Choice of Law: Delaware or California

Quite puzzling to most entrepreneurs is the topic: choice of law. To make it short and sweet, the state you choose to organize your business under provides the body of law that will govern the internal affairs of your business. Now for the million-dollar question–which jurisdiction should I select to govern my entity? In this segment, we will demystify  the hype and appeal of forming a Delaware entity.

Delaware has long been one of the jurisdictions most favorable to the interest of business. In light of Delaware being the state of incorporation for a significant majority of corporations, it is no wonder why so many people are drawn to the first state of Delaware. Believe it or not, some people are attracted to forming in Delaware because they believe it conveys a sense of legitimacy. While it may be true that many legitimate businesses form in Delaware, the corollary does not follow that your business becomes legitimate simply because you formed in Delaware. In fact, as a practical matter, for many businesses it only adds to the hassle and expense of formation.

Historically, Delaware has been considered the most common choice for organization–it is worth noting why. Of course, as with every consideration, the pros and cons for governing the internal affairs of your entity should be weighed in the context of the particular business you’re forming.

Delaware is known for providing flexibility and predictability. With respect to flexibility, Delaware allows the elimination of fiduciary duties and liability for the breach of fiduciary duties. Additionally, there is the freedom to contract or to tailor the infrastructure of an unincorporated Delaware entity according to investor needs.

With respect to predictability, Delaware has a nationally-known Court of Chancery. All cases are heard on an expedited basis by a single judge without a jury–this may be critical for business disputes that may result in financial harm if not timely addressed. A second benefit; the members of the Court of Chancery are experts in the matters of business law and take proactive measures to regularly update these laws. It’s no wonder that their published opinions typically result in less litigation for businesses. Lastly, because Delaware has one hundred years of case law over any other state, the predictability that Delaware affords to business owners cannot be understated.

Both the flexibility and predictability that Delaware provides has resulted in its recognition as the golden standard of business law for the United States. Because business investors want to ensure their deals are enforceable, Delaware is the ideal platform. In fact, if you plan to work with an investment bank or venture capital fund, you will likely have no choice but to incorporate in Delaware.

Now let’s discuss the cost. If you decide to organize your entity in Delaware while doing business in California, there are filing fees to consider.

Specifically, Delaware charges a $90 filing fee for a Limited Liability Company (“LLC”). A Delaware LLC is required to pay an annual Delaware franchise tax equal to $250. Also, it is required to maintain a Delaware registered office and agent for service of process, which may be supplied by a third party for about $100 per year. The Delaware LLC is still subject to the same franchise tax and annual fees as a domestic LLC in California. Additionally, the Delaware LLC doing business in California would be required to register as a foreign LLC with a filing fee of $70. This LLC filing will require a certificate of good standing from the Delaware Department of State which will cost you another $50. Essentially, a Delaware LLC doing business in California will subject you to all the LLC formation requirements and fees in California. All said and done, to organize in Delaware you will pay $500 in additional fees, and face reoccurring annual charges of about $350; all of this in addition to the regular annual fees you will be expected to pay as an LLC in California. In summary, it’s costly, but may be beneficial in the right circumstances.

Lastly, it should be noted that contrary to the popular belief of many advisors that by filing in Delaware a company submits to its jurisdiction, i.e., you can get dragged into Delaware court by a plaintiff even though you don’t do business in Delaware, recent case law supports the view that you can’t always sue Delaware-incorporated companies in Delaware. See In re Link_ A_Media Devices Corp., No 11-M990 (Fed. Cir. 2011).

Series LLC

Although it may peak some interest, the exotic entity known as a Series LLC permitted by the Delaware Act is not recognized in California. Del. Code Ann. tit. 6, § 18-215. Nevertheless, it’s worth noting. The Series LLC acts as a conglomerate where each series within the conglomerate owns specific assets and is insulated from the liability of other series. The utility of a Series LLC is extensive, however, it is typically the preferred vehicle for real estate investors who own several properties or companies that own several product lines and trade names. It provides low start-up cost since there is only one filing, one franchise tax payment, and one registered agent fee all the while providing legal separation for each series within the conglomerate. Of course, the downside is that many states do not recognize the Series LLC, thus, in states like California, the series is treated as an individual LLC with undifferentiated liability. Accordingly, in California, although forming multiple LLC’s that act like a Series LLC is crafty, it is a bit costly with respect to both initial and annual filing fees.