LAW AND SOCIAL ENTREPRENEURSHIP

WOULFE ON CONNECTICUT BENEFIT CORPORATION LAW

James Woulfe, who was involved in the legislative process around Connecticut benefit corporations, and I have had a number of interesting conversations about social enterprise law over the past few years.  Recently, I asked James to share his thoughts on the new Connecticut benefit corporation law for the blog.  His contribution is below.

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After two previous tries, Connecticut recently became the 24th state in the Union to pass benefit corporation legislation. While some may argue that the fact it took Connecticut so long to pass the bill is a sign of problems with the legislature, our state’s business climate, etc., coming a little late to the game was actually an asset. Waiting to pass the legislation gave lawmakers an opportunity to take a look at national and international trends in social enterprise legal structures, and experiment. As a result, Connecticut tweaked the “model” benefit corporation legislation passed in other states, and included an innovative first in the nation clause in Connecticut’s statute, called a “legacy preservation provision.”

Connecticut’s legacy preservation provision gives social entrepreneurs the opportunity to preserve their company’s status as a benefit corporation in perpetuity, despite changes in company leadership or ownership. In other words, the (optional) provision locks in the company’s social or environmental mission as a fundamental part of its legal operating structure. The provision may be adopted following a waiting period of two years and unanimous approval from all shareholders, regardless of their voting rights. Once the provision is adopted, it requires the company, if liquidated, to distribute all assets after the settling of debts to one or more benefit corporations or 501(c)3 organizations with similar social missions.

To learn more about Connecticut’s benefit corporation statute, and to take a look at the specific language of the legacy preservation provision, you can visit CTBenefitCorp.com.

About the Author:

James Woulfe is the Public Policy and Impact Investing Specialist at reSET – Social Enterprise Trust, a Hartford, Connecticut-based 501(c)3 non-profit organization whose mission is to promote, preserve and protect social enterprise as a viable concept and a business reality. You can contact James at Jwoulfe@socialenterprisetrust.org.

Cross-Posted at Business Law Prof Blog.

IMPROVING BENEFIT CORPORATION LAW

Over at Columbia Law School’s excellent, new Blue Sky Blog, I have a post on Delaware’s new public benefit corporation law and improving benefit corporation law in general.

The post concludes:

While it remains to be seen whether Delaware’s foray into benefit corporation law represents a “tipping point in the evolution of capitalism” (especially considering that only a few hundred benefit corporations have been formed over the past three years), it is encouraging to see the individual state laboratories at work, and I am interested in seeing where this pluralism in the corporate form leads.

Go over to the Blue Sky Blog to read the entire post.

UPDATED: BENEFIT CORPORATION CHART

I have updated my benefit corporation state statute chart here.  A number of states (Arizona, Arkansas, Colorado, Nevada, and Oregon) have passed benefit corporation statutes recently, but those are not effective yet and therefore have not yet been included.  Washington D.C.’s statute went effective in May, and is in this version of the chart.  D.C. seemed to follow the January 26, 2012 version of the model legislation without much deviation.

Also, I added and updated some of the more recent versions of the model legislation.  The changes in the model legislation have been quite interesting to me.  The most interesting recent change was moving from a fairly detailed definition of “independence” for the third party standard provider to simply ““[d]eveloped by an entity that is not controlled by the benefit corporation.”

As always, please feel free to contact me with any suggestions or potential corrections.

REPEAL IRC § 4944 TO ENCOURAGE INVESTMENT IN SOCIAL ENTERPRISE

A while ago, I posted to this blog a short (mildly humorous???) story illustrating how certain federal income tax rules generally prohibit “risky” investments by private foundations, even when those investments have potential for tremendous social or environmental benefit. The so-called “jeopardizing investment” rules of IRC § 4944 impose a minimum 10% (with a possible 25% additional) tax on investments by private foundations that “jeopardize the carrying out of [the foundation's] exempt purpose.”

In my prior post, I hypothesized a private foundation considering an early-stage investment in a company developing an inexpensive, solar-powered car. I further hypothesized that the private foundation’s manager reasonably and rationally believed that an investment in the car company could have substantial environmental benefits. Further, the investment was on fair terms and involved no self-dealing or other economic benefit to the private foundation’s insiders. Unless the purchase of stock in the car company qualified under the narrow program-related investment exception, however, the investing private foundation could be subject to a 10% (and possible additional 25%) penalty tax under IRC § 4944. Moreover, the investment in the solar-powered car company could be penalized even though an outright grant by the private foundation to benefit environmental causes clearly would be permissible (and even encouraged).

