Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine

Abstract

The internal affairs doctrine provides that the law of the organizing state will apply to matters pertaining to a business entity’s internal governance, regardless of whether the entity has substantive ties to that jurisdiction. The internal affairs doctrine stands apart from other choice of law rules, which usually favor the jurisdiction with the greatest relationship to the dispute and limit parties’ ability to select another jurisdiction’s law. The doctrine is purportedly justified by business entities’ unique need for a single set of rules to apply to governance matters, and by the efficiency gains that flow from allowing investors and managers to select the law that will govern their relationship.

The contours of the internal affairs doctrine have never been defined with precision, but several recent developments have placed new pressures on the doctrine’s boundaries. These include: (1) states’ attempts to regulate the governance structures of businesses that operate within their borders in order to benefit non-investor constituencies, such as diversity requirements for corporate boards; (2) the growing prevalence of LLCs, which—because of their flexible, contractual structure—blur the lines between investment relationships and employment relationships; (3) the increasing use of shareholder agreements, which are governed by contractual rules, and not infrequently the rules of a jurisdiction other than the one in which the business entity is organized; and (4) jurisprudence permitting the charters and bylaws of Delaware corporations to include provisions that govern litigation based on non-Delaware law.

This Article explores modern challenges to the coherence of the internal affairs doctrine and recommends alternatives.

Keywords: Choice of Law, Conflicts of Law, Internal Affairs Doctrine, Corporations, Securities Law