammann & Hansmann, Extraterritorial Courts P. 5 consequence is that Delaware law governs most publicly-traded firms in the U.S., and is now extending its reach to encompass corporations headquartered around the globe. But Delaware courts are located only in Delaware. Consequently, there is a large and growing disparity between the geographic area where Delaware law is applied and the location of Delaware courts. To be sure, courts in other jurisdictions can hear disputes arising under Delaware law. But their judgments do not constitute binding precedents with respect to Delaware law. And, even if one focuses solely on the parties’ perspective, courts from other jurisdictions will find it hard to be seen as an attractive alternative to Delaware. It is precisely because of Delaware’s unusually competent and efficient judiciary that many firms choose to incorporate in that state. Moreover, quite apart from the particular strengths of Delaware courts, when the courts of other states apply Delaware corporate law, they are faced with the law of a foreign jurisdiction. These observations suggest a simple question: would it not be both desirable and feasible to have Delaware hold hearings and trials out of state? Why, for example, does not Delaware set up courts in San Francisco, or Frankfurt, or Singapore? Why, for that matter, does it not set up a court in New York City, which would be much more convenient than Wilmington, Delaware, even for most of the publicly traded U.S. firms that already incorporate in Delaware? In the remainder of this essay, we explore why this has not been done, whether it should be done, and how it might be done. Although we use Delaware as an example, there is no reason why other important – or wish-to-be important – states or countries that welcome incorporation by out-of-state firms might not also create extraterritorial courts. The United Kingdom, for example, might choose to facilitate access to their own corporation law by the same means, holding hearings and trials elsewhere in Europe, in the U.S., or in the world at large. Singapore might seek to play the same role in East Asia and the Pacific. Nor is there any reason why extraterritorial courts need be confined to corporate law. The same approach could be applied to other aspects of commercial law, such as contract law, where actors commonly choose to be governed by the law of a foreign jurisdiction. Moreover, whatever the merits of extraterritorial courts as a practical proposal, in exploring their promise we gain helpful perspective on the basic 5 Cf. DELAWARE DIVISION OF CORPORATIONS, Why Choose Delaware As Your Corporate Home?, available at http://www.state.de.us/corp/default.shtml (last visited July 20, 2005) (claiming that “[m]ore than half a million business entities have their legal home in Delaware including more than 50% of all U.S. publicly-traded companies and 58% of the Fortune 500”). 6 See Black, supra note 12, at 586-89 (1990) (citing the expertise of Delaware judges as the primary reason for Delaware’s success in the charter market). 7 As pointed out above, the United Kingdom adheres to the state of incorporation doctrine. See Sörensen & Neville, supra note 3, at 185. Dammann & Hansmann, Extraterritorial Courts P. 6 relationships among substantive law, adjudication, and territoriality, and on the differences between private arbitration and public adjudication. Part I argues that the creation of extra-territorial courts by Delaware and other would-be-contenders in the market for corporate charters lies in the interest of society as a whole. Part II then suggests that it also lies in the interest of popular states of incorporation, especially Delaware, to establish such courts. Part III examines possible reasons why, despite their desirability, extraterritorial courts have not been established already and why the relevant obstacles are unlikely to prevent their creation in the future. Part IV briefly explores the potential for extraterritorial courts outside corporate law. Part V then examines the current legal framework and suggests that neither federal nor international law stand in the way of extraterritorial courts provided that the host state grants its permission. Part VI ties together our analysis of the merits of Extraterritorial courts, the value of exporting judicial services in general, and the nature of state sovereignty. Part VII concludes. I. Are Extraterritorial Courts in the Public Interest? The most central question with regard to extraterritorial courts is, of course, whether their creation would be in the interest of society as a whole. There is much reason to believe that the answer is yes. A. Advantages of Extraterritorial Courts The creation of extraterritorial courts by popular states of incorporation such as Delaware could have a number of significant benefits. 