Delaware General Corporation Law Blockchain Amendments: What’s the story, morning glory?
By: Megan McCulloch and Yev Muchnik (Launch Legal)
In 2017, the Delaware Blockchain Initiative demonstrated that regulation could be synchronous with technological innovation, leading the way, apropos Delaware style.
We are hitting the halfway mark of 2020 and not much has changed — what gives?
The First State and also the choice corporate domicile for the majority of private and public companies incorporated in the US, Delaware regulators made a bold move to modernize the Delaware General Corporation Law (DGCL) by allowing companies to utilize distributed electronic networks or databases (through smart contract functionality) to meet basic corporate governance requirements, such as maintaining corporate books and records, such as cap table management, proxy voting, and dividend distributions. Blockchain, a type of distributed ledger technology, allows for the immutable tracking of ownership of an asset (e.g. stock) without the need for third-party verification.
The amendments to the DGCL produced the solution that all technologically forward companies had been craving — efficiency, transparency, accuracy, and speed embodied into a body of legal corporate infrastructure. Greatest thing since sliced bread?
Yet, the signaling from the existing infrastructure is clear — they’re still not ready. Widespread adoption has not occurred. While the current system is lacking, as illustrated in In re Appraisal of Dell, Inc., the resistance to change by market participants has not yielded the corporate governance disruption meets technology solution initially envisioned by legislators.
Summary of the Delaware Blockchain Amendments
Sections 219 and 224 of the DGCL were amended to permit a corporation to rely on the contents of a distributed ledger itself as the stock ledger. Section 219(c) of the DGCL defines “stock ledger” to include “one or more records administered by or on behalf of the corporation.” Section 224 provides that any records “administered by or on behalf of the corporation” may be “one or more distributed electronic networks or databases.”
The amended statutes provide that any distributed ledger used for corporate record-keeping must be able to:
§ Prepare the corporation’s list of shareholders as required by Section 219 and 220, which pertain to shareholder demands to inspect books and records;
§ Record information specified in DGCL Sections 156 (consideration for partly paid for shares), 159 (transfer of shares for collateral security), 217(a) (pledged shares) and 218 (voting trusts); and
§ Record share transfers governed by Article 8 of the Delaware Uniform Commercial Code.
Notwithstanding, companies must still be able to produce paper records when requested to do so.
Section 232 of the DGCL allows communications to shareholders to be made via distributed electronic networks or databases, including those required by a corporation’s certificate of incorporation, bylaws, or other provisions of the DGCL.
Implementing Blockchain Technology for Governance
§ Tracking share ownership: recording share ownership can get complicated as a corporation grows due to a variety of factors, such as share transfers, lost certificates, human error in issuing the same certificate number to multiple recipients, corporate transactions, or intestate ownership. By using a distributed ledger, each issuance and transfer of a digital asset (share) is recorded on a blockchain, and the owner of an asset may only transfer it by using digital cryptographic keys to authenticate the transaction. Properly configured blockchain records are immutable and nearly impossible to tamper with.
§ Shareholder voting: shareholder voting may be done via an electronic network, which can be more efficient, immediate, and accurate than traditional paper or even e-signature voting. This also allows for accurate and accessible historical voting records. Further, determining share ownership for purposes of determining voting eligibility and setting record dates may be done with greater ease.
§ Enforcing share transfer restrictions: transfers may be powered by smart contracts on the blockchain, thus making their enforcement easier and less costly.
§ Communications with shareholders: by utilizing blockchain technology for required communications, a corporation can ensure timely communication as well as accurate record-keeping of communications made.
All of these applications bring with them the added benefit of simplifying due diligence for any future corporate transactions, such as fundraising, M&A, sale, exit, etc. Rather than having to comb through onerous and disorganized files of corporate records seeking the most up to date ownership records, one need only look to the records validated by blockchain technology.
While utilizing distributed ledger technology may sound like an excellent solution to many of the common pain points of corporate governance, it should be noted that implementing electronic networks may be prohibitively expensive for a startup. This includes not only the technology itself but also the costs associated with ensuring compliance with any applicable laws and educating shareholders and potential investors on the benefits and uses of such a system.
One straightforward step a newly formed Delaware c-corporation may take is to adopt the use of uncertificated shares from the very beginning (as opposed to the traditional method of issuing share certificates). This is because if a corporation wishes to use distributed ledger technology for tracking share ownership, any outstanding physical certificates would be outside the purview of the electronic network and would thus render it incomplete.
If an already existing corporation wishes to migrate to an electronic network and has currently outstanding physical certificates, this does not mean it cannot still switch over. While the DGCL does not currently provide a corporation with the power to require shareholders to convert certificates to uncertificated shares, if a corporation can persuade all shareholders to do so, then those certificates — once surrendered — may be converted to uncertificated shares. The corporation would also need to adopt a board resolution requiring the conversion to all uncertificated shares and ensure that the switch is consistent with applicable Delaware law.