Thus, from a tax standpoint, a private foundation manager seeking to support environmental causes is better off investing in BP and then giving away returns to Green Peace than making a “risky” investment in a solar-powered car company—even when that investment might have a much larger and more lasting positive impact on the environment. This makes no sense.

Actually, the most compelling illustration I can provide as to why the “jeopardizing investment” rules of IRC § 4944 ultimately make no sense comes directly from the implementing Regulations. Specifically, Reg. § 53.4944-1(c) provides:

A is a foundation manager of B, a private foundation with assets of $100,000. A approves the following three investments by B after taking into account with respect to each of them B’s portfolio as a whole: (1) An investment of $5,000 in the common stock of corporation X; (2) an investment of $10,000 in the common stock of corporation Y; and (3) an investment of $8,000 in the common stock of corporation Z. Corporation X has been in business a considerable time, its record of earnings is good, and there is no reason to anticipate a diminution of its earnings. [Imagine BP.] Corporation Y has a promising product, has had earnings in some years and substantial losses in others, has never paid a dividend, and is widely reported in investment advisory services as seriously undercapitalized. Corporation Z has been in business a short period of time and manufactures a product that is new, is not sold by others, and must compete with a well-established alternative product that serves the same purpose. Z’s stock is classified as a high-risk investment by most investment advisory services with the possibility of substantial long-term appreciation but with little prospect of a current return. [Imagine Y or Z as our solar-powered car company.] A has studied the records of the three corporations and knows the foregoing facts. In each case the price per share of common stock purchased by B is favorable to B. Under the standards of [IRC § 4944], the investment of $10,000 in the common stock of Y and the investment of $8,000 in the common stock of Z may be classified as jeopardizing investments (emphasis added), while the investment of $5,000 in the common stock of X will not be so classified. B would then be liable for an initial tax of [$1,000 (i.e., 10 percent of $10,000)] for each year (or part thereof) in the taxable period for the investment in Y, and an initial tax of [$800 (i.e., 10 percent of $8,000)] for each year (or part thereof) in the taxable period for the investment in Z. Further, since A had actual knowledge that the investments in the common stock of Y and Z were jeopardizing investments, A [the foundation manager] would then be liable [personally] for the same amount of initial taxes as B.

WHAT??? So the investment in Y is “promising” and at a “favorable” price, but still subject to a penalty tax? The investment in Z has “the possibility of substantial long-term appreciation” and is at a “favorable” price, but likewise is prohibited? Er, okay, let me get out my crystal ball and discern between a “promising” or “substantial long-term” investment and a “jeopardizing” one. Suppose that in the above example X corporation represented Enron instead of BP? In hindsight, an investment in Enron would have been the ultimate jeopardizing investment, but it would have been perfectly fine under IRC § 4944. Oh, and that’s not all! Incredibly, if Y’s “promising” product (e.g., an inexpensive, solar-powered car) would benefit the environment, then even if the investing private foundation’s mission was protecting the environment it could be penalized under IRC § 4944 for buying stock in the company.

The federal income tax rules thus support a bizarre paradox for private foundations: a foundation can give its money away to an organization supporting the foundation’s mission, but if it makes a risky but “promising” investment in support of its mission, the foundation faces the threat of penalty taxes.

If a private foundation is not engaged in self-dealing or otherwise benefitting its managers and other insiders, why do we care how its money is invested? The rules presume that a “risky” investment is a waste. But for whom is a “risky” investment a waste? Where does the “risky” money go? Does it just vaporize into thin air? No, it goes to pay third-parties for services, or products, or ideas, or research, or whatever. From my perspective, nothing would be better than the Gates Foundation spending its billions on risky, unproven, but promising investments potentially benefitting the environment, education, and healthcare. Can you imagine the jobs that would be created? Can you imagine the innovations that might result? At worst, the money spent goes to work in the broader economy rather than being stockpiled. Who says such risky expenditures are “jeopardizing investments”? The only real jeopardy is to social enterprise companies that could use the money to take reasonable and rationale risks for the benefit of us all.

We need to fix this.  Let’s repeal IRC § 4944.

PENNSYLVANIA BECOMES THE TWELFTH STATE TO PASS BENEFIT CORPORATION LAW

On October 24, 2012, Pennsylvania became the twelfth state to pass benefit corporation legislation.

