The Delaware Court of Chancery recently made news when it ruled that Delaware law, not California law, applied to a minority shareholder's request to inspect the books and records of a Delaware corporation with its principal place of business in California. In Juul Labs, Inc. v. Daniel Grove 1, the principal substantive issue was whether Daniel Grove (Grove) waived his inspection rights concerning Juul Labs, Inc., a Delaware corporation (Juul Labs), with its principal place of business in San Francisco, California. Grove contended, among other things, that California Corporations Code Section 1601 applied, which expressly permits inspection rights of a corporation with its principal place of business in California, irrespective of the corporation's domicile. 2] Juul Labs argued that Grove allegedly waived his inspection rights under certain private option and investor agreements, the California law is not applicable and Section 220 of the Delaware General Corporation Law applies,3 and the exclusive forum selection clause in Juul Labs' certificate of incorporation must be enforced.
After a detailed discussion about the merits and various arguments, the court clearly shifted focus, putting aside the substantive waiver issue and analyzed a historically important constitutional law principle: the internal affairs doctrine. The internal affairs doctrine stands for the proposition that the laws of a corporation's domicile govern in a dispute between a corporation and its shareholders, officers or directors. This doctrine seeks to prevent inconsistent legal standards from being applied, "as well as in ensuring that investors in such corporations have an effective voice in corporate affairs." Inspection rights are a fundamental matter of corporate governance and disputes relating to such rights undoubtedly constitute internal affairs. Therefore, the court found that "[u]nder the internal affairs doctrine, however, Grove does not have the right to seek an inspection of books and records under California law. That right exists only under Delaware law."
An interesting take away from this decision is the interplay with California and venture capital transactions. As noted in the commentary in the National Venture Capital Association (NVCA) form of Delaware certificate of incorporation,4 California Corporations Code Section 2115 requires "that certain provisions of California corporate law are applicable to foreign corporations (e.g., one incorporated in Delaware), to the exclusion of the law of the state of incorporation, if more than half of the Corporation's shareholders and more than half its "business" (a defined formula based on property, payroll and sales) are located in California." Interestingly, the statute Grove relied on, California Corporations Code Section 1601, is one of those statutes covered by Section 2115 and purportedly conflicts with the court's decision in Juul Labs (assuming Juul Labs met the shareholder and business requirements). It should be noted that this is not the first time that Delaware and California have clashed on this issue – Delaware previously held that Section 2115 was not applicable when determining the requisite shareholder vote for a Delaware corporation to act,5 and California subsequently appeared to have nodded acceptance of such decision6 — nor is Delaware the only state that takes issue with the breadth of Section 2115. In fact, the California legislature looked at repealing such section in 2012 but ultimately decided to leave it on the books as it provides broad protections to California investors and repealing it would encourage business owners to incorporate in other states—though we doubt repealing the statute would materially shift the landscape as Delaware continues to have the most well accepted and widely understood corporate laws.
So, what is the impact of this decision? What can investors and professional advisors learn? First off, this case is only binding on the courts in Delaware. Courts in other jurisdictions could choose to base its decisions on this holding or ignore it as simply persuasive, though the constitutional arguments would likely apply in all jurisdictions. Corporate governance decisions that traditionally may get overlooked in the spur of the moment, such as where to incorporate, need to be scrupulously analyzed and discussed with the client before action is taken. As seen in Juul Labs, this decision is especially important for businesses that incorporate in Delaware but have a home base in another state, which is the case in many venture capital deals. In addition, legal counsel, particularly lawyers who are responsible for the daily contract needs of their clients, should be keenly aware of what the company's governing documents provide for and negotiate private agreements consistent with such governing documents. That way, issues that arise in Juul Labs may never have to come to fruition.
Going forward, what is clear is that the courts in Delaware will likely evaluate internal disputes between a corporation and its officers, directors or shareholders in accordance with Delaware law. What isn't clear is whether other jurisdictions will follow this guidance and the potential enforceability of certain foreign laws in other jurisdictions, such as California Corporations Code Section 2115. We will continue to monitor this issue.
Footnotes
1 https://law.justia.com/cases/delaware/court-of-chancery/2020/c-a-no-2020-0005-jtl.html
2 https://law.justia.com/codes/california/2016/code-corp/title-1/division-1/chapter-16/section-1601
3 https://codes.findlaw.com/de/title-8-corporations/de-code-sect-8-220.html
4 https://nvca.org/model-legal-documents/
5 VantagePoint Venture Partners 1996 v. Examen, 871 A.2d 1108 (Del. 2005). https://law.justia.com/cases/delaware/court-of-chancery/2005/62800-1.html
6 Lidow v. Superior Court, 141 Cal. Rptr. 3d 729 (Cal. Ct. App. 2012). https://www.casemine.com/judgement/us/5914f6eaadd7b049349925fb
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