howdy I'm Professor Michael Conlin from Texas A&M University School of Law in this video we'll cover the issue of selecting a state of incorporation and why that's so important and then we'll get into some jurisdictional issues that corporations face so strap in because this is going to be one of the longer videos here let's start off with a little trivia question in which US state do more than half of the Fortune 500 companies incorporate in I'll give you a little bit of help it's not California or New York the correct answer is well would you believe it it's the little state of Delaware that's right you see you can incorporate in any state even if you will never do business in that state this may sound a little bit Shady but it's it's perfectly allowed that's why so many of these corporations incorporate in Delaware it's an interesting story how Delaware came to be the number one state for large corporations to incorporate in beginning in the late 1800s States came to the realization that it would be of great benefit to them if a lot of businesses chose to incorporate in their state so some states began actively trying to court businesses for a while New Jersey was a front runner in this area and it was very lucrative for them but then in 1910 future President woodro Wilson was elected governor of New Jersey and in an effort to not gain the reputation of putting business interest above that of the people he repealed some of the statutes that attracted corporations to New Jersey Delaware saw this as an opportunity and the rest is corporate law history now there's an ongo going debate as to whether this incentive structure produces a race to the bottom whereby States offer worse and worse policies to entice businesses to incorporate in their state or a race to the top whereby states offer better and better policies to entice these businesses and this is a subjective determination some very brilliant legal Minds look at a given State policy and conclude that it is bad and thus supports the race to the bottom Theory other legal Minds who are also very brilliant look at the exact same policy and conclude that it is good and thus supports the race to the top Theory Supreme Court Justice brandise eloquently supported the race to the bottom Theory when he described the process as a quote race not of diligence but of laxity but those who support the race to the top Theory point to studies that show that reincorporation in Del Ware is more likely to lead to an increase in stock price in other words more demand for people to purchase and and hold that stock which is inconsistent with the accusation that Delaware benefits management over shareholders those who support the race to the bottom Theory point to what is called the auction winners fallacy essentially this states that when you have multiple parties bidding on something with an uncertain value the winner will almost always overbid in other words the state willing to offer the most enticing incentives to attract corporations is likely overestimating the benefit of having those corporations there in its state uh so something I do in my face-to-face classes to illustrate this principle is I have a big jar of uh like little beans I I think there's around 1,200 beans in the jar and so I have everybody in the class write down just a wild guess what their estimate is as to how many beans are in that jar so the correct answer is 1,200 and um you know most people are fairly close most people say around maybe 800 to 1,600 you know fairly close to to 1,200 but I always get you know one or two who will say maybe like 300 they're way off or way off the other way they'll think it's like over 3,000 okay and then I say okay let's pretend that we're going to have an auction here and for every Bean that's in this jar you get a dollar just automatically okay how what's the maximum amount that you would be willing to bid on this jar well I mean the people who thought there were only 400 beans in there you know they're only willing to bid 300 or 350 and the people who thought there were you know 3,000 beans in the jar well they're willing to bid you know 2500 2600 some sometimes 2,800 you know thinking they'll they'll get at least you know 100 or 200 uh extra dollars out of it but you see I mean if you think there's 300 beans in the jar even if you're conservative and you're only willing to bid 2,000 you're not going to gain a th000 because because you were the winner so by definition the winner is going to be the person who overestimated the value too much and you're going to get the raw end of the deal because there's only 1,200 beans in there you're only going to get $1,200 but you paid $2,000 for it so it's similar with um you know as the theory goes it's similar with these states trying to entice corporations you also see a similar logic when uh states are trying to get like a new Amazon fulfillment center that'll create thousands of jobs or get some new uh you know Advanced uh pharmaceutical Medical Park or something in their state so they'll have all these new jobs well there's a lot of different states that are bidding on that so the one that overestimates the value the most that'll be the winner that's the auction Winner's fallacy well no matter if you subscribe to the race to the bottom or the race to the top Theory Delaware is the current king of incorporation for large firms so I want to ask you a question about why you think Delaware is number one just based on your current