I will update my Benefit Corporations: State Statute Comparison Chart when the law goes into effect (after 90 days).

Lancaster Online has additional details: here.

Below are four thoughts that came to mind after reading the Lancaster Online article:

(1) The statement that the traditional purpose of the corporation is “making a profit for its shareholders” is hotly contested.  See, e.g., Professor Lynn Stout’s recent book, The Shareholder Value Myth.  In May, I made a similar statement, but with a two very important caveats (primary purpose and Delaware corporate law), and, even with those caveats, a number of well-regarded academics disagreed (see the comments).

(2) To date, not many benefit corporations have been formed.  The fact that 19  benefit corporations (reported by other sources as only 12) were formed in California on the first day is nice, but not impressive.  The first benefit corporation statute (Maryland) went effective in 2010, and it appears that a total of fewer than 200 benefit corporations have been formed across the nine states with active statutes (IL, MA, and PA are not yet effective).  To put the total number of benefit corporations into perspective, over 900,000 business entities are formed in Delaware alone.  The benefit corporation form may take off, but it has not yet.

(3) I am extremely interested to see what Pennsylvania’s neighbor, Delaware (the leader in U.S. corporate law), will do to address the social enterprise movement. The total number of benefit corporations currently formed will not get Delaware’s attention, but the media attention and the passion of social entrepreneurs might.  Whatever Delaware’s response, I am sure it will be well thought out.

(4) While I still maintain a healthy skepticism, I am intrigued by these new forms, respect those who are on the ground trying to effectuate change, and am enjoying my research in the area.

HOW TO STRUCTURE SOCIAL ENTERPRISE FOR IMPACT

 

This is a full two-hour lecture at Harvard’s iLab on how to structure your social enterprise for impact. The lecture addresses the three types of social enterprise business models, then compares and contrasts seven legal structures including:

  • Corporation
  • B Corp Certification
  • Benefit Corporation
  • Flexible Purpose Corporation
  • LLC
  • L3C
  • Nonprofit

NJ SIGNS BENEFIT CORPORATION LEGISLATION INTO LAW

With a stroke of the pen Gov. Chris Christie made NJ the third state to enact Benefit Corporation legislation. S-2170, the benefit corporation legislation, passed the both houses of the New Jersey state legislature unanimously. Not a single vote was cast against this legislation.

This version of the Benefit Corporation is unique from Maryland’s version in 3 distinct ways:

1. Appointing of a Benefit Director. The Benefit Director is an independent member of the board of directors that is responsible for monitoring and reporting on the success and/or failure of that Benefit Corporation in meeting it’s General Public Benefit and Specific Public Benefits. He is responsible for issuing an annual Benefit Report .

2. The Benefit Report. This annual report must be available to the public, sent to the shareholders and filed with the NJ Secretary of State for a filing fee of $70. The filing with the Secretary of State adds additional cost and administrative burden, but more importantly, this is the first time we have seen states, interested in the publication of the Benefit Report.

3. Benefit Enforcement Proceeding. If the directors of a Benefit Corporation are not acting to further the General Public Benefit or the Specific Public Benefit, a claim can be brought against them in a Benefit Enforcement Proceeding only by:

(1)   Directly by the benefit corporation; or

(2)   Derivatively by:

(a)   a shareholder;

(b)   a director;

(c)   a person or group of persons that owns beneficially or of record 10% or more of the equity interests in an entity of which the benefit corporation is a subsidiary; or

(d)   such other persons as may be specified in the certificate of incorporation or by-laws of the benefit corporation.

Photo by: Marty.FM

FLEXIBLE PURPOSE BILL INTRODUCED IN CA

Add California to the list of states that is contemplating a new corporate structure that for social entrepreneurs that are seeking to create mission driven for profit companies. On Tuesday, February 8th, The Corporate Flexibility Act of 2011 was introduced into the California Legislature.

The proposed legislation is the first of its kind and is distinct from the Benefit Corporation laws currently on the books in Vermont and Maryland and pending in seven other state legislatures. Stay tuned for a post focusing on the differences in the the two approaches. It should be interesting to see which approach ends up being adopted by the most states in the end.

photo: PatrickSmithPhotography

COLORADO BENEFIT CORPORATION LEGISLATION INTRODUCED

Today Senate Bill 11-005, a bill for the creation of a Benefit Corporation, was introduced into the Colorado state senate. This legislation is similar to the Maryland Benefit Corporation, but there are a few major differences. We will post a more in depth comparison soon, but for now, we want to highlight two key differences.

