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Delaware Encourages Blockchain Technology Through Legal and Technological Innovations

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Authors: Joseph C. Guagliardo, Todd R. Kornfeld, Johanna R. Collins-Wood and Matthew M. Greenberg

Delaware Encourages Blockchain Technology Through Legal and Technological Innovations

From producing electronic records to trading securities and communicating with investors, blockchain technology has the potential to provide companies with innovative clarity, accuracy and speed.

On July 21, Delaware governor John C. Carney Jr. signed into law a series of amendments to the Delaware General Corporation Law (DGCL) that will allow companies to keep shareholder information on blockchain technology-based distributed ledgers and communicate with investors through those ledgers. A key aspect of the law is that Delaware companies will now be able to maintain their ownership records on a blockchain database; a blockchain stock ledger. The amendments took immediate effect, and Delaware companies can now take advantage of blockchain technology to reduce costs and improve efficiency and accuracy, knowing that the technology is supported and recognized under Delaware law.

Delaware is encouraging technology companies to develop blockchain distributed ledger technology for shareholder records and communications. We expect over time — as blockchain technology becomes more widespread and as other players in the equity settlement market, such as custodians and the Depository Trust Company, adopt blockchain technology — that settlement time in publicly traded equities will plummet, perhaps falling to fractions of a second from the T+2 standard that will be implemented in September.

Blockchain Distributed Ledger Technology

Blockchain technology was originally known as the technology underlying the cryptocurrency Bitcoin. In its most basic form, blockchain technology is a decentralized electronic distributed ledger, similar to a stock ledger, that relies on a network of users to verify transactions. The technology is often described as being “trustless,” in that databases can be maintained without the need to rely on a single, central authority to verify transactions. When a transaction occurs and is verified by the network, the ledger records one fixed and highly secure copy of the transaction that all users are able to see at the same time. This technology also enables so-called “smart contracts,” which are self-executing software programs running on blockchain databases that enable rules-based execution of transactions based on specific triggers.

The advantage of such a database is that transactions can be recorded in real time (or near real time) without the need for a trusted third party. Traditional databases, including the stock ledgers currently used for stock and other security transfers, exist in a single, fixed location and were developed in a different era, when computers were slow and data storage was expensive. That resulted in a book-entry beneficial ownership system for equities that was state of the art in the early 1970s, but now seems quaint.

In particular, the book-entry beneficial ownership system does not store a complete beneficial ownership list. In fact, multiple time-consuming queries to record holders are required to generate a beneficial owner list. This means slow settlement of stock trades and difficulties in communicating with stockholders. As a result, many companies are now looking at blockchain technology as a way to provide a fast, streamlined method of recording and transferring stocks and other securities and for communicating with investors.

Blockchain technology allows securities transactions to occur automatically and provides a permanent, trusted record of the transactions and parties involved. For example, a blockchain system can be used to quickly distribute a stock dividend or implement a stock split to the correct stockholders. The existing book-entry system requires multiple market participants, including custodians and brokers, to correctly distribute stock dividends and splits, which is both time consuming and error prone, requiring increased reconciliation as compared to a blockchain system.

In addition, it is possible that companies utilizing a blockchain-based stock ledger may choose to “list” their stock on a blockchain-based alternative trading system (ATS), assuming that all other regulatory requirements are satisfied. This might eliminate the need to list on the New York Stock Exchange or NASDAQ. The SEC has already approved a blockchain-based ATS.

Blockchain technology offers a higher level of transparency because the distributed ledger reflects the real-time ownership and movement of a company’s securities. The technology thereby allows for reduced costs and increased settlement times because all securities transactions potentially can occur on the distributed ledger and without passing through a clearing house.

Delaware Legislation

The new DGCL amendments permit corporations to use electronic networks or databases, including distributed ledger and blockchain technology, to keep their books, records and stock ledgers and to communicate with investors by programming the distributed ledger to automatically generate messages when certain transactions occur. These pre-programmed actions are a form of smart contracts. For example, the initial notices to holders regarding the issuance of uncertificated stock may now be provided electronically. In addition, corporations may maintain their official stockholder lists in electronic form, including on blockchain databases.

The amendments also include requirements for digital ledgers, including that digital ledgers:

  1. can be converted into a clearly legible paper form within a reasonable time, meaning that digital ledgers must be able to be easily printed or transcribed
  2. be able to be used to prepare the list of stockholders required when responding to stockholder demands to inspect the corporation’s books and records (although the list must be provided in paper form on request)
  3. record information about consideration given for partly paid shares, transfers of shares for collateral security, pledged shares and voting trusts
  4. record transfers of stock as governed by Article 8 of the Delaware Uniform Commercial Code (UCC).

Delaware Blockchain Initiative

In addition to permitting the use of blockchain technology under the DGCL, Delaware has sought to encourage technological development in this area through its Delaware Blockchain Initiative. The initiative aims to expand the use and development of distributed ledger technologies by Delaware-incorporated businesses.

As part of the program, Delaware is working with Symbiont, a smart securities company founded in 2015, on several projects to utilize blockchain distributed ledgers for the state’s records. Delaware’s first project was to move the state’s archival records onto a blockchain distributed ledger to develop “smart records.” These smart records now automate compliance with Delaware’s laws on retention and destruction of archival documents. Delaware’s latest project is developing smart UCC filings. This technology implementation, which should be completed by year end, will allow Delaware filers to file smart-contract versions of UCC documents on a blockchain distributed ledger. It is intended to automate the release or renewal of UCC filings and increase the speed of searching UCC records, as well as reduce mistakes, cost and fraud. Delaware appears to be an “early-mover state,” believing that its adoption of blockchain technology will enhance its attractiveness as a corporate domicile.

What Does This Mean for You?

From producing electronic records to trading securities and communicating with investors, blockchain technology has the potential to provide companies with innovative clarity, accuracy and speed. As with all new technologies, the disruptive power of blockchain technology will depend on how many companies adopt it and whether it truly provides a safer and more reliable method of storage, transaction execution and shareholder communication. However, the proliferation of startups in this space and the innovative ways companies have begun to harness blockchain technology suggests that this technology has a vibrant future.

If you have any questions, please reach out to the authors, Joseph C. Guagliardo, chair of Pepper’s blockchain technology practice, Todd R. Kornfeld, Johanna R. Collins-Wood and Matthew M. Greenberg.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.

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