Since 2010, several state legislatures have enacted laws recognizing the “benefit corporation,” a variant of the traditional legal form of the American public corporation. Advocates of the benefit corporate form argue that it protects “social entrepreneurs” from shareholder suits by legally permitting firm managers to consider “social benefits” beyond maximizing shareholder value when making business decisions. Forbes magazine, whose editors assembled its first “Impact 30” list of the world’s top social entrepreneurs in 2011, offers a succinct definition of a for-profit social entrepreneur: “a person who uses business to solve social issues.”

A state’s benefit corporation statute is located within existing corporation law. However, the benefit corporation typically is given three explicit exceptions to that law:

  • The firm has a corporate purpose to create a material positive impact on society or the environment.
  • The firm’s directors have expanded fiduciary duties that require consideration of nonfinancial interests.
  • The corporation has an obligation to report on its overall social or environmental performance as assessed against a comprehensive, credible, independent, and transparent third-party standard.

As of February 2014, the Benefit Corporation Information Center (BCIC)—part of B Lab, a nonprofit organization whose purpose is to use “the power of business to solve social and environmental problems”—lists on its website 20 states and the District of Columbia as having adopted benefit corporation legislation. The BCIC adds that another 16 states are considering adoption.

Benefit corporation statutes vary from state to state, depending on the individual characteristics of each state’s business entity statutory scheme and input from legislators, state bar associations, practitioners, the business community, and other relevant stakeholders. However, the essential provisions are constant across jurisdictions.

Benefit corporations are required to have a purpose of creating “general public benefit” and are permitted to identify one or more “specific public benefit” purposes. Model legislation available from the BCIC lists seven nonexhaustive possibilities for specific public benefits: provide low-income or underserved individuals or communities with beneficial products or services; promote economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business; preserve the environment; improve human health; promote the arts, sciences, or advancement of knowledge; increase the flow of capital to entities with a public benefit purpose; or accomplish any other particular benefit for society or the environment.

Motivation / According to William H. Clark and Larry Vranka, principal authors of an American Bar Association white paper evaluating the legal need for benefit corporation statutes, many social entrepreneurs of publicly traded companies who decide to expand their business operations face resistance from both executives and board members. The managers favor the fiduciary responsibility of shareholder primacy theory when considering investments, acquisitions, mergers, or liquidity options. The social entrepreneurs thus have an omnipresent fear of investor-driven pressure to alter business practices or strategy away from the social mission of the company. Allegedly, both the prevailing profit-maximization business culture and the advice of corporate counsel regarding the risk of shareholder litigation have created a “chilling” business environment for social entrepreneurs who wish to pursue a social mission as an integral component of a profit-driven enterprise. Besides the stories of investor-driven takeovers by boards dissatisfied with company financial performance, one vivid example of such fears is the forced sale of the mission-driven ice cream maker Ben & Jerry’s a few years ago.

Interestingly, Cornell law professor Lynn Stout argued in a recent finance journal article:

The business judgment rule ensures that, contrary to popular belief, the managers of public companies have no enforceable legal duty to maximize shareholder value. Certainly they can choose to maximize profits, but they can also choose to pursue any other objective that is not unlawful, including taking care of employees and suppliers, pleasing customers, benefiting the community and the broader society, and preserving and protecting the corporate entity itself. Shareholders primacy is a management choice—not a legal requirement.

Moreover, as Mark Underberg, a retired partner at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison, noted a couple of years ago, “I am not aware of a single case holding directors liable for a routine business decision because they considered non-shareholder interests or that impose a general duty to maximize profits and short-term shareholder value.” While the most recent legal exposition of shareholder primacy theory found in the complex 2010 case eBay v. Newmark from the Chancery Court of Delaware may have provided further legal support for the shareholder maximization perspective, the lack of evidence in the case law does not support the argument for benefit corporation statutes to be enacted. The statutes are apparently being enacted prophylactically, as a result of the perceived legal and marketing fears of mission-driven, for-profit social entrepreneurs.

Primary statutory provisions / According to the model legislation that is often used to draft benefit corporation acts, corporate directors may consider the interests of shareholders, employees, customers, suppliers, the community, and the local and global environment, as well as short- and long-term interests useful to accomplishing the firm’s general benefit purpose and any specific public benefit purpose. Furthermore, the benefit corporation statutes allow directors to consider other pertinent factors or the interests of any other group that they deem appropriate. The model act legislation states that the consideration of all stakeholders will not constitute a violation of the general duties and responsibilities of directors, thus explicitly restricting corporate liability and the liability of directors and officers for monetary damages from shareholder suits. Benefit corporation directors are protected from litigation by beneficiaries of the corporation’s public purpose. A shareholder, however, is expressly given the right to bring legal action against a director or officer who fails to pursue or create the stated general or specific public benefit purposes, fails to consider the interests of the various stakeholders listed in the statute, or fails to meet the transparency requirements in the statute.

A benefit corporation is required to issue an annual benefit report to shareholders. The report is to be posted on the firm’s website and filed with the incorporating state. The report must contain a narrative describing how it pursued its general—and any specific—public benefit and include an assessment of its overall social and environmental performance against a third-party standard.