understanding of how the US legal system is one based on a system of precedent and considering pragmatic issues of corporate litigation what's an advantage that Delaware has to uh corporations that are thinking about incorporating there and for this answer disregard the issue of whether Delaware statutes are favorable to businesses or not in other words there's a benefit just to being the place where so many corporations incorporate what would that benefit be what do you think well because our legal system is based on precedent the more precedent you have the more predictable the ultimate outcome of a legal dispute will be this is a tremendous benefit to both parties involved the more predictable the benefit the more likely both sides are to settle resulting in a potential win-win solution that saves both parties the financial and time cost cost of a trial also the more predictable legal outcomes are in advance the easier it is to avoid them in the first place sometimes corporations are faced with a decision and they just don't know if one course of action would be unlawful or not additionally judges in Delaware are extremely knowledgeable and efficient regarding corporate law which leads to further predicability and further Time Savings and Delaware corporate law is well known among corporate lawy lawyers in every state for example I went to law school in Kansas but we spent more time studying Delaware corporate law than we did Kansas corporate law so Delaware likely Remains the number one state for large corporations to incorporate in not because its statutes are unfairly biased in favor of Corporations but because it simply has all the benefits that come with the inertia of being number one for so long and again this is a a huge benefit to Delaware as they get almost 20% of their state revenues from franchise taxes and just by the way franchise taxes here that's not like when you have like a McDonald's franchise and you have to pay uh you know royalties back to the uh uh franchise or it's not like that like a McDonald's or a a Gold's Gym or a Subway or a franchise like that this is just any Corporation has to pay these uh franchise fees based on where they're Incorporated in okay so speaking of all those benefits that Delaware gets well some other states have said Well we'd like to get some of those benefits in recent years Nevada has tried to make a run at becoming the number one state of incorporation in a controversial move they offer corporations the ability to be more secretive regarding their reporting uh they have a 0% corporate state tax rate and they actively advocate how you could have your annual shareholders meeting in Vegas baby although that last point is uh somewhat peculiar as a sales pitch because corporations are allowed to have their annual meetings anywhere and often virtually so no matter where you incorporate in you could still have your annual meetings in Vegas if you wanted to All Right Moving on here uh just as on your personal taxes where there's federal income tax and state income tax tax it's the same for corporations as you can see in this chart here state tax rates uh they range from 0% to a little over 10% and as you can see the great state of Texas is consistent we have a 0% corporate tax rate to go along with our 0% personal income tax rate however note that Texas does have a gross receipts tax which corporations must pay also note that corporations pay a franchise tax in the state of incorporation but they pay most all of other taxes based on where the transactions occur in keeping with the theme of how state tax rates incentivize Behavior here's an interesting finding of multiple modern studies personal tax rates affect the ability of professional sports teams to attract top talent teams in high tax states like California and New York have to pay a premium while teams in no tax states like uh Texas and Florida get a discount when it comes to um getting a free agents to come play for their teams well before you go incorporating a Nevada or Delaware note that for most smaller corporations it's best simply to incorporate in your home state this allows you to be your own registered agent also in each state that a corporation conducts business it must be qualified to do so this generally requires appointing a registered agent and filing annual reports so if you are only going to do business in say Texas if you Incorporated in Delaware you would still have to do those things in Texas note that if you just own property maintain a bank account or sell through a third- party vendor in a state that's not enough to require you to go through the process of becoming qualified uh to do business in that state so yeah at the beginning I did tell you that the majority of Fortune 500 companies are Incorporated in Delaware but that's Fortune 500 they're giant corporations for most smaller corporations generally it's just best to incorporate in your home state now some people will suggest that you set up your corporation in different states to make it more difficult for one person to sue all of your corporations I'm not going to tell you if this is ultimately a good strategy that's for you to decide but I will say that such schemes are often associated with scam artists who Pro promise unbelievable tax and liability benefits through an incredibly complex process and that's part of it it's so complex you don't understand and nobody does because it doesn't really work in reality uh and somewhat ironically the