Before Competition: Origins of the Internal Affairs Doctrine

By Tung, Frederick | Journal of Corporation Law, Fall 2006 | Go to article overview

Before Competition: Origins of the Internal Affairs Doctrine


Tung, Frederick, Journal of Corporation Law


ABSTRACT

To the modern corporate scholar and lawyer, the internal affairs doctrine seems in the natural order of things. Corporate law is state law. Each corporation is formed under the law of its chosen state of incorporation. To ensure consistency and predictability, that law must govern the corporation's internal affairs. Yet the origin of such a doctrine is puzzling. Respecting the firm's choice of corporate law, the doctrine forces state legislatures into competition to attract incorporations. But how did legislatures come to concede their traditional territorial regulatory authority, and instead agree to compete? This Article solves this puzzle, offering the first account of the doctrine's surprising origins.

Widespread acceptance of the internal affairs doctrine among U.S. states assures that a firm's choice of corporate law will be respected outside the incorporating state. According to the dominant paradigm, this respect for firm choice creates a common market for corporate law, enabling regulatory competition. Both proponents and critics of competition agree that state legislatures compete-or at least have competed-to sell corporate charters to raise state revenues. In the debate over state competition, all sides take the internal affairs doctrine as a given. But if legislators compete to maximize private benefits in the form of state revenues, why do states recognize foreign corporation law at all? How did state legislatures ever come to surrender their traditional territorial jurisdiction, and instead agree to a choice of law convention forcing them into direct competition?

To date, the puzzle of the internal affairs doctrine has been overlooked. The doctrine's existence has been taken for granted, requiring little in the way of comment, criticism, or explanation. I explain the unexpected origins of the doctrine and its persistence through the early years of modern charter competition in the early part of the twentieth century. This historical analysis shows that the doctrine's origin had nothing to do with regulatory competition. Instead, it emerged before state charter competition, at a time when firms had little choice about where to incorporate. Competition came later, under circumstances radically different from those under which the doctrine was first articulated. That the earlier-crafted doctrine later facilitated regulatory competition was hardly by design. Instead, its path to facilitating modern charter competition depended on a fortuitous sequence of events, driven by ideology, interest group influences, and institutional inertia. This story of historical contingency debunks common assumptions about the emergence of the doctrine, which modern corporate scholars implicitly view to have been inevitable.

I. INTRODUCTION .................... 35

II. THE PUZZLE OF THE INTERNAL AFFAIRS DOCTRINE .................... 39

A. The Docirine.................... 39

B. The Puzzle....................41

C. Solving the Puzzle: Historical Context.................... 44

III. IDEOLOGICAL ORIGINS: TERRITORIAL SOVEREIGNTY OVER LOCAL FIRMS ............... 46

A. Agencies of the State.................... 49

B. State Involvement with Business Corporations.................... 51

1. Special Chartering.................... 52

2. State Financing and Oversight.................... 53

C. Territorial Monopoly in Corporation Law.................... 54

IV. INDUSTRIALIZATION, INTERSTATE FIRMS, AND ARTICULATION OF THE INTERNAL AFFAIRS DOCTRINE .................... 56

A. National Product Markets and Interstate Firms.................... 58

B. Interjurisdictional Pressures on Territorial Corporate Law: Weak-Form Charter Competition.................... 59

1. States' Struggle to Maintain Territorial Monopoly.................... 59

2. General Incorporation and the Regulation of Local Industrial Organization.

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