Adoption barriers / In spite of its recent popular appeal among state legislatures, the benefit corporation is potentially confronted by looming statutory barriers to widespread adoption by businesses contemplating this form of incorporation. One barrier is the statutory requirements to report on how the corporation has performed in meeting its overall social and environmental performance against a third-party standard. Such a reporting requirement will inevitably restrict both the board and management in executive decisionmaking when considering opportunities and responding to threats, because company resources need to be allocated among a variety of stakeholders and their attendant issues. Social entrepreneurs, like other entrepreneurs, need flexibility and adaptability in their managerial decisionmaking to meet traditional business goals and objectives, rather than being statutorily bound to meeting fixed financial or other business performance goals established in their benefit incorporation documents—say, for example, donating 20 percent of pretax annual earnings to nonprofit charities. Furthermore, the benefit corporation shareholders have the legal standing to bring a civil suit against board members and executives who do not meet the stated “public benefits” contained in the state’s enabling statute. Also, state government regulators are charged with identifying a third-party standard for annual audit purposes. At this time, there appears to be no consensus as to which third-party standards are acceptable, nor which organizations are qualified to provide independent, third-party standard certification.

A second barrier concerns stakeholder credibility. If a legally designated benefit corporation is not meeting statutory requirements for maintaining benefit corporation status, will state governments rescind its legal status? If thousands of firms choose this designation, will state governments have regulatory systems in place to effectively enforce the maintenance of this legal status? What about due process for appealing the rescission of benefit corporation status? Will additional annual fees (above statutory audit requirements) need to be assessed by state governments against companies that choose this legal form? Because these companies are incorporated at the state level and there are differences in each state’s incorporation laws, being a “benefit corporation” does not have the same meaning for all such legally designated corporations. Thus, from the standpoint of the consumer and other stakeholders, will there need to be a supplemental third-party certification designation to compare companies’ performance on an “apples-to-apples” basis (i.e., as to the breadth and depth of their social and environmental commitment)? Those important accountability questions remain unresolved.

A third barrier is the potential for a “race to the bottom” by the states that do not have benefit corporation statutes. Critics of existing benefit statutes are already concerned that there is far too much leeway given to boards and management as to which business decisions must consider social and environmental effects. Concerning board responsibility for achieving social and environmental performance goals and objectives, some benefit statutes—such as those in Colorado and Massachusetts—do not require an independent benefit director to internally monitor company business practices. To attract state revenue from incorporations and appease legislative critics of the benefit statute concept who may delay or block such statutes from being successfully enacted, it is possible that fewer or more lenient accountability requirements will be incorporated into future state legislation. Nationwide, this can lead to even further confusion among consumers and other stakeholders about what constitutes a “benefit corporation.” The scenario could also increasingly discourage startup firms from choosing the benefit corporation legal form, as the effort to distinguish themselves from benefit corporations in other states becomes increasingly problematic, not to mention costly.

Regulatory arbitrage misuse? / A few years ago, University of San Diego law professor Victor Fleischer defined regulatory arbitrage as an activity that “exploits the gap between the economic substance of a transaction and its legal or regulatory treatment, taking advantage of the legal system’s intrinsically limited ability to attach formal labels that track the economics of transactions with sufficient provision.” In the case of regulatory arbitrage related to company incorporation strategy, there has been no empirical evidence showing “misuse” of the incorporation choices offered to companies in the 20 states where benefit corporation statutes have been enacted. Could such misuse be occurring? Yes, but as mentioned above, the lower regulatory or legal costs of operation for a company are likely to rest with the traditional form of for-profit incorporation and not the benefit form of incorporation.

A point to consider when addressing regulatory arbitrage misuse is that a social entrepreneur (or existing nonprofit corporation) that chooses to form (or convert to) a benefit corporation is expected to have altruistic motives. If it does, the benefit corporation will not be looking to avoid a regulatory scheme or use it to an advantage other than that directed by statute. On the other hand, a corporation could elect the benefit form strictly for public relations purposes, with no intent to offer anything more than “lip service” to the stakeholders it chooses to benefit. Those stakeholders typically have no standing to sue under the benefit corporation statutes. They would have to rely on shareholders to defend their cause, or purchase enough shares to become significant shareholders themselves.

While the trend toward states adopting the benefit corporation appeared to have picked up momentum through 2013, there also appears to be some recent reluctance on the part of many state legislatures to expedite the process of enacting such statutes. As seen in the foregoing discussion, there are significant business and public policy issues that need to be resolved before the full potential for benefit corporation statutes can be accurately gauged by social entrepreneurs who may be interested in adopting this corporate form.

Readings

  • “Benefit Corporations vs. ‘Regular’ Corporations: A Harmful Dichotomy,” by Mark A. Underberg. Harvard Law School Forum on Corporate Governance and Financial Regulation blog, May 13, 2012.
  • “Regulatory Arbitrage,” by Victor Fleischer. Working paper, University of San Diego, March 4, 2010.
  • “The Need and Rationale for the Benefit Corporation: Why It Is the Legal Form that Best Addresses the Needs of Social Entrepreneurs, Investors, and Ultimately, the Public,” by William H. Clark and Larry Vranka. White paper, American Bar Association, January 18, 2013.
  • “The Shareholder Value Myth,” by Lynn A. Stout. European Financial Review, April 18, 2013.