amount of effort that an attorney trying to sue you takes to locate your hidden corporations in all those different states May ultimately be paid by you if the attorney's fees are awarded at trial so you're spending extra money to get all these complex you know shell corporations set up all over the place so you spend the extra money there just so that you have to spend extra money later uh to compensate the other side's attorney who had to do all this extra research to locate all of your different corporations your chosen state of incorporation is also important in that under the internal affairs Doctrine it determines which state's rules will apply to your internal disputes the internal affairs Doctrine is a conflict of laws principle which recognizes that only one state should have the authority to regulate a corporation's Internal Affairs Internal Affairs is a somewhat amorphous term that includes matters peculiar to the relationships among or between the corporation and its current officers directors and shareholders ERS the reason that only the state of incorporation laws apply to these disputes no matter where the dispute physically occurred is that otherwise corporations would be confronted with untenable conflicting demands let's illustrate this by looking at Walt Disney it's Incorporated in Delaware its headquarters are in California it has a theme park in Florida and California it has a resort in Hawaii it operates cruises out of Texas it sells its stock on the New York Stock Exchange and although this is not included on this map here I'd like to make one addition I know people in Texas love to think that my home state of Oklahoma is this Backwoods place where people still ride horses to work uh and I I did actually grow up on a farm but I can attest that we do have Disney Stores in Oklahoma uh only in Tulsa and Oklahoma City but still we have two Disney Stores so that's another example of how the uh Disney Corporation is in you know all these different states all right so the internal affairs Doctrine absolutely does not maintain that every single lawsuit against Disney will be handled with Delaware law if you are injured in the theme park in Florida you can sue in Florida if you are injured at the resort in Hawaii you can sue in Hawaii and if you are injured in the Disney Store in the mall in Oklahoma you can sue there the internal affairs Doctrine only states that the internal affairs of the corporation will be decided based on the laws of the state of incorporation which for Disney would be Delaware however as with many aspects of the law it's not quite that simple as the term Internal Affairs is somewhat ambiguous it does not Encompass every possible intra corporate dispute for examp example in a 2012 case an officer of a corporation with headquarters in California and Incorporated in Delaware uh but not the Disney Corporation okay so um uh so there was an officer uh the corporation was headquartered in California but it was incorporated in Delaware and this officer was forced out of his position allegedly in retaliation for complaints he made about illegal or harmful activities of the corpor option now under California law this would be actionable you know that he could bring that lawsuit but under Delaware law it was not California courts concluded that the act of removing an officer would normally be considered an internal Affair but protecting whistleblowers from retaliatory removal is an issue of California public policy because this serves a vital interest in California namely protecting Cali Californians from dangerous behaviors of Corporations this is a rather contentious and evolving area of the law and it is unclear if the Supreme Court will ultimately allow California to continue to hear such uh kind of borderline cases now I need to provide one caveat here regarding the examples that I just gave about how lawsuits from injured customers against Disney could be l litigated in all the various states where the injury occurred large corporations are somewhat notorious for using arbitration clauses and forign provision Clauses I'm not sure exactly to what extent Disney does this but in theory when you agree to purchase uh the resort stay in Hawaii there may be some fine print that says if you want to sue for anything that happens there on the resort in Hawaii you can only do so in a given State you know probably California or some other state St that's convenient to the Disney Corporation that's a forum selection clause and the fine print may also stipulate that you can't even Sue and must instead go through binding arbitration as you can imagine such Provisions favor the corporation over the consumer and courts sometimes strike them down in extreme scenarios but they are permissible in fact the Supreme Court recently reaffirmed that Forum selection Clauses are presumptively in for on the topic of jurisdiction for corporate litigation there's one more important issue to discuss here if someone living in California was injured in Disney's California theme park it would not be fair for Disney to force them to sue uh in Delaware or any other state for that matter with the exception of a forum selection Clause that we just discussed but it would also be unfair for that injury customer in California to force Disney to travel to say North Dakota to defend themselves in court there against this uh injured customer this is where longarm statutes come into play so each state has a longarm statute that determines