By Meegan Reilly Moriarty, J.D.
USDA Cooperative Programs
Editor’s note: This article is not intended
to serve as legal advice, but rather as a
survey of several forms of business entities
that readers may want to further explore.
Individuals considering forming a Benefit
Corporation, a B-Corporation or a Social
Purpose Corporation should consult with an
In the November/ December 2015 issue of Rural Cooperatives, I discussed L3C businesses, a type of LLC (limited liability corporation) that must serve a charitable purpose and was designed to attract foundation funds (although it does not have to).
This article focuses on another “hybrid” form of business that serves a dual for-profit and socially beneficial purpose: the benefit corporation. The benefit corporation was created to allow for-profit companies to also pursue a charitable purpose. Unlike the L3C, this business is not limited in its pursuit of income or capital appreciation (other than by its obligation to also pursue a social good). The benefit corporation can be adapted to operate using cooperative principals.
Businesses can operate in a variety of ways and for a variety of lawful purposes. Historically, an organization that intended to serve a charitable purpose logically would consider operating as a nonprofit organization under state law. While a nonprofit can acquire earnings or get funding from private donors and foundations, it cannot distribute (or liquidate) those earnings to the individuals that control the organization. A nonprofit cannot raise equity by issuing stock, since it belongs to the public.
A nonprofit can secure debt financing, but it may not get the best terms, since its difficulty in raising capital makes it harder to pay down the loan. Further, a nonprofit that is exempt from tax under Internal Revenue Code (IRC) Section 501(c)(3) is subject to the stringent private benefit, private inurement and excess benefit transaction rules. Violation of these rules can result in loss of exempt status and/or high excise taxes. (See IRC Sections 501(c)(3) and 4958.)
The corporate form of business also has significant limitations if operating for a beneficial purpose. Directors and officers of a corporation who wish to operate the business for purposes beyond solely generating profits run the risk becoming targets of shareholder lawsuits. Corporations are required by state law to be operated for the benefit of their shareholders. (See Dodge v. Ford Motor Co., 204 Mich. 459, 507, 170 N.W. 668, 684 (1919); eBay Domestic Holdings, Inc. v. Newmark, 16 A. 3d 1 (Del. Ch. 2010).)
Corporate officers and directors owe a fiduciary duty of loyalty and care. The duty of loyalty mandates that fiduciaries act for the best interest of the corporation and put the corporation’s interests ahead of their own when they are in conflict. The duty of care requires that fiduciaries pay attention and make good business decisions. Under the “business judgment rule,” courts rebuttably presume that directors are acting in good faith, with good information, and that their actions will benefit the corporation. (See e.g. Aronson v. Lewis, 473 A.2d 805 (Del. 1984.))
Generally, the business judgment rule gives directors and officers some latitude to make decisions that promote a social good as long as there is a purported, believed, or actual connection to the value of the corporation. Many states (but not Delaware, where many businesses are incorporated) have laws that allow fiduciaries to consider constituencies other than shareholders when making decisions; members of the constituencies vary by state, but may include employees, former employees, suppliers, creditors, customers and the community. (See Eric W. Orts, Beyond Shareholders: Interpreting Corporate Constituency Statutes, 61 Geo. Wash. L. Rev. 14 (1992).)
However, courts continue to see the shareholders’ interests to be paramount even when acknowledging directors’ legitimate interest in considering other constituencies. (See e.g. Baron v. Strawbridge & Clothier, 646 F. Supp. 690 (E.D. Pa. 1986).) So even with the latitude provided by the business judgment rule and even in states with constituency statutes, directors run the risk of being liable in a suit for breach of fiduciary duty.
Generally, when dealing with unwanted takeovers, directors may take reasonable actions to protect the corporation’s policies, but defense of a socially motivated policy that does not enhance the value of the corporation is not permissible. (See e.g. eBay Domestic Holdings Inc. v. Newmark, 16 A. 3d 1 (Del. Ch. 2010)). When a corporation’s ownership or control is being transferred, the directors’ job becomes getting the best stock price for the shareholders. Accepting a bid for the corporation that preserves the corporation or its management when a higher price is available is an actionable breach of fiduciary duty. (See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986); In re The Topps Company Shareholders Litigation, 926 A.2d 58 (Del. Ch. 2007)).
Shareholders can sue if they think directors or officers have engaged in misconduct or wasted corporate assets. Penalties for directors and officers can include money damages, disgorgement of profits from the director or officer, removal of directors or officers, rescission of the relevant transaction, and payment of attorney’s fees. (See Sections 8.31 and 7.46 of the Revised Model Business Corporation Act Third Edition Revised 2002.)