1. Lowering the Costs of Litigation The most obvious advantage is that establishing courts in the geographic vicinity of potential litigants should, in many cases, be cheaper than forcing potential litigants to litigate in the state of incorporation itself. Thus, the establishment of extraterritorial courts in appropriate locations promises to lower the costs of administering justice. To be sure, firms can choose to be governed by a state’s corporation law without bearing the burden of litigating in that state. Delaware courts, for example, have no monopoly on the application of Delaware law. Under the state of incorporation doctrine, courts in other jurisdictions will apply Delaware law to the internal affairs of Delaware corporations. The courts of other states are not, however, an adequate substitute for Delaware courts in applying Delaware law. To begin with, a Delaware corporation cannot be certain that the courts of other states will accept disputes concerning the corporation’s internal affairs. Rather, Dammann & Hansmann, Extraterritorial Courts P. 7 courts may – and sometimes will – invoke the doctrine of forum non conveniens to refuse to hear cases relating to the internal affairs of foreign corporations. Moreover, cases involving Delaware law that are litigated outside of Delaware are beyond the influence of the Delaware judiciary, and thus bring the risk of undermining the coherence and uniform application of Delaware law. Finally, one of the great advantages of Delaware incorporation, it is widely felt, lies in access to Delaware’s uniquely capable and efficient judiciary. In fact, it is arguable that Delaware’s judiciary, rather than the body of substantive doctrine offered by Delaware corporate law, is today the principal attraction of Delaware incorporation. But is it really a big burden for Delaware corporations to litigate in Delaware’s courts? Two considerations might suggest not. 8 For an exemplary definition of the forum non conveniens doctrine see Gulf Oil Corp. v. Gilbert, 330 U.S. 501, 508-09 (1947). 9 Cf., e.g., Kelley v. American Sugar Refining Co., 42 N.E. 2d 592, 594 (Mass. 1942) (coming to the conclusion that the questions at issue should be decided by the courts of the state of issue incorporation); Thompson v. Southern Connellsville Coke Co., 112 A. 533, 534-35 (Pa. 1921) (refusing to exercise jurisdiction over the internal affairs of a foreign corporation); Meade v. Pacific Gamble Robinson Co., 153 P.2d 686, 689 (Wash. 1944) (holding that “[w]here, as in the case at bar, the controversy necessitates interpretation of a statute of the state creating the corporation the general rule against interference with the internal affairs of a foreign corporation is strictly applied”). 10 The internal affairs rule was originally considered to be not only a choice of law doctrine, but also a jurisdictional doctrine. As a result, courts would sometimes decline to hear cases relating to the internal affairs of foreign corporations based on the assumption that they lacked jurisdiction. See, e.g., Boyette v. Preston Motors Corp., 89 So 746, 748-49 (Ala. 1921). However, the modern trend is to apply the forum non conveniens doctrine in deciding the question of whether or not to exercise jurisdiction over the internal affairs of foreign corporations. See., e.g., In re Mercantile Guar. Co., 48 Cal. Rptr. 589, 593 (Cal. App. 1st Dist. 1965); Lonergan v. Crucible Steel Co. of America, 229 N.E.2d 53, 539 (Ill. 1967); State v. Iowa Southern Utilities Co. of Delaware, 2 N.W.2d 372, 390-91 (Iowa 1942); Amatuzio v. Amatuzio, 410 N.W. 2d 871, 874 (Minn. App. 1987); Sterling Grace & Co. v. Seeman Bros., Inc., 215 N.Y.S. 2d 559, 560-61 (1961). 11 See, e.g., ROBERTA ROMANO, THE GENIUS OF AMERICAN CORPORATE LAW 40 (1993) (praising the expertise of Delaware’s judges); Ehud Kamar, A Regulatory Competition Theory of Indeterminacy in Corporate Law, 98 COLUM. L. REV. 1908, 1911 (1998) (noting a consensus that Delaware’s judges are one of the reasons for Delaware’s success in the charter market); David A. Skeel, Bankcruptcy Judges and Bankcruptcy Venue: Some Thoughts on Delaware, 1 DEL. L. REV. 1, 16 (1998) (arguing that Delaware’s judges play an “important part” in explaining Delaware’s success in the charter market); Marcel Kahan & Ehud Kamar, The Myth of State Competition in Corporate Law, 55 STAN. L. REV. 679, 708 (2002) (claiming that “[a] principal attraction of incorporating in Delaware is the high quality of its chancery court”). 