Governor Brown Signs Laws Enabling For-Profit Corporations with Declared Social Objectives
On October 9, 2011, Governor Brown signed two new laws that give for-profit corporations a clear legal foundation to consider social or public impacts of their actions, with a few important strings attached. The laws are effective January 1, 2012.
Corporate law in America has developed along a clean dividing line, with nonprofit entities, which are dedicated to public purposes and not the personal interests of their stakeholders, neatly sequestered away from for-profit entities, which are statutorily compelled to serve the interests of their shareholders exclusively.
In the past two decades, the concept of social ventures with a profit motive (“doing well by doing good”) has become increasingly prevalent in the United States, reflecting the interests of many private investors in putting their money to work in socially conscious for-profit enterprises, and the interests of consumers in seeking out products and services from entities that verifiably support green, or sustainable practices, serve low-income or other special-needs communities, or otherwise promote one or more social purposes. Along with this burgeoning category of businesses has come the realization that our binary structure of corporate law has left a gap in the middle, giving rise to concern about the legality of for-profit companies considering the broader social and environmental ramifications of their actions, sometimes to the detriment of their investors’ return on capital. One of the biggest concerns is the scrutiny that a for-profit board would face if it turned down a financially attractive acquisition offer because of concerns about the buyer’s commitment to the social purposes to which the entity is dedicated.
A national movement has arisen to solve this problem, leading to Governor Brown’s signing two laws, introducing two new categories of business entity to California—the “benefit corporation” and the “flexible purpose corporation.” California follows Hawaii, Maryland, New Jersey, Vermont and Virginia in adopting benefit corporation legislation, and is the first state in the nation to create the flexible purpose corporation (“FPC”).
Becoming a Benefit Corporation or FPC. A California for-profit corporation may elect to become a California public benefit corporation or FPC by modifying its articles of incorporation. Other types of California entities can also become public benefit corporations or FPCs by merging with such an entity or following the existing procedures for “conversion” to a for-profit corporation under existing law.
To opt in, an existing corporation would need to obtain the approval of at least two-thirds of the holders of every class or series of shares in the entity, whether or not normally entitled to vote. The same requirement applies for opting out. NOTE: If a shareholder does not consent, that shareholder may pursue dissenter’s rights requiring the corporation to repurchase his or her shares at fair market value. Many companies dedicated to a social purpose may not have access to adequate capital to deal with this possibility, and should consider carefully whether to require a higher percentage approval, or to defer the action until they are confident they can financially accommodate possible dissenters.
Public Purpose.
• Benefit Corporations. The law provides that a benefit corporation is formed for the purpose of creating “general public benefit,” defined as a material positive impact on society and the environment, taken as a whole. A benefit corporation may also identify one or more specific public benefits as an additional purpose, including providing low-income or underserved individuals or communities with beneficial products or services, promoting economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business, preserving the environment, and improving human health. The law also specifically allows directors to consider the impact on the corporation’s public benefit purposes of the resources, intent, and conduct of any person seeking to acquire control of the benefit corporation, addressing one of the major concerns about considering social purposes under the old law.
• Flexible Purpose Corporations. FPCs are not bound by a general public benefit standard, but must identify one or more “special purposes,” which must consist of one of the following:
- One or more charitable or public purpose activities that could be carried out by a California nonprofit public benefit corporation;
- Promoting positive, or minimizing negative, short-term or long-term effects of the flexible purpose corporation’s activities upon stakeholders, the community and society, or the environment;
Obligations of Benefit Corporations and FPCs. Those considering electing benefit corporation or FPC status should be aware that the law imposes a variety of novel legal responsibilities on the entity.
Mandatory Consideration of Purpose. The consideration of the public impact of acts of the benefit corporation is not permissive, it is mandatory–the directors are required to consider the impacts of any corporate action or proposed action upon the entity’s shareholders and employees, customers who are beneficiaries of the general or specific public benefit purposes of the entity, and on the environment. Interestingly, while the FPC statute explicitly permits the directors to consider the social purposes of the corporation specified in its charter, it does not require such consideration, although it would certainly be inadvisable for a director to fail to do so.
Reports.
- Benefit Corporations. A key feature of the benefit corporation law is a requirement to deliver to shareholders and file with the state an annual benefit report to be prepared in accordance with a set of standards developed by an independent standards body. The report must include, among other things, a statement indicating whether, in the board’s opinion, the benefit corporation failed to pursue its general public benefit or any specific public benefit, a description of the ways in which the benefit corporation pursued those benefits, the extent to which those benefits were created, and the process and rationale for selecting the standard used to prepare the benefit reports. The source of the legislation was B Lab, an organization that serves as the most prominent standards body at this time and provides standards certification in exchange for an annual fee of up to $25,000 per year. Largely as a result of concern over B Lab’s own financial interest in the legislation, several observers, including the California Department of Corporations and committees of the state bar, have opposed the benefit corporation legislation.
- Flexible purpose corporations. Probably the most fundamental difference between benefit corporations and FPCs is that the FPC law does not impose any baseline public benefit requirement or third party certification or standard the FPC must meet. Instead, it imposes a higher transparency requirement. FPCs are required to provide to their shareholders and to publicly post, within 120 days after each fiscal year, full financial statements and a management’s discussion and analysis of the FPC’s objectives regarding its declared public purposes, measures being taken and funds being spent to achieve them, and the mechanisms used to evaluate them. In addition to the annual report, they are required to distribute interim reports within 45 days after expenditures having material adverse effects on the results of operations, or the elimination of a declared special purpose or material reduction in the previously announced spending plan to achieve it.
Other Considerations. As with most major changes in the law, this one leaves several questions unanswered. It does not address taxes at all, meaning that at least for the time being, there is no special tax advantage or incentive for being a benefit corporation or an FPC, or investing in one, compared to a regular for-profit corporation. The law does not provide a similar structure for other types of entities such as limited liability companies, other than contemplating that they could convert or merge into a benefit corporation or FPC. And the standards by which the annual benefit report is to be measured, when it is due, what filing fees will be charged by the state, etc. will need to await further regulatory guidance. There is also a concern among corporate practitioners that the laws introduce vagueness about and potential relaxation of the fiduciary duty of directors and the ability to measure their conduct against a clear standard. And in the case of the benefit corporation law (which was modeled on a template developed and promoted by B Lab) the new statute does not mesh well with the existing corporations code, creating gaps and inconsistencies that will need to be cleaned up in future legislation and will leave important questions unanswered in the interim.
Given the many implications of the new laws, those who intend to form or convert an entity into a benefit corporation or flexible purpose corporation should carefully evaluate the practical and legal consequences of doing so, with the advice and assistance of experienced corporate counsel.
This article was written by Greg Beattie (greg@mbvlaw.com), a partner at MBV Law, LLP who assists companies with formation, raising capital, mergers and acquisitions, business transactions and corporate governance.
