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Self Study Examinations for CLE Credit: The Bar Association of San FranciscoMay 2011 Self Study Examination
To B, or not to B, that is the question… Author: Felicia Vallera, San Francisco Community Business Law Center
The Singing Seamstresses of SOMA have a terrific idea. They want to start a new collaborative business organization that helps low-income single mothers develop job skills and gain economic independence by learning how to create fashionable hand-made hats from recycled materials and market them over the Internet. The Seamstresses are confused, though. Is this new sustainable business enterprise going to be a nonprofit or a for-profit organization? Even though they need to support themselves at modest levels, they don’t like the idea of being a for-profit business because they want to be free to reinvest most of the money they make right back into the program to increase their community service – so any traditional financial investors would be quite unhappy. However, if they try to operate as a nonprofit, they are afraid that they won’t qualify for tax exempt status or won’t be able to afford the administrative costs. What these harmonious humanitarians really need is… something in between? Desire and demand for heightened social responsibility in business is here to stay. Across the nation, state legislatures are considering and passing corporations code amendments to create new “in between” business entity types accordingly. However, when clients with social enterprise goals ask questions about entity choice, the array of alternative new legal forms facing business attorneys can be a confusing quagmire. If this is new to you, here’s a simple primer to help you start navigating. Let’s Start With Some Basic Definitions Nonprofit entities “may not be operated for the private gain of any person”1 but instead operate for the benefit of the public or their collective membership group. Nonprofits must limit their missions to charitable or other tax-exempt purposes, must fully and permanently dedicate ownership of their assets to tax-exempt purposes, and may not allow any profit or surplus to inure to the benefit of any private shareholder or individual.2 However, nonprofit administration is expensive, funding is a difficult challenge, and directors of nonprofits may be personally liable for breach of duty of care if they cause the organization to lose its tax exempt status through fundraising methods that are not allowed by the taxing authorities. As noted in a recent publication of the Federal Reserve Bank, “[a]cquiring start-up capital is a common issue for many nonprofits. It’s exacerbated by federal tax laws that restrict nonprofits from accessing traditional forms of equity, such as venture capital and, sometimes, commercial debt.”3 For-profit entities, owned by and held for the benefit of their equity investors, are usually focused solely on a mission of profit-maximization as measured by a purely financial bottom line – earnings per share and/or stock price.4 Even if directors of for-profit organizations would like to support social responsibility goals, they often are not able to do so. If they make decisions that are deemed to breach their duty of care to the corporation because they waste corporate assets – with “waste” in most bodies of case law defined in terms of maximizing financial return on assets - they risk losing the protection of the Business Judgment Rule which shields them from personal liability to the company’s shareholders. For example, the Revlon ruling in Delaware requires directors to take the highest offer regardless of non-financial considerations when a company is in play, and in Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000), the Delaware Supreme Court defined “waste” as a situation in which “no person of ordinary, sound business judgment could conclude that the corporation has received adequate consideration.” Social Enterprises are organizations that combine a philanthropic, or socially-responsible mission, with the kind of capitalistic market-oriented business methods traditionally reserved for the for-profit sector. These socially-responsible business entities may only partially dedicate their assets, or may define social responsibility factors as equally important bottom line goals that directors are authorized, or even required, to pursue (hence the slang terms, “double-bottom-line” or “triple-bottom-line” business entities). Among the various types of new socially-responsible business entities: B Corporations are purpose-driven and create benefit for all stakeholders, not just shareholders, by committing to “[m]eet comprehensive and transparent social and environmental performance standards” and “meet higher legal accountability standards….”5 The term “B Corporation” does not refer to a specific state-chartered legal entity type, but rather indicates that an organization has qualified under and made a commitment to national certification standards that measure performance against stated social responsibility goals. The Company must also agree to legally expand the responsibilities of the corporation to include the interests of its employees, suppliers, consumers, community, and environment as and when it may legally do so under applicable state law. Many different types of state chartered legal entities may be certified as B Corps, even sole proprietorships. B Lab, a nonprofit organization, benchmarks social and environmental impact for good companies and develops and advocates for new corporate forms that enable these goals, while an independent Standards