Entrepreneurs and Investors Get Legislative Support

Daily Journal

Two new bills recently introduced in the California Legislature would allow socially conscious entrepreneurs to form either a "flexible purpose corporation" or a "benefit corporation."  These two new forms of corporate entities would serve to not only maximize financial returns to shareholders, but also advance a broader social and environmental purpose (known as a "special purpose").  The flexible purpose corporations and the benefit corporations will continue to be subject to all other provisions of the General Corporations Law, except as specifically noted in the new law.

Socially conscious entrepreneurs looking to form new business ventures that further a "special purpose" currently have limited options in structuring their corporate entities.  Traditional corporations have proven to be problematic structures because corporate executives and board members must make decisions based on maximizing financial returns for shareholders rather than those on the basis of a "special purpose."  Although directors of a corporation are normally protected by the "business judgment rule," shareholders can still sue corporations and its directors for negatively impacting shareholders' returns.  The legal issue of fiduciary responsibility has long been a barrier to companies taking more proactive social and environmental measures.  In many cases, it has given both privately held and publicly traded companies an excuse to avoid taking action.

Other forms such as limited liability companies, which are not specifically required to be a profit-seeking enterprise, are better suited for smaller ventures given their tax-pass through and partnership like qualities.  Finally, capital markets have generally rejected nonprofit corporations, which are a hybrid model championed by social entrepreneurs, given its operational restrictions.  And although groups of socially responsible investors, social and environmental activists, and others have tried unsuccessfully for years to influence progressive change in publicly held companies, getting these companies to change has been all but impossible.

Senate Bill 201, known as the Corporate Flexibility Act of 2011, would enable a new form of for-profit corporation, which would permit companies to pursue environmental and social measures instead of simply making money. 

Sen. Mark DeSaulnier introduced Senate Bill 1463 in the state Senate in 2010 and reintroduced SB 201 on Feb. 8, 2011.  SB 201 does not currently include any substantive changes from the original SB 1463; it would authorize and regulate the formation and operation of a new form of corporate entity known as a "flexible purpose corporation."  The bill would permit these corporations to be formed or converted from other entities to pursue a "special purpose" in addition to maximizing shareholder wealth. 

Pursuant to its articles of incorporation, existing and potential shareholders will be put on notice that the corporation's directors will consider the "special purpose" of the corporation when taking corporate actions, which may or may not align with the goal of maximizing financial returns to shareholders.  Directors will be protected by a standard similar to the existing business judgment rule, but which will additionally allow a director to consider and give weight to other relevant factors including short-term and long-term prospects of the flexible purpose corporation, the best interests of the corporation and its shareholders, and the purposes of the corporation.

Introduced on March 4 by Assembly Member Jared Huffman of the 6th Assembly District, Assembly Bill 361 would create a "benefit corporation." This new type of corporation is restricted to pursuing a specified "general public benefit," which is "a material positive impact on society and the environment, taken as a whole, as measured by a third-party standard, from the business and operations of a benefit corporation."  This "third-party standard" must be developed by an organization that is independent of the benefit corporation and meets a litany of specified requirements. 

In addition, the articles of incorporation may identify one or more "specific public benefits," which the benefit corporation may pursue.  These specific public benefits include 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, improving human health, promoting the arts, sciences or advancement of knowledge, increasing the flow of capital to entities with a public benefit purpose, and the accomplishment of any other particular benefit for society or the environment.

There is a list of interests that directors of a benefit corporation are required to take into consideration when discharging their duties, as well as a list of interests that directors are permitted to take into consideration.  For example, directors must consider the impacts of any action upon the following: shareholders, employees, the workforce, customer interests, community and social considerations, the local and global environment, the short-term and long-term interests of the benefit corporation, and the ability of the benefit corporation to accomplish its general and specific benefit purposes.  However, directors are not required to give priority to the interests of any particular person or group set forth in this list unless the benefit corporation has stated its intention to give priority.

Furthermore, no person may bring an action or assert any claim against a benefit corporation or its directors or officers with respect to the duties of directors and officers or with respect to the general or any specific public benefit purpose except in a "benefit enforcement proceeding," defined as a claim or action brought directly by a benefit corporation or derivatively on its behalf against a director or officer for failure to pursue the general or specific public benefit purpose or for violation of a duty or standard of conduct imposed by the benefit corporation statutes.

By the introduction of SB 201 and AB 361, California joins a growing list of states to consider allowing the formation of corporate entities that place social and environmental considerations over maximizing financial returns for its shareholders.  Should either bill pass, companies will be able to pursue environmental and social goals as aggressively as they do financial ones. 

SB 201 has cleared both the Senate Banking and Financial Institutions Committee and the Senate Judiciary Committee.  The Senate Appropriations Committee will hear the bill in early May.  AB 361 is scheduled for hearing in the Assembly Judiciary Committee on May 3.

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