12 See, e.g., Bernard S. Black, Is Corporate Law Trivial?: A Political and Economic Analysis, 84 NW. U. L. REV. 542, 586-89 (1990). Dammann & Hansmann, Extraterritorial Courts P. 8 a. The Ease of Litigating from a Distance To begin with, litigating at a distance has become fairly simple, especially in Delaware. You do not have to go to Delaware to prepare briefs or memoranda, review documents, interview witnesses, or take depositions. In fact, the Chancery Court Rules even provide for the electronic filing of documents. However, while much of the work to be done in litigation can be done without coming to Wilmington, personal appearances by counsel and litigants are still often unavoidable. And, even if one can litigate from a distance, this may not always be the most efficient way to conduct a trial. It is quite possible that corporate clients and their counsel would spend more time before the Chancery Court if it were not located so inconveniently. Moreover, even rare appearances before a court can be quite burdensome for foreign-based firms. For foreigners, the inconveniences of litigating in Delaware include not just the problem of travel and of litigating in a foreign language, but also, today, permission to enter the country. In the worst case, a past violation of visa rules or some other misstep proves to be a permanent obstacle to entry into the United States. The unpredictability of United States immigration policy is now a significant deterrent to incorporating in the United States. 14 Perhaps more importantly, the argument that the costs and difficulties of communicating at a distance have declined and will continue to decline cuts both ways. Admittedly, lower communication costs mean that litigating in a far-away court becomes much easier, thereby reducing the need for extraterritorial courts. At the same time, however, any decline in the costs of communicating at a distance also means that the number of corporations for which incorporation in a foreign jurisdiction becomes feasible increases. Thus, the demand for extraterritorial courts grows. It is noteworthy in this context that U.S. law firms have steadily increased their presence in other countries. For example, Sullivan & Cromwell, Debevoise, and Skadden Arps now have offices in Frankfurt. To be sure, there are many differences between the services provided by courts and those provided by law firms. Nevertheless, the thesis that low communication 13 Cf. DEL. CH. CT. R. 79.1 (2004) (leaving it up to the Chancellor to determine whether or not it is appropriate, in a civil case or in a category of cases, to follow the procedures for eFiling). 14 For a more detailed analysis of why non-U.S. firms may be reluctant to incorporate in Delaware see Jens C. Dammann, A New Approach to Corporate Choice of Law, 39 VAND. J. TRANSNAT'L L. (forthcoming 2005) [hereinafter Dammann, New Approach]. 15 One might reason, for example, that courts need not be located as close to the litigants as lawyers are because courts deal with legally experienced players -namely corporate lawyers -whereas law firms interact with clients who have no legal training and therefore depend more on face-to-face communication. Since most large corporations have in-house counsel, however, the force of this logic is unclear. Dammann & Hansmann, Extraterritorial Courts P. 9 costs will necessarily lead rational providers of law-related services to reduce their physical presence in other jurisdictions seems premature. b. The Prevalence of Public Corporations Another reason why the geographic remoteness of the courts of Delaware, and of would-be Delawares, might seem unimportant is that Delaware’s lead in the charter market exists mainly among large, publicly-traded corporations for whom litigation in a geographically distant location is not as onerous as it might be for smaller litigants. Yet the problems just recited affect even publicly traded corporations, and especially foreign firms. Moreover, while Delaware’s lead is indeed greatest among publicly traded corporations, that state is currently home to roughly 300,000 corporations, a number far larger than the total of all publicly traded corporations in the United States. Indeed, the overall number of U.S. corporations whose stock is listed on stock exchanges is less than 2,500. Of course, many large companies are not, in fact, listed. However, IRS data suggests that the number of large U.S. firms is not, in fact, terribly large. Indeed, as late as 2002, the number of income tax returns filed by corporations with total assets equal to or exceeding $5 million was only 137,163 – well below the total number of Delaware corporations. Moreover, the total number of income tax returns filed by corporations with total assets of ten million dollars or more was only 79,755. It follows that there may be many Delaware corporations for which the costs of litigating outside the headquarters state actually matter. In fact, despite the large number of closely held firms incorporated in Delaware, that state’s dominance in the charter market does not extend to close corporations in 16 Cf., e.g., Lucian Arye Bebchuk, Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law, 105 HARV. L. REV. 1435, 1442 (1992) (“[C]lose corporations generally incorporate in the states in which their principal places of business are located”); David A. Skeel, Jr., Rethinking the Line Between Corporate Law and Corporate Bankruptcy, 72 TEX. L. REV. 471, 522-523 (1994) (“[C]losely held corporations almost always incorporate in the same state in which they do all (or most) of their business.”). 