Advisory Council develops and administers legal and performance certification standards that help guard against greenwashing and other marketing practices. Benefit Corporations are a specific new type of state-chartered for-profit corporation based on model legislation jointly developed by B Lab, the American Sustainable Business Counsel, and others. Benefit Corporations are “… a new class of corporation that 1) creates a material positive impact on society and the environment; 2) redefines fiduciary duty to require consideration of non-financial interests when making decision; and 3) reports on its overall social and environmental performance using recognized third party standards.”6 The model legislation for Benefit Corporations proposes to solve the fiduciary duty problem for directors who consider non-financial interests in decision-making, and expands shareholder rights to give shareholders the power to enforce these higher standards. Maryland was the first state to adopt the Benefit Corporation in April of 2010, followed by Vermont, Virginia, and New Jersey. At press date for this article, Benefit Corporation legislation is pending in California, Colorado, Hawaii, Michigan, New York, North Carolina, and Pennsylvania. In California, AB361 was introduced to the California Legislature by Assemblyman Jared Huffman on February 14, 2011. Constituency Statutes (or “non-shareholder constituency” statutes), enacted in response to the Revlon ruling of the 1980’s and currently in place in over 30 states in the United States, give corporate directors some limited ability to consider non-financial factors such as impact on employees, suppliers, customers, creditors, or the local and national economy and society at large, in making decisions. However, most state constituency statutes do not give shareholders the right to actually enforce director consideration of non-financial factors, give any relative weight to the different constituency factors, or provide any standards for implementation, and there is no constituency statute in effect in Delaware. Flexible Purpose Corporations are another possible new entity form being considered only in California under SB201, the Corporate Flexibility Act of 2011, introduced in California’s State Senate in February. Among other considerations, this unique bill would authorize existing corporations and other forms of business entities to “merge into or convert into a flexible purpose corporation upon completion of specified requirements… would specify the required and permitted contents of articles of incorporation that a flexible purpose corporation would be required to file with the Secretary of State, including the special purposes… that may include, but not be limited to, charitable and public purpose activities that could be carried out by a nonprofit public benefit corporation….”7 Although Flexible Purpose Corporations and Benefit Corporations have some factors in common, there are also important differences in entity purpose, shareholder rights, and director fiduciary duty that our California legislature will have to carefully consider in the coming months or years. Low-Profit Limited Liability Companies, also known as L3C’s, are a hybrid form of for-profit limited liability company. “First, an L3C ‘s organizing document… must set forth as its primary business objective ‘one or more charitable or educational purposes,’ as defined by the Internal Revenue Code. In addition, the term ‘low profit’ is embedded in the title of the business form to put investors and philanthropic funders on notice that the entity is motivated first and foremost by its expressed social mission, but not necessarily to the exclusion of making money. Second, the L3C‘s articles of organization must state that the operating agreement among its members contain specific language that mirrors IRS regulations regarding program-related investments, or PRIs.”8 One practical benefit of L3C’s is that they are merely a variant of existing limited liability company legislation already enacted in all 50 states. However, these entities require highly sophisticated tax and nonprofit legal and financial expertise in their creation and ongoing management, and therefore are generally not a feasible entity form for the typical independent community microbusiness startup on a tight budget. How to Help Your Client Choose the Best Option How do we advise our hypothetical Singing Seamstresses of SOMA? Since they are on a tight budget and located in California where new corporate legislation has not yet passed, a modified traditional LLC coupled with B Corporation certification may be the most legally feasible and cost-effective solution for them right now. We shall see what the future holds for these types of entities as the law continues to evolve.
Footnotes 2. See, e.g., IRS Publication 4220 for information regarding one very common type A new business model for socially responsible investing,” The Federal Reserve Bank of Minneapolis, November 2009. 4. See, e.g., Friedman, Milton, “The Social Responsibility of Business is to Increase Profits,” The New York Times Magazine, September 13, 1970. 5. See, generally, www.bcorporation.net, for extensive information about B Lab and B Corporations. 6. See “Legal FAQ’s” on http://www.bcorporation.net/publicpolicy. 7. See Legislative Counsel’s Digest, SB 201, February 8, 2011. Examination Questions (True/False) and InstructionsDownload the questions and instructions on receiving CLE credit.
BASF is a State Bar of California CLE provider. This activity has been approved for MCLE credit by the State Bar of California in the amount specified. |
