Delaware and the Market for LLC Law: A Theory of Contractibility and Legal Indeterminacy

Abstract

Incorporating in Delaware can be expensive. Corporations pay up to $180,000 annually for this simple privilege – a figure that is substantially higher than incorporation in any other state. In their controversial article, Price Discrimination in the Market for Corporate Law, Professors Marcel Kahan and Ehud Kamar show that Delaware’s ability to charge a premium for incorporations, in the form of its annual franchise tax, is evidence of Delaware’s market power in the jurisdictional competition for corporate charters. Beyond simply charging a premium, however, Professors Kahan and Kamar show that Delaware further increases its profits by engaging in price discrimination – tailoring its premium according to the value each firm attributes to the privilege of incorporating in Delaware. The ability of Delaware to charge a premium and to further price discriminate leads Professors Kahan and Kamar to conclude that in the competition for corporate charters, “it is evident that Delaware possesses substantial market power.”This Article projects Professors Kahan and Kamar’s analysis onto the world of limited liability companies (“LLCs”). To assess Delaware’s market power in the jurisdictional competition for LLC charters, this Article examines the LLC analog of the corporate franchise tax. Instead of a franchise tax, every Delaware LLC is charged a flat annual tax of $250. As this Article will show, unlike its corporate franchise tax, Delaware’s LLC tax does not represent a premium. Nor does it price discriminate. Delaware’s failure to charge a premium price in the form of its LLC tax suggests that, in the jurisdictional competition for LLC charters, Delaware lacks the kind of market power it has long enjoyed for corporate charters. But why? This Article will present an explanation that rests on contractibility and legal indeterminacy. Specifically, this Article will argue that the high level of contractibility, and the resulting reduction in legal indeterminacy, offered by Delaware LLC law substantially diminishes the value of two of Delaware’s traditional competitive advantages: (1) the network effects associated with its law and (2) its expert judiciary. Thus, contractibility and reduced indeterminacy can explain why Delaware seems to lack market power in the competition for LLC charters. Without an obviously superior product, and with several available substitutes, Delaware LLC law, unlike its corporate law, is unable to command a premium price. If the analysis of this Article is correct, then several important implications follow for Delaware, the indeterminacy in its LLC law, the regulatory competition between the corporate and LLC forms, as well as the jurisdictional competition between states for LLC charters.