17 On December 31, 2003, the number of Delaware corporations totaled 297,602. E-mail from Cheryl Wyatt, Delaware Division of Corporations (August 24, 2004, 19:43:12 EST) (on file with author). 18 Cf. SECURITIES EXCHANGE COMMISSION, SELECT SEC AND MARKET DATA 2005, p. 30, Table 13: Securities Listed on Exchanges 1, available at: http://www.sec.gov/about/secstats2005.pdf (last visited on March 6, 2006). According to that table, the total number of common stocks listed on U.S. stock exchanges at the end of 2004 was 2930. That number already appears to count double any dual listings. Also, the number includes 549 foreign stocks, so the the number of U.S. common stocks is equal to or less than 2381. 19 See INTERNAAL REVENUE SERVICE, SOI TAX STATS – CORPORATION DATA BY SIZE 20 See id. Dammann & Hansmann, Extraterritorial Courts P. 10 general, which still typically incorpor+ate in the state in which they are headquartered. While there are several considerations that may help to explain this pattern, the relatively large potential costs to a small firm of having to litigate in Delaware rather than in the firm’s headquarters state appear to be particularly important. Indeed, the geographical limits on Delaware’s judicial system may explain why Delaware has only a limited incentive to compete for close corporations in the first place. Given that such corporations will often litigate in their headquarters state rather than in their state of incorporation, a successful effort by Delaware to attract many small out-of-state corporations might be self-defeating: The quality of Delaware’s case law might deteriorate as a result of conflicting decisions handed down by courts in other states. 2. Invigorating Regulatory Competition Another potential benefit of extra-territorial courts lies in stimulating regulatory competition in corporate law. To be sure, not all scholars are convinced that regulatory competition benefits shareholders. We will not pursue that debate here, but will simply accept, for the sake of analysis, the prevailing view that, on balance, the ability of firms to choose their state of incorporation contributes to overall social welfare. Extraterritorial courts could invigorate charter competition in several ways. We begin with the situation inside the United States and then turn to the international context. 21 See the sources cited supra note 16. 22 See Jens C. Dammann, Adjudicative Jurisdiction and the Market for Corporate Charters, Working Paper (November 2003), available at: http://ssrn.com/abstract=466760 [hereinafter: Dammann, Adjudicative Jurisdiction] (listing and analyzing various factors). 23 Cf. Dammann, Adjudicative Jurisdiction, supra note 22 (noting that the need to litigate in the state of incorporation is likely to deter close corporations from incorporating out of state). Cf. also Ian Ayres, Judging Close Corporations in the Age of Statutes, 70 WASH. U. L. Q. 365, 374-375 (1992) (arguing that the risk of having to litigate outside of the headquarters state constitutes one of the factors motivating close corporations to incorporate locally). 24 For a critical view see, e.g., Lucian Bebchuk, Alma Cohen & Allen Ferrell, Does the Evidence Favor State Competition in Corporate Law?, 90 CAL. L. REV. 1775, 1820 (2002) (empirical evidence fails to show that state competition benefits shareholders). 25 See, e.g., FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 222 (1991) (while one may search in vain for a race to the top, state competition creates a “powerful tendency” to enact laws benefiting shareholders); Roberta Romano, Competition for Corporate Charters and the Lesson of Takeover Statutes, 61 FORDHAM L. REV. 843, 847 (1993) (state competition benefits shareholders “on balance”). Dammann & Hansmann, Extraterritorial Courts P. 11 a. Within the United States We have already observed that extraterritorial courts would help make out-of-state incorporation a feasible alternative for close corporations. Thus, the phenomenon of charter competition, which remains largely restricted to publiclytraded corporations, could potentially be extended to close corporations. In addition, extraterritorial courts might help other American states compete with Delaware for corporations of all types. While there are many reasons why Delaware has risen to dominance in the charter market, one mundane but important factor may simply be that Delaware is located more advantageously than many of its potential competitors, such as Nevada.