The Delaware General Corporation Law was amended last summer to allow companies to maintain their corporate records using blockchain technology. The purpose of this short post is to provide a high-level overview of this evolving intersection of technology and corporate law that will have an increasingly profound impact on corporate governance and related areas of the law–in addition to the impact it will have on many other fields and industries. The enabling legislation is designed to permit the use of a particular technology to maintain corporate records in a way that addresses a problem with the current system, especially for larger companies with millions of stockholders, for example, about who owns the stock and how they voted in a merger.
The Basics
A recent article in the Harvard Business Law Review that describes blockchain developments in the context of Delaware law, explained that: “Blockchain technology is also known as “distributed ledger technology” (DLT), because copies of a single, shared ledger are distributed across a decentralized network of multiple “nodes,” or users.” If a transaction or other information is confirmed or validated by all nodes, the transaction or information is cryptographically recorded in a shared ledger. This system eliminates the intermediaries who are now involved, for example, in recording the owners of shares and how they voted. Instead, using DLT the transaction is authenticated in real time by automated network consensus.
Of course, there is much more minutiae involved in the use of DLT, but describing the details of how blockchain technology or DLT works is beyond the scope of this modest post. For those interested in that minutiae, however, an article entitled Corporate Governance and Blockchain provides extensive explanations about the intricacies of blockchain technology in the context of corporate record keeping and voting.
Current Corporate Problems that Blockchain Addresses
In order to understand why some view the use of blockchain technology for corporate records as “arriving at the promised land”, one must understand the many problems inherent in the current system of maintaining stock ledgers and recording stockholder votes. Vice Chancellor J. Travis Laster of the Delaware Court of Chancery outlined several problems with the current system of voting shares in a keynote speech to the Council of Institutional Investors on September 29, 2016. His Honor observed that most beneficial owners of stock register their shares in the name of Cede & Co., the nominee of the Depository Trust Company, or DTC. Banks and brokerage firms own DTC. Separate accounts for the custodians’ customers are not maintained because DTC holds the shares of its custodians in fungible bulk.
But Delaware law was not designed for the nominee system of holding stock. Rather, it assumes that stockholders own shares directly. Delaware’s adoption of Article 8 of the UCC is inconsistent with Delaware corporate law, however, because the UCC treats each stockholder as owning a pro rata interest in the fungible bulk.
Beneficial-Nominee Systemic Problems
Several recent opinions by the Court of Chancery illustrate the problems. See In re Appraisal of Dell Inc. (Dell Continuous Ownership), 2015 WL 4313206 (Del. Ch. July 30, 2015) and the later decision captioned In re Appraisal of Dell Inc. (Dell Dissenter Requirement), — A.3d –, 2016 WL 3030909 (Del. Ch. May 11, 2016). In the first Dell decision, because the nominee issued certificates for the stockholders seeking appraisal in the name of the custodial banks, the shares were no longer held continuously by the same record holder through the close of the merger, and therefore the statutory requirement for an appraisal was not satisfied–through no fault of the stockholder. Though this result was required by the applicable law, the vice chancellor regarded it as an absurd result.
Voting Problems
In order to pursue an appraisal under Delaware law, the stockholder must not have voted for the merger. In the second Dell decision cited above, T. Rowe Price was the beneficial owner of several million shares for which Cede served as the record holder. DTC had a duty to ensure that T. Rowe’s shares were voted according to T. Rowe’s instructions. DTC did this by executing a proxy to T. Rowe’s participant, State Street. Then, State Street outsourced the task of implementing voting instructions from T. Rowe to Broadridge Financial Solutions. But T. Rowe used Institutional Shareholder Services to transmit its voting instructions. T. Rowe had a computerized system that generated default voting instructions for ISS to vote in favor of a management-supported merger. In this instance, they changed the default vote and confirmed different instructions. But the date of the shareholder vote was later postponed three times, and the third time the default system was not changed. Thus, by mistake, and through no fault of the record owner of the stock, the vote was mistakenly made in favor of the merger.
Because the ownership of individual shares held beneficially is not tracked in the U.S. clearance and settlement system, imprecision occurs. When the vote is close, certainty about the exact number of votes cast often remains elusive. See In re Transkaryotic Therapies, Inc., 954 A.2d 346 (Del. Ch. 2008)(highlighted on these pages), and Marcel Kahan & Edward Rock, The Hanging Chads of Corporate Voting, 96 Geo. L.J. 1227, 1279 (2008). This lack of ability of the current system to ensure accuracy in the number of shares voted, and by whom, creates tension with the increased importance that Delaware law gives to the stockholder vote. See, e.g., Corwin v. KKR Fin. Holdings, LLC, 125 A.3d 304 (Del. 2015).
Amendments to the Delaware General Corporation Law
Among the recent amendments allowing use of the new approach to corporate record keeping and communication with stockholders is DGCL Section 224, which was amended to allow the use of distributed ledger technology to create and maintain corporate records. Section 219 was also revised to allow the stock ledger to be maintained by “or on behalf of the corporation” to allow for use of this new technological approach to maintaining the stock ledger. This would allow for a much for precise and dependable method to determine who the record owner of stock is in a company and how that stock was voted for a particular transaction.
Current Status in Delaware and New Competition by Wyoming
An article in Fortune magazine marked the occasion of the passage last year of these enabling amendments to the DGCL. A recent article in the local Delaware newspaper called The News Journal chronicles the apparent “reduced enthusiasm” of current Delaware state officials in pursuing the Delaware Blockchain Initiative at a fast pace, until the consequences that may be visited upon the many players in the current “infrastructure” of the current system–which is responsible, directly or indirectly, for a substantial portion of the state’s annual budget–are fully considered. But, Wyoming reportedly is galloping at a expedited pace to become the leading state for the implementation of blockchain technology in corporate matters and other areas as well.
Only a month or so ago, several types of multi-faceted blockchain legislative changes recently passed by the Wyoming legislature were signed by the state’s governor, and other states are reportedly joining the race to join the party.
At a seminar a few days ago in Delaware, sponsored by the Delaware State Bar Association, entitled “Blockchain Technology for Lawyers”, the panelists attributed the “pushing of the pause” button on further blockchain initiatives (beyond the existing changes to allow the use of blockchain), as part of the deliberative process that has been a part of the careful approach that Delaware has always taken before making major changes to its corporate statute that about two-thirds of Fortune 500 companies rely on, and that the State of Delaware relies on for a large part of its annual budget–as opposed to a lack of enthusiasm for taking the lead on this new development of major importance and potentially epic impact on Delaware corporate governance.
Much has already been written about this exciting new development in Delaware corporate law, and this short post was only intended as a cursory review of the topic with links to allow readers access to other sources with more thorough treatment of the issues involved.
SUPPLEMENT: A few days after I published this post, I learned that Vice Chancellor Laster just co-authored an article on this topic. Anyone serious about this subject matter must read that article. See J. Travis Laster and Marcel T. Rosner, Distributed Stock Ledgers and Delaware Law, 73 Bus. Law. 319 (Spring 2018)