Election of a Benefit Director

The Colorado legislation requires the election of an independent director to the board who is responsible for monitoring the actions of the Benefit Corporation in regards to it General Public Benefit and Specific Benefit. The Benefit Director is also required to draft the Annual Benefit Report.

Expanded Reporting Responsibilities

The Colorado legislation requires more detail in its Annual Benefit Report as well as requiring the Benefit Corporation to file the Annual Benefit Report with the Secretary of State.

photo: QualityFrog

MD GOVERNOR SIGNS BENEFIT CORPORATIONS INTO LAW

ANNAPOLIS, Md., Apr. 14 /CSRwire/ – Maryland Governor Martin O’Malley signed into law the nation’s first legislation creating Benefit Corporations, a new class of corporations required to create benefit for society as well as shareholders.

Unlike traditional corporations, Benefit Corporations must by law create a material positive impact on society; consider how decisions affect employees, community and the environment; and publicly report their social and environmental performance using established third-party standards.

The legislation, sponsored by Senators Jamie Raskin and Brian Frosh and Delegate Brian Feldman, passed the Maryland Senate with a vote of 44 – 0 and the Assembly 135 – 5.

“Milton Friedman would have loved this,” said Andrew Kassoy, co-founder of B Lab, the non-profit that drafted the model legislation with William H. Clark, Jr., partner in the Corporate & Securities Practice Group of Drinker Biddle and Reath. “For the first time, we have a market-based solution supporting investors and entrepreneurs who want to make money and make a difference,” Kassoy added.

The new law addresses a long time concern among entrepreneurs who need to raise growth capital but fear losing control of the social or environmental mission of their business. These entrepreneurs and other shareholders of Benefit Corporations now have additional rights to hold directors accountable for failure to create a material positive impact on society or to consider the impact of decisions on employees, community, and the environment.

From a company’s point of view, the new law empowers directors of Benefit Corporations to consider employees, community and the environment in addition to shareholder value when they make operating and liquidity decisions. And, it offers them legal protection for those considerations.

“Today marks an inflection point in the evolution of capitalism,” said B Lab co-founder Jay Coen Gilbert. “With public trust in business at an all-time low, this represents the first systemic response to the underlying problems that created the financial crisis — protecting companies from the pressures of short-termism while creating benefit for shareholders and society over the long-haul.”

“This is a great moment in the evolution of commercial life in Maryland and America,” said Senator Raskin. “We are giving companies a way to do good and do well at the same time. The benefit corporations will tie public and private purposes together.”

Maryland is the first state to pass Benefit Corporation legislation, but others are quickly following Maryland’s lead. Vermont Bill S.263, co-sponsored by Senators Hinda Miller and Peter Shumlin, has already passed the Senate and will be considered by the Vermont Assembly over the next 30 days. Other states considering the legislation include Colorado, New York, North Carolina, Oregon, Pennsylvania, and Washington.

Benefit Corporation — Major Provisions

Purpose

  • shall create general public benefit
  • shall have right to name specific public benefit purposes (e.g. 50% profits to charity, carbon neutral, 100% local sourcing, beneficial product to customers in poverty)
  • the creation of public benefit is in the best interests of the Benefit Corporation

Accountability

  • directors’ duties are to make decisions in the best interests of the corporation
  • directors and officers shall consider effect of decisions on shareholders and employees, suppliers, customers, community, environment (together the “Stakeholders”)
    • not required to give priority to any particular stakeholder
    • have discretion to give priority to particular stakeholders consistent with general and any specific public benefit purposes
    • standard of accountability is identical for operating and liquidity/change of control decisions

Transparency

  • shall publish annual Benefit Report in accordance with recognized third party standards for defining, reporting, and assessing social and environmental performance, including assessment of successes and failures in achieving general and specific public benefit purpose and in considering effects of decisions on stakeholders
  • Benefit Report delivered to: 1) all shareholders; and 2) public website with exclusion of proprietary data

 

Right of Action

  • only shareholders and directors have right of action
  • no third party right of action
  • Right of Action can be for 1) violation of or failure to pursue general or specific public benefit; 2) violation of duty or standard of conduct

Change of Control/Purpose/Structure

  • shall require 2/3 majority vote

From CSR Wire: http://www.csrwire.com/press/press_release/29332-Maryland-First-State-in-Union-to-Pass-Benefit-Corporation-Legislation