Given the limitations of the nonprofit and corporate business forms, creative individuals have invented several business entities that can operate for a social benefit purpose, raise capital, preserve an adopted social or environmental purpose in the event of merger and acquisition, and earn and distribute profits. One of these entities is the benefit corporation (or the public benefit corporation, the name by which an alternative form to the model benefit corporation is known in some jurisdictions).
Benefit corporation legislation has been adapted in 31 states and is being considered by five more. The model legislation, drafted by attorney Bill Clark, with Drinker, Biddle and Reath LLP, creates a new category of business entity, but unless otherwise specified in the benefit corporation legislation, existing corporate law applies. All references in this article are to the model legislation; practitioners should examine the specific state legislation that they are considering because it may differ from the model legislation.
Unlike strictly profit-motivated corporations, a benefit corporation’s purpose is to have a general public benefit, defined as a “material, positive impact on society and the environment.” Benefit corporation fiduciaries are required under the model legislation to consider the impact of their decisions on shareholders, other constituencies — including workers, suppliers, customers, subsidiaries, and the community — and on non-financial objectives, including benefiting the environment and society. Fiduciaries are also required by the model legislation to consider the short-term and longterm interests of the corporation (the long-term interests of which may best be served by not being acquired or merged into another company). The corporation may also name a specific public benefit that it will pursue.
According to the white paper by Clark and Larry Vranka of Canonchet Group LLC, the “general public benefit” provision in the model statute was included (rather than just allowing the corporation to choose a specific benefit) for two reasons: 1. to permit corporations to pursue a broad social mission without fiduciary liability, and 2. to prevent them from “greenwashing” their organizations by choosing and publicizing one benefit and using other corporate resources to engage in activities that are not beneficial.
The general public benefit provision is intended to be flexible and to give a positive orientation to the business. It is drafted broadly to allow individual corporations to creatively arrive at a public benefit. While the requirement that the corporation benefit society and the environment seems onerous, according to the white paper, corporations are not necessarily always required to benefit both. The benefit is to be “taken as a whole” under the statute and assessed as a whole. Additionally, commentators have complained (according to the white paper) that the requirement for a general public benefit that makes a “material” difference is vague. The drafters responded in the white paper that the assessment against the independent standard clarifies the meaning of “material.”
The model statue suggests several specific public benefits that a benefit corporation could include as part of its mission:
1. Providing beneficial products or services to the low-income or underserved;
2. Promoting economic opportunities;
3. Protecting the environment;
4. Promoting health;
5. Promoting the arts and sciences;
6. Funding beneficial entities;
7. “Conferring any other particular benefit on society or the environment.”
As item 7 indicates, this list is not intended exclude other beneficial purposes.
The model legislation drafters avoided including statutory performance standards or creating a new government body to evaluate the corporations. Instead, they mandated reporting using a private third-party standard. The white paper lists a number of third-party standards organizations that would be acceptable under the legislation. These include BLab, The Global Reporting Initiative (GRI), GreenSeal, Underwriters Laboratories, ISO2600, and Green America. GRI and B Lab do not charge for the use of certain of their standards.
Except in Delaware, a benefit corporation must promulgate an annual report based on a private third-party standard: 1. to its shareholders; 2. on its website, and 3. with the state secretary.
This report would not be required to be audited, but some benefit corporations may decide to have thirdparty audits conducted to enhance their credibility. The model statute mandates that the third-party standard be independent, comprehensive, credible, and transparent.
The third-party organization is independent of the benefit corporation if it follows rules assuring that it is not funded by the benefit corporation’s industry and that most of the organization’s governing body is not associated with the industry.
The standard is comprehensive if it takes into account the benefit corporation shareholders, workforce, the workforce of its subsidiaries and suppliers, its customers, the community, the local and global environment, societal factors, the short- and longterm interests of the corporation, and the general and specific benefit being pursued by the corporation.
The standard is credible under the model legislation if it is created using expertise and a multi-stakeholder approach including a public comment period.
Transparency is achieved: 1. By mandating that criteria (and their relative weightings) used by the standard are publicly available, and 2. By requiring the organization developing the standard to identify its members (as well as any conflicts of interest) and to describe how membership changes and standard revision changes are made.
