U.S. states are shedding shareholder protections. That's an advantage for Canada

Marie-Josée Neveu, Sean Stevens and Sarah Gingrich are partners at Fasken Martineau DuMoulin LLP.

Amid a highly public feud between Elon Musk and Delaware courts, Tesla Inc. TSLA-Q recently moved its corporate domicile from Delaware to Texas. The possibility that this phenomenon of U.S. companies reincorporating out of Delaware – cheekily called “Dexit” – could catch on more widely has prompted a race to attract them among other U.S. states. But while that may be good news for large shareholders in the U.S., it’s generally bad news for their companies and smaller shareholders. That makes Canada’s boardrooms a competitive advantage in the new fight for investment capital.

Talk of Dexit began with the legal battle over Mr. Musk’s US$55.8-billion pay package at Tesla in 2023. Delaware courts twice refused to allow the package, finding that Tesla’s board was improperly influenced by Mr. Musk. He first reacted by publicly denouncing Delaware’s law and courts. He then argued that companies should leave Delaware to reincorporate elsewhere, such as Texas, which Tesla did earlier this year.

Dexit is an existential threat for Delaware. Simply put, the state has long been the corporate heart of the U.S. economy. More than half of U.S. publicly traded companies are incorporated there, including about two-thirds of Fortune 500 companies. And about 90 per cent of U.S.-based IPOs feature Delaware-incorporated companies.

For a very small state such as Delaware, with only about one million people, the corporate fees and business travel for lawsuits that come with incorporation there are a giant source of state revenues. To lose its status as the go-to state for incorporation would be catastrophic.

The response of Delaware lawmakers to talk of Dexit was therefore swift. They changed key provisions of their corporate statute in an attempt to appease those companies that might be pressured to leave or incorporate elsewhere to begin with. But what might be good for larger shareholders isn’t necessarily good for the company or smaller shareholders.

John Coates, a professor of law and economics at Harvard, called it “the day Delaware decided it no longer wanted to protect shareholders.” Alan Jagolinzer, a professor of financial accounting at Cambridge, called it evidence of the “most acute information and accountability crisis of our lifetimes.” The concern is that the changes seriously reduce the ability of shareholders to hold controlling shareholders and management liable for mischief such as conflict-of-interest transactions.

For states such as Texas and Nevada, on the other hand, the possibility of Dexit represents an incredible opportunity. And so they’ve responded by making similar changes to their corporate law to try to entice companies their way.

Texas, for example, has made it harder for small shareholders to bring lawsuits against directors they believe have breached their fiduciary duties. Nevada has made it harder for small shareholders to claim that a larger shareholder has improperly influenced the company’s board. The race to shed shareholder protections is on.

The result for Canada is a growing competitive advantage in terms of corporate governance. Here, unlike in Delaware and Texas, the fiduciary duties of directors can never be waived. Shareholders in Canadian companies also benefit from something called the “oppression” remedy, a broad and flexible right of recourse that is unique to Canadian law and protects the “reasonable expectations” of shareholders, as well as creditors and other corporate stakeholders.

Another example is that, even if a large shareholder has a contractual right to appoint one or more “nominee” directors, in Canada the directors still owe their duties to the company and not that particular shareholder.

Canada’s boardrooms have long been well-known for adhering to high standards of corporate governance. This is partly driven by our corporate law, which emphasizes rigorous and informed decision-making and puts heavy emphasis on director independence and avoiding conflicts of interest, whether actual or even just reasonably perceived.

This is also backed by our securities law. Regulators have broad “public interest” powers to intervene where they believe the interests of shareholders warrant it, such as to ensure directors have made sufficient public disclosure to shareholders amid conflict-of-interest transactions.

With the policies of the second Trump administration, Canada is in a fight for investment capital like never before. With Dexit and the race to shed shareholder protections playing out in the U.S., Canada’s growing corporate governance advantage is a legitimate argument to help attract investors. More Canadian companies should know this, as should their current and potential shareholders.