how that state can kind of reach in like a long arm you know reach into another state and and grab up a uh defendant and force them to come into that state to defend themselves all right so I'll illustrate by discussing a real life case from 1980 the Robinson's lived in New York and purchased an Audi from a New York Volkswagen dealer they then drove cross country to their new home in Arizona well that was their plan anyway Unfortunately they were rear ended in Oklahoma by a drunk driver going 100 miles an hour this resulted in a tragic scene where the Robinson were trapped in their car and they received third degree burns the Robinson's tried to sue the New York distributor in Oklahoma where the accident occurred in order to exercise personal jurisdiction over the New York dealer they used Oklahoma's longarm statute every state has these longarm statutes and again they allow a local plaintiff to reach out like a long arm into another state like New York and bring that out ofate defendant often a corporation uh into that state for trial but there are some limits here I mean uh you know Oklahoma would love to be able to reach into every state they want under any situation and bring defendants there it's great for Oklahoma because then you bring those defendants there off in corporations you sue them so they have to come to your state you know they have to bring their their teams of attorneys and they they go to restaurants and they they stay in hotels while the trial's going on so you're you're benefiting your state that way and then if you win at trial the money is coming from out of state and it's usually going to somebody who lives in your state so then that person's going to pay state taxes there and then spend the money in the state so every state would be in incentivized to have a uh extremely strong uh long arm statute but but there's limits here a company must have minimum contacts in the Forum state in order to be dragged there to defend themselves so this term minimum contacts it would be things like you know advertising in that state selling in that state uh in in the case of an automobile servicing the vehicle in that state Etc uh now again I know Texans love to think that Oklahoma is not very Advanced but I can personally attest that we do have Volkswagen dealers uh they they advertise and they service cars there in Oklahoma yes it's only in Tulsa in Oklahoma City but still they're there all right since the New York dealer did not have minimum contacts in Oklahoma they were not forced to travel there to defend themselves again they didn't have those minimum contacts they don't sell in Oklahoma they don't advertise in Oklahoma they don't service those cars in Oklahoma they do all that stuff in New York not Oklahoma um okay note that just being aware that cars you sell in New York will likely be driven all around the country and and sometimes in Oklahoma that's not enough to establish minimum contacts even though that's what the Robinsons unsuccessfully tried to argue that would be just too broad and things got worse for the Robinsons as when they eventually got to sue they lost as the jury determined that there was nothing defective about the Audi it's just that that when someone rear ends you at 100 miles hour bad things often happen in this example involving the Robinsons we see that the New York dealer clearly did not have minimum contacts in the state of Oklahoma and we could easily see that in the international Volkswagen corporation that makes Audi vehicles they clearly do have minimum contacts in Oklahoma because they sell cars there they may even have a plant that puts together cars there I'm not sure about that one but they sell cars there they advertise there uh they service the cars there on and on however as is often the case in studying the law there's this gray area between those two extremes where it's not so clear imagine an ultra exotic car company that makes its cars in California they mailed brochures to a car collector in Oklahoma after some phone calls with the Oklahoma they deliver the car to him in Oklahoma and every 3 months they fly out a technician to perform maintenance on that one car in Oklahoma but that's the only car they service in Oklahoma well this is certainly more contacts in the Forum State than the New York uh Audi dealer but it's certainly less minimum contacts than the international Volkswagen Corporation would have in Oklahoma so it's unclear if in this pathetical if Oklahoma's longarm statute would allow this Oklahoma with very expensive tastes to reach out into California and take the corporation to court in Oklahoma so you'll you'll often times see this in the law you know there's there's one clear-cut example over here where it's okay that's perfectly fine there's a clear-cut example way on the other side of the spectrum you know okay that's absolutely not okay but then when you start walking things into the middle you get into this gray area and it's it's not clear and even if you talk to lawyers who were you know experts in in that given field they would say I don't know you know the court might say this the court might say this it's it's a close call so in conclusion you can see the importance of cautiously selecting your state of incorporation because under the internal affairs Doctrine that's the set of laws that your Internal Affairs will be adjudicated under also in this video we provided a very basic understanding of how jurisdiction works with corporations