Importantly, the model legislation uses language in several sections intended to ensure that courts will not hold fiduciaries liable for failing to follow shareholder primacy rules. It states that the general and public benefits are “in the best interest of the benefit corporation,” thus assuring that benefit company directors and officers who pursue public benefits (rather than solely focusing on profit maximization) will not be liable for fiduciary violations. The model statute explicitly states that directors do not need to give priority to the interests of shareholders or any other particular stakeholder or group unless mandated by the bylaws of the corporation.
Directors and officers have wide authority to further the best interest of the corporation, so long as they pursue a public benefit; any specific benefit mandated by the corporation; the interests of community stakeholders (the shareholders, employees, suppliers, customers, and subsidiaries); the environment; and the long- and shortterm interests of the corporation.
Fiduciaries remain subject to and protected by the business judgment rule. A disinterested director who makes a good-faith, informed decision that the director rationally believes to be in the best interest of the corporation is protected from liability.
Interestingly, directors and officers are not liable for money damages if they fail to pursue the general or specific public benefit. And fiduciaries have no duties toward third-party beneficiaries of the general or specific public benefit purpose of the corporation unless the corporation articles allow a specific class of individuals to bring an enforcement action. Generally, directors, shareholders who own 2 percent of outstanding shares, and 5-percent owners of a parent company are the only constituents with standing to bring a derivative action on behalf of the corporation to enforce the benefit purpose.
Derivative suits can move forward if: a director or officer failed to pursue the corporation’s general or specific benefit; did not achieve a duty or standard of conduct; or did not provide the public with the annual benefit report (by publishing it on a website, delivering it to shareholders and providing it to the secretary of the state) written in accordance with a third-party standard.
Remedies available under the statute are equitable. The white paper speculates that a good faith effort to pursue the general or specific benefit purpose might defeat a derivative suit; but for meritorious actions, a court might give an extended period of time to demonstrate the achievement of a benefit. Other remedies could include putting in place procedures to consider constituencies that had been neglected and enforcing the requirement to publish the benefit report.
Directors are still required to pursue the purpose of the benefit corporation and consider community stakeholders in a change of control, merger, consolidation, or conversion. Any change in the form of the entity is required to be approved by two-thirds of the shareholders. The corporation’s bylaws can be amended by a two-thirds vote of the shareholders to terminate its status as a benefit corporation. Sale of all the benefit corporation’s assets also effectively terminates the corporation and must be approved by a two-thirds vote.
Benefit director and benefit officer
Publicly traded benefit corporations are required to designate a benefit director whose duties include preparing the annual benefit report. In preparing the report, the benefit director is required to address whether the corporation pursued its general and specific purpose and whether the directors followed appropriate standards of conduct including considering community and environmental interests.
The benefit director also must describe any compliance failure in the report. Non-publicly traded corporations may also designate a benefit director. Benefit companies are also permitted to designate a benefit officer who can help the company pursue its public benefit or prepare the benefit report.
Converting to a benefit corporation
When an entity is planning to change to a benefit corporation (or cease to be a benefit corporation) as a result of a merger, consolidation or conversion, the model benefit legislation requires that shareholders of every class (and individuals entitled to receive property distributions) approve the plan by a two-thirds vote. This method of approval is required regardless of contrary voting or consent rules in the entity’s articles of incorporation, bylaws, or (in the case of a limited liability company) operating agreement.
The corporation must amend its articles of incorporation to include a statement that the corporation is a benefit corporation. In some states, dissenting shareholders are entitled to receive the fair market value of their shares.
B-Corps and B-Lab
B-Lab provides third-party standards for benefit companies and was the organization behind the creation of the model benefit company legislation. BLab was formed by Jay Cohen Gilbert, Bart Houlahan and Andrew Kassoy, all Stanford University alumni. Gilbert and Houlahan previously ran a multimillion-dollar sports footwear and apparel company while Kassoy was a private equity investor.
B-Corporations are corporations that have received the seal of approval from B-Lab. Companies earn the seal by undergoing a B-impact assessment, developed by an advisory board of business people and academics. The assessment quantifies the company’s impact and describes how it is doing compared with other similar companies. The assessment measures the company’s environmental practices, treatment of workers, customers, and consumers, and its governance practices particularly with respect to accountability and transparency.
Cooperatives and other businesses can consider operating as one of the corporate entities that have been specific purpose but can elect to also have a general purpose. These entities may be a good choice for businesses that do not want to go to the expense of adhering to a third-party standard, or in the case of the California SPC, want to have just a specific social purpose. However, the more stringent requirements of the benefit corporation provide more credibility for organizations that want to avoid the appearance of “greenwashing.”